The Insider’s Guide to Share Buybacks: What You Need to Know

Bryce: [00:00:31] Welcome to get started investing a podcast where we help you learn to invest in 15 minutes or less. Each episode we take a real world business story and apply a key investing lesson to help you build your investor toolkit. If you are joining us for the very first time, welcome. We strongly recommend that you scroll up and start at episode one. And just a reminder before we kick in that we're not experts, we're not financial professionals, and we are not licenced. We're here learning just like you, and nothing on this podcast should be taken as advice. With that said, let's crack on. My name is Bryce and as always, I'm joined by my equity buddy, Ren. How are you going? 

Alec: [00:01:05] I'm very good, Bryce. Good to be here. We have officially moved studios. We're out of our shared office and into our own space. Yeah, if people are watching on YouTube or this has been clicked for socials, it's looking pretty nondescript at the moment and it's also freezing as it is. But over the next few weeks, we're going to build this out. And yeah, we're excited. We've moved.

Bryce: [00:01:30] We have we've moved up in the world away from. 

Alec: [00:01:32] Where we work. But wherever we are, the content train keeps rolling. 

Bryce: [00:01:35] Content train keeps rolling. And we're here with another news story. If you're interested in saying the office, obviously you can check out this episode on YouTube or follow us on social media. Plenty of action coming from our rooftop, which is pretty amazing. 

Alec: [00:01:49] I also saved the whole move as an Instagram story highlight.

Bryce: [00:01:54] Nice.  

Alec: [00:01:55] So you can watch that. Awesome. I'm learning social skills. 

Bryce: [00:01:57] And where we are, we're endeavouring to get this lesson out in 15 minutes or less. So let's get straight into it. The story this week is that over in the United States, they're about to pass a massive climate bill, tax bill and health care. 

Alec: [00:02:13] Bill, all in one climate tax and health care bill. One bill. 

Bryce: [00:02:17] One bill, one bill. It's it's had some implications on what we call buybacks at the very last minute. They've put in a provision that it has included share buybacks. So what are we saying here?

Alec: [00:02:29] The news story is there's now going to be a 1% tax on share buybacks. And we thought this was a good opportunity to, I guess, talk about what buybacks are. And we titled it the sneaky way companies return your money because dividends, you know, you know what a dividend is. It's when a company takes money. They've made a profit and puts it in your bank account, puts it in your brokerage account, gives you cold, hard cash. You can choose to reinvest that dividend, but that's money that you that you see come to you. But there's a sneaky way that companies can also pay you from their profits, and that is a buyback. [00:03:04][35.1]

Speaker 5: [00:03:04] The future of stock buybacks in focus today on where Democrats appear poised to pass their Inflation Reduction Act, which includes a new 1% excise tax on that practise. The question is whether it will, in fact, have a material impact or not, what that might mean for stocks. [00:03:18][14.0]

Alec: [00:03:19] So, Bryce, let's take a step back. Yeah. You're the CEO of a company. Yes. Literally, you make a profit. Yeah, hopefully one day. Yes. So what can you do with that profit? [00:03:31][11.8]

Bryce: [00:03:32] I have four choices. We have four choices are running a company when you make a profit. The first is that we can save it just like you as a consumer, you get paid more than then you spend. You can put that in the bank, build up the cash on the balance sheet, just keep it sitting there for purposes. Later on, if you want to go out and buy a new office, whatever. [00:03:51][18.7]

Alec: [00:03:51] It might be, I think people get less savings. Yeah. [00:03:53][1.6]

Bryce: [00:03:54] You can invest it. You can hire new staff, you can expand research and development, put the money back into the business to help it grow. Yeah, you've already mentioned rent dividends. You can pay a dividend which is giving the cash back to current shareholders, rewarding them for being a shareholder. Hey, let's split the profits. That's a dividend. [00:04:09][15.6]

Alec: [00:04:10] Yeah, yeah. Rewarding them for being a shareholder or giving them what they do as a part owner of a company. Sure. [00:04:16][5.6]

Bryce: [00:04:17] True. And then the fourth reason one we're going to touch on today is buying back their stock. And this is where I can decide to buy some of the company stock, back off the shareholders and destroy them. And in doing so, there's going to be a return of value. [00:04:32][15.7]

Alec: [00:04:33] Okay. So you'd rather than pay me a dividend, you buy a stock of other shareholders and then you destroy it. Why would you buy something just to destroy it? [00:04:43][10.0]

