Against the backdrop of a slumping stock market which may be indicative of an economic downturn, a few publicly traded companies have recently taken the opportunity to announce plans to repurchase their shares on the open market. Such companies within the local sphere include Sygnus Credit Investments Limited, FirstRock Real Estate Investments Limited, and most recently Kingston Properties Limited. In the overseas markets, tech giants such as Apple Inc and Alphabet Inc are other examples of public companies that have used share repurchase plans as part of their payout policy.

Global trends in payout policy indicate that although differences exist across countries and over time, depending on investor preferences, the percentage of companies making stock repurchases has been trending upwards in places such as the US since the 1980s and in the United Kingdom and continental Europe since the 1990s. Major companies in Asia (particularly China and Japan) have made substantial repurchases since the 2010s. But what do share buy-backs mean for shareholders and how do they stand to benefit or lose from this type of payout policy?

Payout policy encompasses more than cash dividends, as it includes other means such as stock splits and stock dividends. These methods represent a few of the numerous ways in which a public company might choose to return value to its shareholders. In Jamaica, equity investors are most accustomed to cash dividend payouts, which are disbursements of funds or money paid to stockholders, generally sourced from a firm’s current earnings or accumulated profits.

In contrast to dividends, a share buy-back is a corporate action through which the company purchases its own shares from existing shareholders, thereby reducing the total number of shares outstanding in the market and putting upward pressure on the share price. Reducing the supply of a stock may also mitigate against future declines in the price. The buy-back price that is offered to shareholders is generally at a premium to the current market price, which incentivises shareholders to participate in the process.

In this way, buy-backs provide companies with an alternate route for transferring surplus cash on the balance sheet to its shareholders. However, when compared to cash dividends, this form of cash remuneration may have an additional benefit in the form of potential tax advantages. This happens in jurisdictions where the tax rate on capital gains is lower than the tax rate on dividend income and favours the concept of buy-backs over cash dividends because investors get to choose when their returns are taxed through the execution of a stock sale. In Jamaica, this is especially beneficial since the average investor doesn’t pay any capital gains taxes when a profit is realised on the sale of shares for which the price has appreciated since the date of purchase.

Apart from an increase in the share price, which undoubtedly brings more value to shareholders whether they sell or continue to hold onto company shares, another rationale for a buy-back (versus dividends) is the signal that it might convey to the market. When a company purchases its own stock, it can signal to investors that management views its own stock as a good investment. Signalling is important in the presence of asymmetric information (where corporate insiders have access to better information about the company’s prospects than outside investors). Through buy-backs, management can send a signal to investors that the outlook for the company is positive. Therefore, buy-backs are especially useful when management feels that the company’s share price is undervalued.

On the flip side, investors should also be aware of the drawbacks associated with share buy-backs, as well as the negative signals they might potentially convey. Firstly, the buyback process is time-consuming and requires disclosures to stock exchanges and approvals from regulatory bodies. Reducing the supply of a company’s shares may also serve to undermine a stock’s liquidity as it may begin to trade less frequently. A stock buyback may also signal that the company doesn’t have any profitable opportunities to invest in, which may send the wrong signal to long-term growth investors looking for capital appreciation.

As with any investment, context therefore becomes important when investors evaluate whether a corporate action such as a share buyback announcement is truly beneficial in both the short and long term. Consider it this way: if you invest in stocks and you’re unsure whether a stock buy-back is positive or negative, a repurchase could be advantageous for shareholders if the company is doing well, has extra cash on hand, and its shares are undervalued. However, a company’s decision to repurchase shares of stock while ignoring other aspects of its operations or delaying investments in its future growth can deprive shareholders of value in the long run.

With all this in mind, I end by expressing that in keeping with global trends, it is important that local investors be aware of the possibility that public companies in Jamaica (especially those whose shares trade on the Main Market) may shift towards more frequently announcing share buy-backs in the not-so-distant future. Indeed, there is a strong case to be made for this in light of the recent slump in the stock market.

With share prices at depressed levels, companies now have ample opportunities to repurchase their shares at discounted prices. I encourage investors to take advantage of these discounted prices as well, as they endeavour towards creating generational wealth and financial independence for themselves and their families.

Marlon Rhoden is a research analyst at VM Wealth Management Limited with a passion for seeing clients build their wealth. His particular focus is the bond market and counterparty credit risk.