How much growth does a share buyback really cost?
Share buybacks are usually welcomed by investors, especially when a stock appears undervalued.
When a company buys back its own shares, the number of shares outstanding falls, so the same amount of profit is spread over fewer shares. This can increase earnings per share. At the same time, the company returns excess cash to shareholders who sell their shares.
Last week, we looked at buybacks from a capital allocation perspective by comparing return on invested capital, or ROIC, with the weighted average cost of capital, or WACC. Companies with few opportunities to earn returns above their cost of capital may be better off returning excess cash rather than reinvesting it simply to expand.
But the same buyback decision can also affect how fast a company can grow from the earnings it keeps. Every peso used for a stock buyback is cash that can no longer support future expansion. The impact on growth depends on how much of the company’s profits go to buybacks.
In 1977, in a study by finance professor Robert Higgins published in Financial Management, he argued that a company cannot keep growing faster than its financial resources can support without eventually changing how it finances that growth. He then introduced the concept of the sustainable growth rate (SGR).
SGR can be computed by multiplying a company’s return on equity (ROE) by its retention ratio, which is the portion of earnings kept in the business rather than paid out to shareholders.
Take SM Prime Holdings as an example. Based on our estimates, the company has an ROE of about 10.4 percent and a dividend payout ratio of about 24.6 percent. Without share buybacks, it would retain about 75.4 percent of its earnings, which translates to an estimated sustainable growth rate of about 7.85 percent.
But when we include its share buybacks this year, its total payout rises to about 38.2 percent of earnings. The retention ratio falls to about 61.8 percent, which reduces its estimated sustainable growth rate to 6.44 percent.
In effect, the buyback reduces SM Prime’s sustainable growth capacity by about 1.41 percentage points.
This does not mean SM Prime’s actual earnings will grow 1.41 percentage points slower. SGR is not an earnings forecast. It estimates how fast the company can grow its sales without having to raise new equity, since higher sales normally require additional assets and capital to support them.
Now if we apply this framework to the 14 companies that conducted buybacks this year, we can estimate their sustainable growth rates based on trailing 12-month earnings, ROE and shareholder payouts through dividends and buybacks.
We then calculated what their sustainable growth rates would have been if they had paid the same dividends but had not repurchased shares.
Across the 12 companies where we could estimate SGR, the effect of buybacks on growth capacity was very different. In some companies, the reduction was almost negligible. But in four out of the 12 companies, buybacks took away more than 10 percent of the sales growth they could otherwise have supported.
This suggests that the amount spent on buybacks does not tell the whole story. A company can spend billions on repurchases and still give up relatively little growth capacity, while a much smaller buyback can have a bigger effect if it takes up a large share of earnings.
International Container Terminal Services Inc. (ICTSI) is a good example. Its estimated sustainable growth rate falls from 27.52 percent without the buyback to 26.15 percent after the buyback, a reduction of 1.37 percentage points. Yet the buyback takes away only about 5 percent of the sales growth capacity it could otherwise have supported.
This is largely because ICTSI has an ROE of about 58 percent. Its high profitability allows the company to return some of its earnings to shareholders while still retaining enough to support a relatively high sustainable growth rate.
While the effect was small for some companies, Ayala Land’s total share buybacks so far were equivalent to about 10.5 percent of its trailing earnings. Its estimated sustainable growth rate falls from 9.41 percent without the buyback to 8.26 percent after it. This means the repurchase takes away about 12 percent of the sales growth capacity the company could otherwise have supported.
This is why the amount spent on buybacks alone can be misleading. For growth analysis, a better measure is the portion of earnings that could have remained in the business but was instead used to buy back shares.
This tradeoff is also supported by academic research. In a 2021 Journal of Financial Economics study, Zigan Wang, Qie Ellie Yin and Luping Yu found that companies relied largely on internal cash to finance share repurchases, which was associated with lower capital expenditures and research and development spending. They also found that repurchasing firms experienced lower long-term growth.
The findings reinforce the idea that buybacks can come at the expense of future growth capacity. While repurchases may benefit shareholders in other ways, the cash used to buy back shares is cash that can no longer support the same level of expansion.
Henry Ong is a registered financial planner of RFP Philippines. To learn more about investment planning, attend the 118th batch of RFP Program this October 2026. To register, email [email protected].
