Chapter 5 made the point that stock repurchases do not add value for shareholders if they are made at fair market value (that is, at efficient market prices): Value received is value given up. So, it is often asked, why do we often see an increase in the stock price when stock repurchases are announced? The answer must be that investors infer that management are repurchasing stock because, with their superior information, they see the stock is underpriced and buying underpriced stock does add value.
That is, the stock repurchase is a signal of value. This is similar to dividend signaling: Paying dividends typically does not add value (as chapter 3 explains) but can convey information that management believe that earnings in the future will be sufficient to cover the increased dividend2M and earnings do add value.
The S&P Buyback Index2Mequally weighted index of 100 firms in the S&P 500 with the highest proportion of cash spent on buybacks relative market capitalization2M has outperformed the broader S&P 500 equally weighted index 14 out of 20 years up to 2024. In 2024, considerably more large UK companies repurchased shares than US companies. A signal of undervaluation of the FTSE 100 relative to the S&P 500? The UK index traded at a forward P/E of 12.2 compared with 23.6 for the S&P 500. By March 2025, the FTSE was up 7.14% for the calendar year.