Should you be happy about a small cap share buyback?

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The buzz is all about dividends right now (will you get those franking credits?) but there’s another cash handout flying under the radar which may or may not help a company’s share price.

We’re talking share buybacks.

This is when a company buys back its own shares on market or at a predetermined price and then cancels them. The idea is to push the share price up by reducing the number of shares available in the market.

But for small caps, which should ideally be using their money to become mid or large caps, the practice is not considered kosher.

In the last month, 16 small caps have been running share buybacks where they’ve bought the stock directly on the ASX — also known as buying on market.

They don’t need shareholder approval to do this if they’re buying less than 10 per cent of the company over 12 months.

On the numbers alone it doesn’t look like share buybacks are working as a way to pump stock.

Only Fitzroy River (ASX:FZR), Timah Resources (ASX:TML) and Probiotec (ASX:PBP) have share prices higher than when they started the buyback.

Probiotec is also paying a dividend.

WaterCo (ASX:WAT) has been running buybacks since 2016 and this is Adacel’s (ASX:ADA) second year of an active buyback campaign.

ASX says no

If buybacks are designed to bump up share prices then the effect on a small illiquid stock should be dramatic.

Novus Capital advisor Nick Kapes says it can give investors in small stocks the opportunity for some liquidity.

But even minor trades of a couple of thousand dollars can double or triple the effect on a small cap’s share price when suddenly there’s a willing buyer (or seller) on the other side of the trade.

This is where the ASX has stepped in to make sure companies can’t artificially inflate their share prices by buying $1000 of stock directly on the market.

The rules say a company can only buy their own shares if someone else trades the stock on at least five days during the three months preceding the start of a buyback.

And companies can’t pay above the 5 per cent volume weighted average price of the stock for the preceding five days.

The factors that make a buyback work

Share buybacks are not considered a good thing in the world of small caps, says investor, corporate advisor and small cap company director Alex Sundich.

“Generally only if the company is cash flow positive, that then creates potential EPS [earnings per share] accretion. If not then there’d be no benefit at all,” he told Stockhead.

Sundich runs Bridge Street Capital and is on the boards of Cleveland Mining (ASX:CDG) and Ellex Medical Lasers (ASX:ELX).

Well-known Melbourne investment banker David Williams says they can be good but only for companies that have done their homework.

“In general they’re good for shareholders but before you come to that conclusion you really need to have analysed the prospects of the business to make sure that you can’t better use those funds elsewhere in growing the core business itself,” he told Stockhead.

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The stock also has to be undervalued.

Williams points to PolyNovo (ASX:PNV), a next-gen breast implant maker and one of the small caps he’s invested in, as an example.

They’ve got $21m in the bank and are “pretty close” to breaking even. So why not share the wealth in some way with shareholders?

Williams says the market is telling them it wants PolyNovo to keep spending and growing.

The share price went from just under 60c until the middle of January to an all-time high, this week, of 96c.

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