What Is a Buyback Ratio?
The buyback ratio is the amount of cash paid by a company for buying back its common shares over a time period, usually the past year, divided by its market capitalization at the beginning of the buyback period. The buyback ratio enables analysts to compare the potential impact of repurchases across different companies.
The ratio is also a solid indicator of a company’s ability to return value to its shareholders since companies that engage in regular buybacks have historically outperformed the broader market. Buybacks shrink a company’s outstanding share float, which improves earnings and cash flow per share. Furthermore, buybacks have the advantage over dividends in that they offer management greater flexibility with their timetables.
- The buyback ratio is a value that indicates the amount of cash paid by a company for buying back its common shares over the past year, divided by its market capitalization at the beginning of the buyback period.
- Buybacks shrink a company’s outstanding share float, which improves earnings and cash flow per share.
- Investors can invest in companies that engage in regular buybacks through indexes like the S&P 500 Buyback Index and exchange-traded funds.
Understanding Buyback Ratios
As an example of a buyback ratio, consider the following scenario. Company ABC spends $100 million on buying back its common shares over the past 12 months. They have a market capitalization of $2.5 billion at the beginning of this period, in which case its buyback ratio would be 4%.
On the other hand, if Company XYZ spent $500 million on buying back its shares over the same period and had a market cap of $20 billion, its buyback ratio would consequently be 2.5%. Company ABC thus has the higher buyback ratio—despite spending only a fifth of the amount expended on share repurchases by Company XYZ because of its much lower market cap.
Buybacks tend to peak when the markets are thriving, and they tend to slow down during bear markets, suggesting that investment managers do not excel at timing the market.
Investors can invest in companies that engage in regular buybacks through indexes such as the S&P 500 Buyback Index and exchange-traded funds (ETFs) such as the Invesco BuyBack Achievers Portfolio (PKW).
The S&P 500 Buyback Index includes the top 100 companies in the S&P 500 with the highest buyback ratios over the past 12 months, while the Invesco ETF tracks the performance of U.S. companies that have repurchased at least 5% of their outstanding shares over the past 12 months.
The share buyback program can be conducted for a prolonged period of time. This differentiates them from dividends, which legally must be paid to investors immediately. Furthermore, companies are under no obligation to offer such repurchasing programs, and those that do can modify or cancel the program at any period of time. There is flexibility in buyback programs for companies.
Even more so, shareholders are not compelled to sell back the shares. They may do so, at will, but it is not a requirement imposed upon them. The premium paid for the shares is often an incentive to do so.
As part of the Inflation Reduction Act of 2022, public domestic companies that engage in share buybacks will be subject to a 1% excise tax, which may affect how often companies engage in buyback strategies.
Frequently Asked Questions
Do I Have to Sell My Shares in a Buyback?
No, you do not have to sell your shares in a buyback. The company cannot force you to do so; however, companies offer a premium for the shares to entice shareholders to sell their shares.
Is a Share Buyback Beneficial?
Share buybacks can be beneficial to investors. Investors that sell their shares back often receive a premium. Buybacks also tend to increase the company's share price temporarily, which can also benefit current shareholders that do not sell back their shares. Share buybacks often send a signal to investors that the company is healthy with good long-term prospects and that the shares are undervalued.
Do I Have to Pay Taxes on a Share Buyback?
If you are a shareholder that sells your shares back to the company and in return receives payment, yes, you have to pay taxes on the amount you received. You will have to pay capital gains tax.