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Share buybacks are for dummies – unless you follow the Wolfson rules Share buybacks are for dummies – unless you follow the Wolfson rules
(6 months later)
There was an excellent passage in Lord Wolfson's review of Next's annual results that could have been titled "Share Buybacks for Dummies".There was an excellent passage in Lord Wolfson's review of Next's annual results that could have been titled "Share Buybacks for Dummies".
It should be required reading in the boardroom of any company contemplating a buyback. Why? Because Next was a pioneer in this field and is virtually alone in making this form of distribution of cash work effectively for shareholders, as the rise in the firm's share price from £5 in 1999 to £43 today well illustrates.It should be required reading in the boardroom of any company contemplating a buyback. Why? Because Next was a pioneer in this field and is virtually alone in making this form of distribution of cash work effectively for shareholders, as the rise in the firm's share price from £5 in 1999 to £43 today well illustrates.
Other companies, it often seems, assume any buyback that enhances earnings per share must automatically be beneficial. It's not that simple, as Wolfson shows.Other companies, it often seems, assume any buyback that enhances earnings per share must automatically be beneficial. It's not that simple, as Wolfson shows.
He offers six rules. Even number one, about ensuring enhancement to earnings, carries a qualification. A buyback must also a make healthy "equivalent rate of return" (EER) – in other words, a return better than could be achieved from investing the cash in an alternative investment.He offers six rules. Even number one, about ensuring enhancement to earnings, carries a qualification. A buyback must also a make healthy "equivalent rate of return" (EER) – in other words, a return better than could be achieved from investing the cash in an alternative investment.
In the case of Next, buy-backs would enhance earnings beyond £60 a share. But, applying the EER calculation, Wolfson says Next would be "less enthusiastic" about buybacks if returns dropped much below 9%, equivalent to a share price of about £45.In the case of Next, buy-backs would enhance earnings beyond £60 a share. But, applying the EER calculation, Wolfson says Next would be "less enthusiastic" about buybacks if returns dropped much below 9%, equivalent to a share price of about £45.
"So to a certain extent the share price provides a natural moderator of a disciplined buyback programme," he concludes."So to a certain extent the share price provides a natural moderator of a disciplined buyback programme," he concludes.
If only other companies were as disciplined. Most never mention EER and most breach Wolfson's fifth rule – "be consistent". Next has bought back shares every year for a decade, halving the number in issue.If only other companies were as disciplined. Most never mention EER and most breach Wolfson's fifth rule – "be consistent". Next has bought back shares every year for a decade, halving the number in issue.
By contrast, most boards conduct one big splurge over the course of a year or so. That's usually pointless, especially if the core business doesn't have clear prospects of long-term growth (rule six) and rising earnings per share.By contrast, most boards conduct one big splurge over the course of a year or so. That's usually pointless, especially if the core business doesn't have clear prospects of long-term growth (rule six) and rising earnings per share.
Frankly, the number of companies that meet all Wolfson's criteria is probably tiny. That's why so many – Marks & Spencer and Home Retail being two prime offenders in the retail sector – end up buying shares at prices that soon look silly.Frankly, the number of companies that meet all Wolfson's criteria is probably tiny. That's why so many – Marks & Spencer and Home Retail being two prime offenders in the retail sector – end up buying shares at prices that soon look silly.
In fact, rather than merely reading Wolfson's rules, it ought to made compulsory for boards launching buybacks to show how they measure up against them.In fact, rather than merely reading Wolfson's rules, it ought to made compulsory for boards launching buybacks to show how they measure up against them.
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