The financial addiction that is slowly killing Britain’s economy
Share buybacks are bleeding the UK of funds that could fuel much-needed investment
Share buybacks – the practice of reducing a company’s share capital by buying the stock in the market and then cancelling it – has always divided investment opinion.
On the plus side, they are theoretically more tax efficient than dividends, since the seller pays capital gains tax on the distribution rather than income tax, which is what dividends are subject to. They should also be earnings accretive, in that they reduce the number of shares in issue.
But there is another reason executives find buybacks preferable to dividends. They are much easier to cancel without anyone really noticing compared to the annual dividend payment, where any cut tends to be regarded as a manifestation of management failure.
Anecdotally, moreover, buyback activity tends to be at its greatest when share prices are at their peak, not as it should be when prices are down in the dumps. As such, they can be a classic top-of-the-market signal, more so a case of irrational exuberance than efficient use of capital.
As often as not, companies waste capital by overpaying for their shares, disadvantaging the shareholders left behind. Management confidence that the shares are cheaper than they should be is frequently misplaced. The manipulation of earnings per share via buybacks becomes an even more contentious issue when incentive schemes are directly related to earnings performance.
And finally, money spent buying back shares is money not reinvested in the underlying business, and can therefore be seen as part of Britain’s underinvestment problem.
All these negative considerations should worry us, since right now, buyback activity in the UK market is close to record levels. According to collations by Russ Mould, investment director at AJ Bell, share buyback programmes in the UK market this year have already reached £46.6bn.
With some 30 trading statements still to come from FTSE 100 companies over the next couple of weeks, the total for the year is likely to come close to last year’s record of £58.2bn, and may even exceed it.
This may of course be largely yesterday’s story. Much higher interest rates make share buybacks more expensive to finance, so you’d expect the numbers to fall quite significantly next year. As I say, managements are on the whole keener to protect the dividend than the buyback programme.
But there is also a wider reason to worry. Over the past 30 years, there has been a remarkable shift in share ownership for UK companies, with international ownership of the FTSE 100 increasing from around 12pc to 56pc. UK Pension Fund and Insurance Company ownership has meanwhile fallen from 52pc to just 4pc. Even retail and unit trust ownership has plummeted.
The upshot is that the bulk of the money from UK buybacks and dividends goes overseas these days, rather than being recycled back into the domestic economy.
As such, the explosive growth of buybacks can reasonably be seen as at least some part of Britain’s shamefully low overall level of business investment. Capital that is notionally available for investment within the company, or alternatively through dividends in the wider economy, is instead being syphoned off and invested elsewhere by overseas shareholders.
British companies have in other words become a kind of wasting asset, with their lifeblood being slowly sucked out of the UK economy.
Gross fixed capital formation (GFCF) – a measure of both public and private investment – in the UK is already one of the lowest in the OECD. Rishi Sunak and Jeremy Hunt have made it their mission to improve on that position, even if slashing the Government’s capital spending budget scarcely helps them achieve it.
Even so, there is some evidence to suggest that Downing Street’s strategy of significantly raising the rate of corporation tax for larger companies so as to patch up public finances, while at the same time increasing allowances for investment, is working.
Since the Government introduced super deductions in the spring of 2021, replaced this year by “full expensing”, business investment in the UK has risen faster than any other G7 economy, albeit from a much lower base.
The Chancellor has said he’d very much like to make “full expensing” – a 100pc offset against tax for investment in plant and machinery – permanent once Britain’s public finances can afford it. For the time being, however, his fiscal rules limit the initiative to just three years.
The CBI has estimated that permanent “full expensing” could boost business investment by £50bn annually. But just consider this: if all the money currently spent on buybacks was instead invested back into the UK economy, we’d already be there. Instead, it ends up in America, Europe and beyond.
On the whole, it’s a good thing that Britain is one of the world’s most open economies, where investors and companies are free to do what they like with their money. The benefits probably outweigh the negatives. Yet downsides there most definitely are.
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