How Share Buybacks Benefit Investors

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By Kiplinger Staff From Kiplinger’s Personal Finance

Question: What are share buybacks? And as an investor, should I be glad about share buybacks or not?

Answer: Companies have at their disposal two main options when they want to return cash to shareholders.

Dividends tend to be preferred by income investors. A dividend is a cash payout to shareholders, typically issued on a half-yearly basis. The other method is to use a share buyback. This means just what it says—the company buys back its own shares.

It’s easy to see why shareholders like dividend payouts. But how do buybacks benefit shareholders? Well, when a company buys and cancels some of its own shares, the remaining shareholders are left holding a greater proportion of the company.

Let’s say a firm has one million shares in issue, and the share price is $10 per share. It made $1 million profit last year. So it has earnings per share of $1.

Now let’s say it wants to return the whole one million dollars in profit to its shareholders via a share buyback. It buys back 100,000 shares at $10 a share and cancels them. This leaves 900,000 shares in issue.

That means earnings per share has increased from $1 to just over $1.11 because there are now fewer shares. In turn, assuming that investors keep valuing its earnings on a constant basis, the share price would rise to just over $11.

Fans of buybacks argue that they are more tax-efficient than dividends. For managers, buybacks are also more flexible than dividend payments. Shareholders tend to react more negatively to a dividend cut than to a reduction in buyback levels.

Critics argue that executives have an incentive to use buybacks to meet performance targets linked to share-price growth. So they may curb investment or borrow too much to fund buybacks.

Timing can also be a problem. Some studies suggest that larger companies, in particular, have a bad habit of buying back shares near the top of the market, when they’re expensive, rather than nearer the bottom, when they’re cheap.

Question: I didn’t have enough taxes withheld from my paycheck last year and then got hit by a big tax bill. Is it too late now to do anything about it so this doesn’t happen again?

Answer: Use the IRS’ Tax Withholding Estimator as soon as you can to determine whether you should file a new Form W-4 with your employer and increase the amount of taxes withheld from your paycheck before the end of the year.

You’ll need your most recent pay stub and a copy of your 2021 tax return to help estimate your 2022 income. If it looks like you’re going to owe money when you file your next tax return, the IRS tool will tell you how much “extra withholding” you should put down on Line 4(c) of Form W-4 to catch you up on withholding for the year. Then, early next year, complete another W-4 for withholding in 2023.

(For more on this and similar money topics, visit Kiplinger.com.)

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