The buyback of own shares

As we already saw in this blog, the dividend It is the most common way to remunerate the shareholders of a company, but it is not the only one. In this article we will analyze the repurchase of own shares as a method of remuneration for investors, we will see its beneficial taxation and the potential problems of this business practice.

What is the buyback of treasury shares?

The repurchase of own shares (called “stock buyback” or “stock repurchase” in English) is a way of remunerating the shareholder that consists, as its name suggests, in which the company buys its own shares on the market and then redeems them. It seems like an unintuitive way to remunerate shareholders, so it is important to explain it better.

Why is the buyback of own shares a way of remunerating the shareholder?

The best way to see how share buyback is a form of shareholder compensation is through an example:

Suppose a company has 100 shares and earns 100 euros per year on a constant basis, that is, it earns 1 euro per share (100/100). Now suppose that the company uses those 100 euros to buy half of its shares and amortizes them, keeping only 50 shares. From that moment on, although the net profit remains constant at 100 euros, shareholders will earn 2 euros per share (100/50), these shares becoming worth twice as much.

A fiscally efficient alternative

The main advantage of the remuneration to shareholders through the buyback of shares is that we are facing a fiscally efficient method. As we have already seen, dividends are taxed at 21% in Spain. That is to say, of every 1.000 euros that we collect in dividends, the state keeps at least 210 and we with 790 at most. On the other hand, the money that the company uses to buy back shares has no tax burden, making it more efficient for shareholders.

Share buyback, a double-edged sword

The repurchase of shares, despite being a more fiscally efficient form of remuneration for shareholders than the distribution of dividends, is not always recommended. Share buybacks are advisable only if the company's shares are undervalued. But is this what usually happens?

In the following graph you can see the evolution of the repurchase of own shares by US companies.

intrinsic value.

Warren Buffett's share buybacks in Berkshire Hathaway

Once again, Warren Buffett serves as an example for us on this blog, this time to teach us when to buy back shares. Buffett only does so when the price of Berkshire Hathaway shares falls below 1,1 times their book value, a criterion he considers appropriate to value his company. In this way, it will only buy back own shares when it adds value to its shareholders, managing the company's money efficiently.