Share buybacks can be a powerful tool for companies to boost their future earnings per share. By buying back shares, a company’s future earnings can now be shared between fewer shares, boosting the amount each shareholder can get. Take Apple (NASDAQ: AAPL) for example. From 2016 to 2022, the iPhone maker’s net income increased by 118%, or around 14% annualised. That’s pretty impressive. But Apple’s earnings per share (EPS) outpaced net income growth by a big margin: EPS advanced by 193%, or 19.6% per year. The gap exists because Apple used share buybacks to decrease its share count. Its outstanding share count dropped by around 30%, or an annualised rate of close to 5.7%, over the same period. But the power of buybacks is very much dependent on the price at which they are conducted. If a company’s share price represents a high valuation, earnings per share growth from buybacks will be less, and vice versa.

Valuations matter

To compare how buybacks lose their effectiveness when valuations rise, let’s examine a simple illustration....