Key points:
- Diageo is pursuing its share buyback plan
- Should we take this as a buying signal for us?
- Or is it just background noise we can ignore?
- Diageo Up 3% On Week, Down 8% On Year – What Next?
Diageo (LON: DGE) shares are almost unmoved as the company announces that it is continuing with its stock buyback plans. It’s possible to look at such plans in one of two ways – which view we take will then determine how important we think this news is for our own trading plans.
Diageo has been buying in shares most of the past week – we had announcements on the 12th, 13th, 14th as well. So today’s addition that is hardly a surprise. What we need to work out, though, is what does it mean for the future price of Diageo shares? At which point opinions can differ.
The most immediate reaction to share buyback programmes is that there will, in future, be fewer shares in issue. As Diageo says, once they’ve got those shares in treasury then they’re going to cancel them. So, if there are fewer shares representing ownership of the company, then each remaining share should be worth more. We can also think of share repurchases as being an alternative to dividends as a way of returning profits to shareholders. For some selling into a buyback program (more often for American investors but still) will be more tax-efficient, for example.
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OK, so, a higher return to shareholders and fewer shares in the future, this should push the share price up. Assume this is true and the share price change should happen at the time of the announcement of the programme. The actual execution of it is just something happening that we already knew was going to happen.
On the other hand, returning capital to shareholders. What’s the implication of this? That the management doesn’t have any other profitable use for that money. Again, opinions can differ here. One thought could be that this is a bad sign for the future growth prospects of Diageo. If there are no projects that capital can be put to, then what is this telling us about future growth prospects? Then again, perhaps we should be grateful that management isn’t cooking up marginally useful projects just to try to absorb that free cash flow being generated from current activities?
It is, that is, possible to be in several minds about share buyback programmes like those at Diageo. It’s rare that the answer is entirely clear-cut. There have been examples of management agreeing not to use the money – ie, increasing payouts – hugely increasing value. One time at Vodafone comes to mind. There have also been opposite examples, where ongoing investment in new products was thought a better use – most of the entire life of Amazon for example.
Our view of the future valuation of Diageo shares – with respect to the share buyback programme – thus will depend upon which of the views we hold about the return of capital to shareholders. Does the shrinking of the share count outweigh any worries we might have about the possible lack of internal investment opportunities?