You might have heard the phrase ‘share buyback’s thrown around quite a lot in recent years (although probably not since February). It’s a concept that has gotten a lot of media attention in recent years – and a lot of praise from investors.

Even the great Warren Buffett has waxed lyrical about buybacks over the years, saying he prefers them to straight dividend payments from his (meaning Berkshire Hathaway’s) holdings:

“Disciplined repurchases are the surest way to use funds intelligently: It’s hard to go wrong when you’re buying dollar bills for 80¢ or less” Buffett said in his 2012 letter to Berkshire Hathaway shareholders.

But why? Surely receiving dividends in cash is a better option to a share buyback for the average investor? Well, let’s have a look and see.

What is a share buyback?

A ‘share buyback’ program refers to a decision by a company’s management to use its cash to purchase its own company’s shares off of the open market. Once the shares are bought, they are ‘retired’ – it’s the opposite of a company issuing new shares to raise capital.

So how does this help investors? Well, say if Company A has 100 shares outstanding and you as an investor own 10. That would equate to a 10% ownership stake of that company and an entitlement to 10% of the company’s earnings.

But say Company A’s management decide to buy back 20 shares using the company’s profits. Now, there are only 80 shares of Company A on issue, meaning us, the investor, still owns 10 shares. But these 10 shares now represent 12.5% of the company’s ownership – meaning our stake in the company has increased. It’s a similar outcome to if the company paid out a dividend and you reinvested it instead (except without taxes getting in the way).

Are share buybacks always a good idea?

Not always. It can be deleterious to a shareholder’s long-term wealth if a company pays too much for its own shares – much like for an investor.

But conversely, it can be extremely beneficial if the company manages to buy back shares at a discount.

One of my own holdings – Magellan High Conviction Trust (ASX: MHH) – permits share buybacks if the trust’s unit price is trading under the net tangible assets (or real value) of each unit. Just last week, the trust informed the ASX that over $3.5 million worth of MHH shares were purchased on market for a price below what each unit is worth.

As a shareholder, I am very pleased with these actions for the reasons outlined above.

More reading

• How to make a $1 million share portfolio by investing $1,000 a month
• 2 ASX shares I would use for a starter ASX portfolio
• 3 shares to buy if the ASX shares crash again
• Are Magellan shares a high-conviction buy today?
• Where I’d invest $5,000 into ASX shares right now

Motley Fool contributor Sebastian Bowen owns shares of Magellan High Conviction Trust. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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The irrational bear market has thrown investors many false dawns over the past 2 months. We have had many false starts and bear rallies, all traps for new players. Nonetheless it has created some of the most extraordinary value investing opportunities in my lifetime. Many companies that are almost totally unaffected by the pandemic have seen share prices slashed in blind panic. 

For example, the Evolution Mining Ltd (ASX: EVN) share price has rocketed up ~60% since its low point on 16 March. IDP Education Ltd (ASX: IEL) is a company that is marginally impacted. Yet after being over sold dramatically, the IDP share price has risen by 41.4% since 23 March. Lastly, the mighty Afterpay Ltd (ASX: APT) share price has risen by 350.6% from its low point on 23 March.

These are not normal returns, just as these are not normal times. However, there are still opportunities in the S&P/ASX 200 Index (INDEXASX: XJO). The 3 ASX 200 shares below are set to see a significant rebound as restrictions start to relax. 

Value investing opportunities

Santos Ltd (ASX: STO) has shown itself to be a well managed company with a strong chance of emerging from the oil crisis as a productivity leader. The Santos share price has already risen by ~79% from its low point on 19 March. Yet its price-to-earnings (P/E) ratio is still 6 points lower than its 10-year average P/E at 9.9.

The Santos share price still has a way to rise. By my calculations it needs to rise another 61% to meet average 10 year P/E levels. That doesn’t factor in the huge productivity gains the company has made over the past 2 months. This is a prime candidate for value investing.

The Bank of Queensland Limited (ASX: BOQ) share price has dropped by 33% year to date, giving it a P/E ratio of 7.7. This is 3 points lower than the 10-year average. To get back to this level, the bank’s share price will need to rise by 51%.

The bank also has good dividend stability of ~95% despite the present deferral. At the current price, the trailing 12-month dividend yield is 13.4%, placing the company as one of the better paying dividend shares. I believe this bank is a good candidate for value investing. Its share price is likely to see a jump over the next 3 – 6 months as the pandemic eases.

The BHP Group Ltd (ASX: BHP) share price has risen 25% from its low point on 16 March. It has another ~17% before equalling its 10-year P/E ratio. However, I don’t think the market has fairly valued the company’s future earnings.

BHP has 4 things in its favour. First, the low Australian dollar increases the value of every tonne of product sold in USD. Second, the iron ore market has withstood the impacts of COVID-19. Third, BHP is the third largest producer of copper, a commodity soon to see a price increase.

Lastly, the company has no exposure to aluminium, unlike mining stablemate Rio Tinto Limited (ASX: RIO). Aluminium is likely to see further price falls without high car manufacturing volumes. 

More reading

• The latest ASX shares to be downgraded by top brokers
• Is the Altium share price a buy?
• ASX 200 starts the week strongly, up 1.3%
• Start your week off with these 3 top Warren Buffett quotes
• Morgans warns investors to sell these ASX 200 shares in the rally

Motley Fool contributor Daryl Mather has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of AFTERPAY T FPO. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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