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Fit for purpose

Do you ever brush your teeth with your sun-glasses or iron your clothes with a mobile phone? I only ask because of what I have been reading in the national press about how share buybacks have officially been declared the eighth deadly sin by Terry the First and, while I am no theologian, I am not completely convinced that is the case.

To be clear, I am not saying Terry “Fund” Smith is wrong. This is partly, I concede, because he has never seemed to be the sort of person who would take well to being called wrong but mainly because he never went so far as to damn all share buybacks although one could possibly forgive a casual observer of the financial pages for thinking otherwise.

A bigger person than I might even forgive assorted national hacks for getting confused and pushing an erroneous “all buybacks are evil” angle. After all, Smith’s Share buybacks – friend or foe paper does spend eight pages saying what I might presump-tuously summarise as “there is nothing fundamentally wrong with share buybacks but lots of companies do them at the wrong time”.

Or to put it another way – as I wipe the blood from my scalp after scratching my ear with the cat – misusing things can end badly.

One of Smith’s four conclusions – I shall return to the others later – is indeed that “share buybacks only create value if the shares repurchased are trading below intrinsic value and there is no better use for the cash which would generate a higher return”.

Compare and contrast that with a line from another chap who I understand also runs an investment company. “When companies with outstanding businesses and comfortable financial positions find their shares selling far below intrinsic value in the market-place, no alternative action can benefit shareholders as surely as repurchases.”

That Warren Buffett quote was repeated in one of the leading pro-buyback theses which was written five years ago by Michael J Mauboussin, respected investment author and chief investment strat- egist at Legg Mason Capital Management.

Now I will not even try to reproduce his formulae for calculating “percentage increase in intrinsic value per share” or “post-buyback intrinsic value per share” – although only because they are, ahem, too wide to fit the format of this column – and instead am grateful to Kevin Murphy, co-manager of Schro-der recovery, for providing me with subtitles.

My resulting “under-standing” of Mauboussin is buybacks work if a company repurchases its shares for less than their intrinsic worth because the difference between the price paid and that worth is then enjoyed by the remaining shareholders. However, if a company pays too much, the remaining shareholders get to pick up the tab – so it all boils down to whether a company repurchases its shares for more or less than their true worth.

Of course, the big trick is working out what that true worth is but that is when investors have to step up to the plate and take a view. Presumably, most people buy companies when they think the market has not spotted their full potential and, as such, should be fairly sanguine that any share repurchases will enhance value. And if you think a company you own is buying back shares for more than they are intrinsically worth, there is an easy answer – sell up and take the cash.

I am not sure that side of the argument was universally put across. I have no idea why that might be although I suppose the national press does like its investment-bashing stories, especially when they contain, a, hints of ignorance, incomp-etence and greed, b, a whiff of a conspiracy or misbeh-aviour and, c, the City stiffing investors.

Returning to Smith’s other conclusions, we learn “share buybacks are not sufficiently understood by company investors and commentators and maybe by company managements (although some of them may under- stand them perfectly well but not be using them to create value for anyone other than themselves)”, “current accounting for share buybacks conceals their true effect” and “most share buybacks now destroy value for remaining shareholders”. Ah.

Julian Marr is editorial direc-tor of and


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