Why some Nvidia shareholders are surprised by its $25bn stock buyback plan

The chip-maker's shares are up 220 per cent so far this year

Nvidia's stock buyback is the fifth-biggest repurchase announcement among US-based companies this year. AFP

Nvidia's move to buy back $25 billion of its shares after its stock more than tripled this year caught some investors off-guard, even as they cheered a stellar second-quarter report.

The company's shares touched a record high on Thursday, a day after it blew past expectations with its quarterly revenue forecast as an artificial-intelligence boom drove demand for its chips.

Nvidia shares, which rallied in the days leading up to its report, climbed more than 6 per cent on Thursday but pared gains to end the day little changed.

However, the company's stock buyback – the fifth-biggest repurchase announcement among US-based companies this year, according to EPFR – surprised some investors.

Companies commonly repurchase their stock as a way to return capital to shareholders.

Such buybacks can benefit a stock's price by reducing the supply of shares and increasing demand, and can boost earnings per share, a closely watched investor metric.

But while shareholders often see buybacks as an encouraging sign when a company’s stock appears cheap, Nvidia’s shares are up 220 per cent in 2023, leaving investors searching for the reasons behind the company’s move.

"It's a little bit of a head-scratcher," said King Lip, chief strategist at Baker Avenue Wealth Management, which has $2.5 billion in assets under management and counts Nvidia as a top-10 holding.

"As a shareholder, we like to see stock buybacks, but for a company like Nvidia that is growing so fast, you kind of want to see their earnings being ploughed back into the company.”

Daniel Morgan, a senior portfolio manager at Synovus Trust, which owns Nvidia shares, said the move "comes as a surprise" given that Nvidia is "a hot growth tech name", as opposed to companies with sluggish financial performance growth that turn to buybacks to help prop up earnings per share.

"The message seems to be that [Nvidia's] management believes that their stock is undervalued," Mr Morgan said.

For some investors, an "undervalued" Nvidia might be a difficult message to stomach. Nvidia shares traded at 45 times forward 12-month earnings estimates as of Wednesday, compared with about 19 times for the overall S&P 500, according to Refinitiv Datastream.

"Historically, you'd love it when a company is able to buy their stock back when it is depressed, but I don't think anybody can make the case that it is at a depressed place right now," said Tom Plumb, chief executive and lead portfolio manager at Plumb Funds, which has Nvidia as one of its largest holdings.

However, Mr Plumb said the company might be limited in how it can use its resources after its deal to buy semiconductor designer Arm Holdings collapsed last year amid regulatory concerns.

"They're generating incredible amounts of cash, more than they need for their current investment strategy, and they're prohibited from buying significant complementary businesses," Mr Plumb said.

"So, what are they going to do with their cash?"

Nvidia spent about 27 per cent of revenue on research and development last year, in line with rival chip companies.

The company did not immediately respond to a request for comment.

In its second-quarter earnings release on Wednesday, Nvidia said its board approved $25 billion in additional share repurchases "without expiration", and that the company planned to continue repurchases this fiscal year.

Despite the staggering dollar amount, Nvidia's buyback amounted to only 2.1 per cent of its market value of about $1.2 trillion as of Wednesday.

That is less than the historic 2.58 per cent buyback yield for the overall S&P 500, when looking over one-year periods, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

Meanwhile, several other megacap technology and growth companies have announced even bigger buybacks this year: Apple at $90 billion, Alphabet at $70 billion and Meta Platforms at $40 billion.

Tech companies tend to prefer using cash for buybacks over dividends, because "if they are on the hook for a dividend every quarter that may hinder their ability to take advantage of growth opportunities", said Daniel Klausner, head of US public equity advisory at Houlihan Lokey.

Some investors welcomed Nvidia's buyback decision.

"It’s a show of confidence," said Francisco Bido, senior portfolio manager for F/M Investments' large cap focused fund, which holds Nvidia shares.

"If they had better use for [the cash], I am pretty sure they would have done it."