Bryce: [00:04:43] Because what I want to do is take less shares off the market. And in doing so, there's going to be less shares available to buy and you're going to be influencing supply and demand of that stock. [00:04:53][10.1]

Alec: [00:04:54] Yeah, yeah, definitely supply and demand. But also like turn the share market off for a second. Forget the day to day movements of prices and Jim Cramer yelling on CNBC and hitting a big red button just like a remember at its core, what investing is you becoming a part owner in a company? And let's say Equity Mates is split into ten shares. Each of those shares is worth 10% of the company. If we make a profit, we go out and we go to two shareholders and say it will buy back the shares from you at the market value. We buy their shares and we destroy them. Then there's only eight shares left. Each of those eight shares are now worth 12.5% of the company. So turn the share market off, you write. It generally does push the share price up, but at its core, buying back shares means each shareholder owns more of the company. Yeah. Now, in that worked example, there were ten shares in Apple. There's what, like 300 million shares or something? But Apple's spent like $22 billion on buybacks in the last quarter. And what they when they went out in the market, they bought shares, they destroyed them. And so all remaining Apple shares have a little bit more a fraction more ownership of the company. Yeah. Yeah. [00:06:06][72.2]

Bryce: [00:06:06] So why would a company, I guess, do this? One of the reasons is it's a more tax efficient way to return money to shareholders. [00:06:15][8.7]

Alec: [00:06:16] Yes. So if there's a there's a textbook reason and a cynical reason, and depending on time, we might not get to the cynical. Right. [00:06:23][7.1]

Bryce: [00:06:23] That's good. Let's just stick to the theory. So when you're paying out a dividend, you hit some double taxation effects. As a company, I'm paying profit tax on my profits and then paying a dividend to the shareholder. And then the shareholder themselves will have to pay income tax on the dividend. So you get a double taxation whammy effects there. The advantage in the share buyback is there's only one taxation event and that's on the profit that the company pays. [00:06:51][27.6]

Alec: [00:06:51] So when I go from owning 10% of Equity Mates to 12 and a half percent of Equity Mates, the tax office doesn't say, hold on, you've made a gain and we're going to tax on that. But if Equity Mates pays me a dividend, the tax office is like, whoa, whoa, whoa, include that in your assessable income. Yes. Now, that is where franking credits come in. And there are three countries in the world that have dividend imputation, a.k.a. franking credits. Australia, New Zealand and Malta. There are a few other countries with partial dividend imputation. Canada, Korea and the United Kingdom. But it's really the big three where the law says the company's already been taxed on those profits. So we're going to give you a credit and then you won't be taxed personally on those profits. Yeah. And so for Australians listening, that's what a franking credit is. It's a credit that you get to cash in at the tax office and say, whoa, whoa, whoa, I've already been taxed on this, so you can't talk to me again. [00:07:48][57.1]

Bryce: [00:07:49] Yes. Now, check out we've done some episodes in the past on Equity Mates Investing podcast that are directly related to dividends and tax time. I know it is tax time. At the moment you would be doing your tax returns and there is conversation in the Equity Mates discussion group as well on that. So check out those episodes. I'd search Charlie Viola as we did a Q&A on tax with him. [00:08:10][21.4]

Alec: [00:08:11] So that's the textbook reason. It's a tax efficient way. If you're in the US and you know your investors get double taxed, it's a tax efficient way to return money to shareholders. Can I quickly say the cynical what shocked a lot of executives of big companies? Their bonuses are tied to the share price. And if you're buying back shares, the earnings per share metrics look better because there's less shares. And that will push the share price up and that will make it more likely to get your bonus. [00:08:42][31.2]

Bryce: [00:08:42] So cynical. But it's true. It's true. Yeah. It's been something that we've seen happen a lot over in the States in I'd say in the last decade. [00:08:51][8.6]

Alec: [00:08:51] Yeah. Do you remember we interviewed Jesse Felder on Equity Mates, the other podcast, and he wrote about the Fantastic Four of financial engineering, McDonald's, Boeing, Caterpillar and three M, who were just absolutely shooting the lights out like they were outperforming the S&P 500, those outperforming the FAANG stocks. And all they were doing was they're all like pretty slow growing, boring companies, but they were borrowing heaps of money and using that borrowed money like that debt to buy back their own stock. [00:09:24][32.9]

Bryce: [00:09:25] Dodgy. [00:09:25][0.0]

