On July 28th of this year, Shell PLC announced a $6 billion share buyback plan over the following three months. From there, Shell went on to record profits in the second quarter to the tune of $11.5 billion. Within their plan to buy back shares, Shell will use some of these profits to purchase some of its outstanding shares in the market. For professionals working at Shell, there are a number of ways to accumulate Shell shares through the GESPP, performance shares, and other long-term incentives. As the organization begins buying back shares, we believe it’s important to understand what buybacks mean for investors and how to plan for it within your portfolio.
In Shell’s share buyback plan, the company will repurchase its shares before canceling them. Doing so will result in a lowering of the overall shares of available Shell stock. This is, of course, subject to market conditions at the time because Shell isn’t required to buy back all of the intended shares.
We’ve recently received several questions from clients about this and believe there are a few to address, including:
Historically, Shell has not been shy about establishing a buyback program. In the first half of 2022 Shell repurchased $8.5 billion in shares of their own stock. Prior to this, Shell established a buyback program in 2018. When the energy sector began to pull back in 2020 as part of the COVID-19 pandemic, Shell suspended their buyback program.
Many companies employ the buyback strategy as they bring in cash at the end of their balance sheet. Often, leveraging buybacks enables a company to reward its current shareholders while using its profits to benefit the company.
Buyback or stock repurchase agreements are a way for companies to add value for current shareholders in a potentially low-risk and tax-efficient way. In the simplest of terms, the company is attempting to tilt supply and demand in its favor.
Buybacks remove current shares from the open market which reduces the available supply. If we assume demand stays the same or better, we should see the stock price appreciate as the profits are divided amongst fewer shareholders.
When a company makes a profit, they have a few options for what to do with the funds.
Through a buyback program, a company can increase the earnings per share on the stock, assuming everything else stays equal. Conceptually, if we look at the company’s earnings like a pie, buybacks minimize the number of people asking for slices. What does this mean for investors? A greater share per earnings value.
By reducing the available share count, buybacks increase the stock’s potential upside for shareholders who want to remain owners. Share buybacks can be a more tax-efficient way to return the earnings of the business to its shareholders when compared to dividends. Dividends are taxable to those who receive them, whereas buybacks generally increase the price of the stock which is taxed when sold.
However, not all companies use this strategy. It's easy to see why it can be beneficial, but there are downsides as well. So, what are the negative implications of a buyback program for those invested in Shell stock?
Simply put, there are times when a buyback program is not in the best interest of the company, its shareholders, or its employees.
If a company has a significant amount of debt and chooses to repurchase shares of its own stock instead of paying some of that debt down, it could be a cause for concern. Also, buybacks may function as a way for companies to hide stock issuances to their executives. Consider this: if managers have stock options and the ability to influence the stock price via repurchases, they may decide that they can temporarily boost the stock price through buybacks in order to secure a gain on their options.
Finally, a stock buyback can simply be poorly done. If the company goes out into the open market, it could be buying its stock back at an undesirable price.
Renowned investor, Warren Buffett has constantly commented on the benefits of buybacks over the years and has stated when done correctly, is a way for a company to use it profits intelligently.
In his 2011 letter to his shareholders, Buffett identified the two conditions that must be met in order for him to favor a company buying back its own shares.
While the reasons discussed above are cause for concern, Shell has a long-standing history of successfully-executed repurchase programs as a way to benefit their shareholders and employees.
Navigating what a stock buyback or repurchase program means for the company and its shareholders can be tough if you aren’t familiar with the process. Not only do you need to know what your company does with its profits, but you also need to understand how those choices impact you and your tax situation.
As we mentioned earlier, companies with profits have to choose what they do with those funds.
A popular choice to benefit the current shareholders is to increase the dividend of the stock. Dividend increases can improve the total return of the stock, but they may not yield the best tax benefit for the shareholders. When a company realizes dividends, anyone who owns shares receives taxable income for what they have in that stock. Even if the stock is down for the year, shareholders still have to pay taxes on the dividends they receive.
The additional income from dividends can potentially have a significant impact on an individual’s tax situation. What if you’re on the cusp of the next tax bracket and your dividend income bumps you to the next tier? For our retired clients who are 63 or older, unplanned dividend income could shift them into a higher Medicare bracket.
With a buyback, stocks may see price appreciation over time, but the shareholder only gets taxed when those shares are sold. Additionally, you can target specific share lots to control gains or to use elsewhere to offset losses.
In comparison, stock buybacks offer significantly more control and flexibility for tax planning!
Shell offers several versions of stock compensation and benefits for its employees. One of the great benefits Shell offers for employee incentive compensation is Shell performance shares. Shell also offers an employee stock purchase plan, called the GESPP, where employees can purchase shares at a great discount. Over an employee’s career, they could easily accumulate a large concentration of Shell stock as a portion of their portfolio.
These are simply a few examples of why it is important to work with a financial planner who has knowledge of both your tax situation and Shell benefits. An advisor with a deep breadth of knowledge of the company you work for, their benefit and compensation packages, and the history of their stock performance or buyback programs can better assist you in determining the right investment strategies for the company stock you own.
At WJA, our advisors are experienced in Shell’s stock plans and have leveraged those benefits to help many Shell employees and retirees on their journey to financial independence. If you have questions about your Shell shares or how to leverage them within your portfolio to achieve your goals, reach out to one of our advisors for a complimentary discussion.