In recent months the practice of companies buying their own shares has made a comeback. Insurance firm Aviva (AV.) was the latest              to add its name to a growing list which includes Diageo (DGE), Unilever (ULVR) and BP (BP.). On 12 August Aviva announced a £750 million buyback as part of plans for a capital return to shareholders of more than £4 billion.

As well as individual companies, investment trusts periodically purchase their own shares but typically for slightly different reasons.

This flurry of buyback activity raises several posers for investors, including how should they react and what happens to the repurchased shares.

The first question to ask is why a company doesn’t have a better or more imaginative use for its money? Perhaps investing or innovating for future growth.

The short answer is that the recent run of buybacks have come through as firms which built up a cash buffer during the pandemic, which is no longer required, look to reward patient shareholders and those which just paused their buyback plans get them back on track.

In Aviva’s case it has generated lots of cash by offloading its non-core operations.

There is only one type of buyback where investors really have any control and that’s when what is called a tender offer is launched. This gives investors the option of selling some of their holding, whether or not you do so might depend on if you need the cash or how you feel about the investment going forward.

Tender offers are more common when investment trusts look to repurchase shares and often these offers will be pitched at a premium to incentivise holders to sell. This can be a way for trusts, which as a reminder can trade above or below the value of the assets they hold, to narrow the discount to their NAV or net asset value.

Other buybacks are just pursued in the open market, with a company buying stock in the same way you or I would, just on a much grander scale. Here the individual investor is not really being presented with a scenario whereby they need to decide whether to sell.

The alternative for a management team to using surplus funds for a buyback is to pay out a special dividend.

Investors who hold shares outside of a tax-efficient wrapper like an ISA would typically pay less tax on selling their shares through a buyback than they would from receiving the cash as a dividend.

By buying in the market, a company can help push up its share price as well as increasing its EPS (earnings per share) and DPS (dividend per share) by reducing the number of shares in issue.

However, this can be a negative too as it can be an easy way for management teams incentivised based on EPS performance to manipulate the figures. Also it’s worth looking to see if the company has a policy of buying back its own shares only when it perceives them to be trading below their true value.

Once a company has purchased its own shares it has two main options it can cancel them or it can keep them in its treasury. Shares kept in treasury can be reissued, perhaps to new investors or for employee share options.

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