With the UK market looking oversold and unloved, much has been made of the fact that big investors simply are not buying domestic shares.
Office for National Statistics data shows insurance and pension funds held just 4.2 per cent of UK-listed shares in 2022, down from 45.7 per cent in 1997.
Many of the major global equity funds also fail to buy massively into the market. Fundsmith Equity, the UK’s most popular fund, has seen its UK allocation fall from nearly a quarter of the portfolio at the end of 2012 to less than 6 per cent in late 2023.
And yet UK-listed companies have found a new buyer of their shares in, well, themselves. FTSE 100 firms had already unveiled plans for some £38.5bn in share buybacks for 2024 as of the mid-point of this year, AJ Bell data shows (see AJ Bell Dividend Dashboard from July 1).
That puts buyback activity on course to exceed the levels of 2023, when FTSE 100 bought back £52.1bn, and 2022’s record £58.2bn.
Some of this instinctively makes sense. Having been in the doldrums for much of the period since 2016, UK shares have enjoyed something of a resurgence, with FE data showing the FTSE All Share up by 18.4 per cent over the 12 months to late August, putting it roughly in line with the S&P 500’s 20 per cent (sterling) total return.
But that recovery is not yet reflected in valuations: a FTSE All Share tracker currently comes with a price/earnings ratio of just 12.4, compared with almost 28 for a fund tracking the S&P 500. UK companies can therefore make good returns by buying their own shares on the cheap, though some drawbacks do need to be considered.
The buyback boost
Buybacks can have various advantages. They can help a company clear unhappy investors from a shareholder register, and even clear out the likes of activist investors in some cases.
But the practice also benefits those who choose to stick with their shares for two reasons. Firstly, they end up owning a bigger chunk of the business because there are now fewer shares in circulation.
And secondly, a reduction in the number of shares should automatically boost a company’s earnings per share figure, lowering the PE ratio that is commonly used as a valuation metric and luring fresh investors in, to push the price up. More generally, if a company’s shares look especially cheap then buying these back can seem like a good use of capital.
Laith Khalaf, head of investment analysis at AJ Bell, argues the buyback bonanza should be seen as a positive for UK stocks, given it shows “that companies have cash to burn and boards think their shares are trading at an attractive price”. But as he notes, there are some valid criticisms.
Some investors, for one, may prefer a commitment to a higher dividend rather than a share buyback – though it is worth noting that the capital gains that accrue from share buybacks are currently taxed more favourably than dividends.
Indeed, AJ Bell’s latest Dividend Dashboard report found that, as of the mid-point of this year, analysts expected dividend growth of just 1 per cent for the FTSE 100 in 2024. This small increase could well reflect the fact that companies are allocating funds to buybacks rather than dividend payouts.
Meanwhile Computershare’s UK Dividend Monitor for Q2 2024 found that buyback programmes were exerting a “noticeable drag” on dividends. One extreme example of this came last year when housebuilder Vistry canned a dividend in favour of a buyback programme.
Some could see this as a problem given one of the UK market's traditional selling points is its high concentration of big dividend payers.
Opportunity cost
There are also questions about how else these cash piles could be deployed. Companies and professional investors do seem to view buybacks as a way to exploit bargains for now, but the money could also be used for other purposes, from internal investment to buying other companies.
Buybacks might make sense in industries where the routes to growth are not obvious but investors in more promising areas might want more of a focus on the future.
As Khalaf puts it: “Another criticism of share buybacks is they represent a lack of ideas when it comes to reinvesting in the business, and perhaps they are chosen because they boost earnings per share, which is a metric usually used in management remuneration packages.”
Anthony Lynch, manager of the JPM UK Equity Plus fund and the Mercantile investment trust, says that these days many businesses are capital light, meaning internal investment does not need to come at the expense of growing dividends or share buybacks.
For example, hiring and training more people is not as capital intensive or cash consumptive as building a new plant or buying new equipment.
He says: "By identifying capital-light businesses with strong capital allocation, we can therefore benefit from well-invested businesses, with strong dividend growth potential. We think good examples would include the technology value-added resellers, certain contracting businesses and professional services providers."
Lynch says he typically likes to see a growing dividend stream, reflecting growing earnings over time, but he notes a buyback can be a good way of returning a one-off windfall without setting the dividend at a level that would be difficult to maintain.
With the UK market still looking cheap on a number of fronts, it is unlikely that the buyback frenzy will run out of steam soon. But any further recovery for share prices could prompt investors to ask how else the cash might be put to work.
david.baxter@ft.com
