Prime Numbers: Share repurchases still don’t prop up value

As executives consider the pros and cons of issuing share repurchases, they are asking themselves (and their finance teams) some good questions about the value of doing so.

Don’t repurchases artificially prop up a company’s value? Share repurchases and dividends both decrease the market value of a fairly traded company by the same amount (since cash is being paid out). Dividends lower the price per share (since the share count stays the same), while share repurchases lower the share count and don’t affect the price per share. Repurchases do boost earnings per share (EPS), helping managers hit their EPS-based compensation targets, but the associated share price generally stays the same. In addition, finance professionals tend to use TSR rather than EPS in their market performance analyses and incentive systems, which helps them adjust for the short-term effects of share repurchases and dividends.

Is the net-neutral effect on returns consistent? In 2011, McKinsey analysis showed that US companies returned, on average, 60 percent of their net income in dividends and share repurchases to shareholders between 1965 and 2008. There was no clear impact on returns or multiples. We recently repeated this analysis, and the findings hold true. The total payout by US companies to shareholders between 1995 and 2021, on average, is up to 78 percent, with slightly more repurchases than dividends. But neither the payout size nor the mix automatically affects EBITA multiple (Exhibit 1) or TSR (Exhibit 2) for nonfinancial companies in the S&P 500.

Whether a company pays out using share repurchases or dividends, its valuation multiples are not affected.
Whether a company pays out using repurchases or dividends, shareholder returns are not affected.

If there is no net benefit to shareholders, why do companies give any money back, regardless of the mechanism? Because good companies have more cash than they can invest. Think about a company with $1 billion a year in after-tax profits projected to grow at 5 percent a year with a 25 percent return on capital. It could have $800 million of excess cash (after R&D and capital expenditures) that could be invested or returned to shareholders. But how easy would it be to find new value-creating investments for 80 percent of the company’s net income each year? The short answer: it would be very tough, regardless of industry—especially since a lot of high-performing companies already deploy billions of dollars in R&D and capital expenditures.

Overall, companies may be better off by returning cash to shareholders rather than investing in businesses and assets that they have no competence to run or grow (which would be value destroying). In most cases, shareholders will not sit on the cash; they will redeploy it to other, better value-creating opportunities.

Aya Benlakhder is a capabilities and insights analyst in McKinsey’s Lisbon office; Vartika Gupta is a solution manager in the New York office, where David Kohn is an associate partner; Tim Koller is a partner in the Denver office; and Werner Rehm is a partner in the New Jersey office.

For a full discussion of market dynamics, see Valuation: Measuring and Managing the Value of Companies, seventh edition (John Wiley & Sons, 2020), by Marc Goedhart, Tim Koller, and David Wessels.

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