How share buybacks generate brilliant returns
Temple Bar (TMPL ) fund manager Nick Purves explains how the UK companies in his portoflio trading at an average of just eight times earnings generate terrific value for shareholders when they buy back their shares.
With an earnings yield of over 12%, these cash generative businesses can afford to pay a good dividend and repurchase shares which, by shrinking the pool of equity over which the remaining profits are spread, further enhances the yield, or return, to shareholders.
This is the third video excerpt from our virtual event with Temple Bar, which won ‘Best UK Equity Income Investment Trust’ last week at Citywire’s awards. You can watch the other excerpts on:
Or you can watch the whole one-hour ‘Big Broadcast’ of the whole event:
Can’t watch now? Read the transcript
Nick Purves:
The portfolio as a whole is on an average price earnings ratio of around eight times. Flip that over, you get an earnings yield of around 12%, 12.5%, that sort of number. When you’re on that sort of earnings yield and you use your cashflows to buy back cheap stock and then reduce the number of shares in issue, that is terrifically value enhancing for the shareholders who choose not to sell into the share buyback.
Of course, we have not been selling into those buybacks because we think the shares are undervalued. The way that works is, if you think simply about it, if ... you’re generating cashflows which are 12% of your share price, you might use six of the 12% to buy back shares. You reduce the number of shares in issue by 6% and what that means is that every pound of profit you make next year in earnings per share terms is 6% more valuable. The other 6% might be given back as a dividend.
What the shareholder has got, therefore, in that year. They’ve got 6% dividend yield, and they’ve got 6% earnings per share growth because the number of shares in issue is reducing. Hopefully that makes sense. Therefore, that’s a 12% annual total return for the client. That may be a bit detailed, but it really, really is important. So, when companies are buying back cheap shares and retiring the equity, which in most cases they are, it is driving real value for the shareholders.