Alec: [00:09:26] Yeah, dodgy. But it was for a while. Yeah. Then it stopped working. [00:09:30][4.3]

Bryce: [00:09:31] You're right. Rent. A lot of companies have been doing it. Here are a few stats. S&P 500 index over in the states with the largest 500 companies spent about 280 billion in the past three months alone on buybacks, huge amounts of money. [00:09:44][13.7]

Alec: [00:09:45] You think that's a lot? In the last five years, the S&P 500 has spent 1.24 trillion in buybacks. Huge. [00:09:52][7.5]

Bryce: [00:09:52] And some of the biggest players, Apple 22.96 billion alphabet. [00:09:56][3.5]

Alec: [00:09:57] This is just in 2022. [00:09:57][0.6]

Bryce: [00:09:58] In 2022 alphabet the company owning Google 13.3 billion meta formerly known as Facebook 10.4 billion. Microsoft 8.8 billion and S&P Global 7.5 billion. So some pretty huge buybacks coming from some of the world's biggest companies. Yeah. [00:10:15][17.3]

Alec: [00:10:16] So I guess that's the long and the short of it when you're hearing about this tax on buybacks, traditionally, companies could buyback their stock with no tax implication. They would pay tax on their profit. And then. I would say, well, I can pay it as a dividend to my shareholders, but they will get taxed if they're not in Australia, New Zealand or Malta. Or I can avoid that double taxation and just buy back my own stock, maybe help me get my bonus as well, but but also give a benefit to shareholders. But a lot of people probably don't realise they were getting that benefit. So I think it's important to know. But now Bryce, let's circle right back to where we started, which was the news story. There is now a 1% tax on buybacks. So whether you pay a dividend or you buyback your own shares, there will be double taxation. Does this change anything? [00:11:07][51.6]

Bryce: [00:11:08] It doesn't change anything for me as a shareholder, which is the good news. [00:11:12][3.5]

Alec: [00:11:12] Okay. [00:11:12][0.0]

Bryce: [00:11:13] I'm not going to have to make any changes to my tax or anything like that. The two companies, the one that's going to be taxed. [00:11:19][5.7]

Alec: [00:11:19] I think that's an important point to start with. You don't have to report what companies bought back shares or anything like. [00:11:24][5.3]

Bryce: [00:11:25] It's on. [00:11:25][0.1]

Alec: [00:11:25] The company.

Bryce: [00:11:26] So no stress. It's all good for a shareholder. You don't have to do anything different. What we might see is that over in America, traditionally companies that haven't been paying dividends, you might start to see them pay a little more in dividends rather than pay the 1% in tax if it is more efficient for them to do so. And also you might see them as we've spoken about reinvestment, reinvesting some of their profits back into companies rather than paying out in dividends or buying back their stock. So you might see some change in behaviour of companies, but it's all going to be relative against that 1% tax that they would pay. 

Alec: [00:12:02] Yeah. Otherwise I think it's going to be like super on the margin though because it's the tax is 1% like it's a lot in the context of the S&P 500 spent 280 billion in the past three months. So the Government is going to collect a cool 2.8 billion in tax on that. For a company you're say CEO, you're thinking the lowest tax rate in America is 10%, and I think the highest is 37%. So I can pay 1% tax on a buyback or I can give the money as a dividend and my investors will be taxed between ten and 37% of the money. So it still is more tax efficient to do the buyback. But also my cynical raising comes into play. It also probably helps them get their bonuses and stuff like that. On the margin, hopefully we see a little bit more investment, a little bit more investment in R and D hiring expansion and stuff like that because you don't get taxed if you reinvest in your company. No, but I think that will be very much on the margin. Yeah. Yeah. 

Bryce: [00:13:01] So the lesson here are this. There are two ways that a company can return money to you as an as an investor. And we hope that we've been able to help you understand one of those, which is the buyback. Yeah. If you say that your company is doing a buyback, don't freak out. It results in you owning slightly more of the company than you had in the past. So, again, that's it. That's the lesson. We'll pick it up next week with another news story. Don't forget, grab Finn fest tickets Equity Mates dot com slash re-invest. Check out all the other content that we're doing. If you're enjoying this format, let us know. Contact@equitymates.com. Similarly, if you're interested in more business news, check out our business news podcast, the dive in your podcast player. Now Ren will pick it up next week. 

Alec: [00:13:44] Sounds good.