Image source: Getty Images
In general, UK shares have underperformed their US counterparts over the last 10 years. But there’s a big reason to be bullish on FTSE 100 stocks going forward. According to recent reports, UK firms are favouring buybacks over dividends for returning cash to investors. And this could be very positive for share prices.
Share buybacks
In general, businesses face choices about what to do with the cash they generate. One option is to use some or all of it to buy their own shares and then cancel them. The main benefit is that it reduces the overall number of shares. That means each remaining share has a bigger ownership stake in the underlying business – and a claim on more of its profits.
This can increase the value of the outstanding shares and cause prices to rise, but only if the stock a company buys is worth less than the cash it pays for it – in other words, only if it’s undervalued.
The likes of Lloyds Banking Group (LSE:LLOY), Shell, and BP have been buying back shares in a big way recently. And if this continues, it could be very positive for share prices in the future.
Apple
In February 2018, Apple (NASDAQ:AAPL) announced its plans to return excess cash to investors. And during the next three years, the firm spent around £159bn on share buybacks.
As a result, the company’s outstanding share count fell by almost 20% during this period. And the stock went from around $40 to just under $145 – a gain of 250%.
After working through its excess cash however, the pace of Apple’s share buybacks has slowed. Since 2021, the firm’s only bought back around 8% of its outstanding shares. It’s no coincidence the stock hasn’t climbed as rapidly during this time and it’s not on my buy list at the moment.
It’s managed a very respectable 75%, but it hasn’t been as fast as it was when it was aggressively repurchasing shares.
Cyclicality
Concerns about motor loan regulations notwithstanding, Lloyds has seen its share price climb 45% in the last 12 months. And that’s partly the result of an ongoing share buyback programme.
One thing to keep an eye on however, is the interest rate environment. The FTSE 100 bank has benefitted from wider lending margins while rates have been relatively high recently. If that changes, the company might well find itself less profitable – in fact, I think that’s highly likely. And in this situation, the firm might well have less cash available for share buybacks.
Investors therefore need to think carefully when it comes to share buybacks. They can push a stock higher and create value for shareholders, but it’s important to consider how durable they are.
FTSE 100 shares
There are however, plenty of FTSE 100 companies are looking to accelerate share repurchases. And I think this provides reason to be optimistic about UK stocks as a whole.
Beyond the likes of Lloyds — which I expect to slow its buybacks when interest rates fall — there are other stocks on my radar. And potential buybacks are a big part of my investment thesis.
This story originally appeared on Motley Fool
