Running head: SHARE REPURCHASES AND STOCK VALUATION MODELS 1 ShareRepurchases and Stock Valuation ModelsNameInstitution
Current Value Per Share
Current value = D / (r – g)
=D = $3, r – 12%, g -6%
= 3/ (12% – 6%)
Dividend yield = D / p
= D = $3, P – $50
= (3/50) * 100%
Expected stock price
= P0 (1 + r) – D
= 50 (1 + 12%) – 3
= $ 53
Growth rate in price per share = (563– 50)/ 50
Current price per share (Stowe, McLeavey & Pinto, 2007).
Po = (d + b)/ (r – g)
= (1.8 + 1.2) / (12% -6%)
= 1.8 / 50
= 1.2 / 50
fraction of the one million outstanding shares will be repurchased the first year
= 0.024 / (1 + 0.12 – 0.0036)
= 2.214% or 2.24% * 1000000 = 22440 shares
Growth rate in dividend per share
= (1+ g) (1-f) – 1
= (1 + 0.06) (1 – 0.58) – 1
Expected stock price in one year)
= 0.58 * (1.06*1.8)+ 1.8 / (1+1.12) ^-1
Thegrowth rate in price per share
=58.81-56 / 56
Dividends and sharerepurchases have increased over the years since the article waswritten. Figure 2.0 below shows the historical dividend andrepurchases for S & P companies from 1999 to 2017
Figure 2.0 (Yardeni,Abbott & Quintana, 2016).
Stock repurchases happen when an entity requests the shareholders totender their stocks for repurchase by the entity. It is carried toincrease the shareholders’ value. Stock repurchase may be used bythe company to restructure the capital structure of the companywithout raising the level of leverage. On addition to this, insteadof the entity changing its dividend policy, it can be able to offervalue to the shareholders through the stock repurchases given thatthe capital gain taxes are usually lower compared to the dividendtaxes. Some of the main advantages of stock repurchase it helps toraise the value of the stock (mainly companies buy stocks when theyare perceived to be undervalued) and compared to the cash dividendstock repurchases give investors the decision (either to sell or toretain the share). On addition, stock repurchases help to prevent asituation where the potential stockholders fear that a largestockholder may sell all the shares and bring down the value of theirstock.
However, despite the advantages, share repurchases has some demeritscompared to the dividend. First, cash dividend is dependable from theinvestors’ perspective but the stock repurchase is not. Dividend ismainly paid on a regular basis compared to stock repurchase, whichcan be more appealing to investors compared to the stock dividend.Secondly, stock repurchases can make a company pay too much, where anevent happens after the repurchase which lowers the value of thestock. Finally, stock repurchase may lead to a lawsuit that isexpensive to the company when stockholders offer they stocks tendertheir shares for repurchase without been aware of all the repurchasedetails. They may end up suing the company which is seen as a risk.
Stock repurchases present a situation where the price of the sharetends to rise following the announcement of the repurchase, but forthe companies that execute heavy buybacks share price tends todecline in a long run. This means that stock repurchases may placethe long-term investors at a disadvantage. For example, when theshare price of a company raises by $2 following the repurchaseannouncement, short term investors will gain $2 in capital gain,however, for a long term investor may be at a disadvantage when inthe future the price of the stock normalizes to the stock’sintrinsic value.
Stowe, J. D., McLeavey, D. W., &Pinto, J. E. (2007). Share repurchases and stock valuationmodels. Availableat SSRN 1051281.
Yardeni E., Abbott J., & Quintana J., (2016). Stock MarketIndicators: S&P 500 Buybacks & Dividends. YardeniResearch, Inc.