hello, welcome. We're going to discuss the pros and cons of dividends and  repurchases. So advantages of repurchases, the advantages of stock  repurchases, can be listed as follows. One, repurchase announcements are  viewed as positive signals by investors, because the repurchase is often  motivated by management's belief that the firm shares are undervalued because we want to see the company go in repurchase their own stock, because they  feel that it's undervalued, and they'll signal to the market that management feels  that they're going to see appreciation in their stock price or capital gain, and  their stock price over the term of the horizon, the time horizon, right over this five year period, or whatever it is, right? And management thinks, well, our stocks  valued at 20 in the market. We think it's in five years, will be valued at 30. So  we're going to buy back our stock. We are going to see, hopefully, that $10 price appreciation over that five years. Take those capital gains and reinvest them  back into our company. Shareholders have a choice when the firm distributes  cash by repurchasing stock, they can sell or not sell. Those stockholders who  need cash can sell back some of their shares, while others can simply retain  their stock with a cash dividend. On the other hand, stockholders must accept a  dividend payment. Dividends are what we call sticky in the short run, because  management is usually reluctant to raise the dividend if the increase cannot be  maintained in the future, and cutting cash dividends is always avoided because  of the negative signal it gives. Hence, if the excess cash flow is thought to be  only temporary, management may prefer making the distribution in the form of a  stock repurchase to declare an increase in cash over declaring a increase in  cash dividend that cannot be maintained. So we may go out into the market and  spend 50 million repurchasing our stock right, or we can raise our dividend, say,  from three and a half to 5% and that may not be sustainable in the future,  because we may hit some turbulence in the industry. We may see recession  coming in the economy, and we know that that dividend rate, or that dividend  yield is unsustainable moving forward in the future, so management will then  have to make a decision on, do we repurchase stock shares, or do we continue  to increase the dividend, which may be unsustainable in the future? So a lot of  times, firms will forego increasing the dividend yield and repurchase stock to  capitalize on their needs now and mitigate the risk away of uncertainty in the  future, and not raise their dividend yield so we can capture the capital gains by  the appreciation of price and spend less money right now. We'll spend more  money now, but potentially less money than we would have in the future by  repurchasing our stock. Companies can use the residual model to set a target  cash distribution level and then divide the distribution into a dividend component and a repurchase component. The dividend payout ratio will be relatively low,  but the dividend itself will be relatively secure, and it will grow as a result of the  declining number of shares outstanding. The company has more flexibility in  adjusting the total distribution than it would if the entire distribution were in the 

form of cash dividends, because repurchases can be varied over year to year  without giving off adverse signals. Repurchases can also be used to produce  large scale changes in capital structures. For example, several years ago,  consolidation, Consolidated Edison decided to borrow 400 million and use the  funds to repurchase some of its common stock. Thus, Con Ed was able to  quickly change its capital structure through the repurchase companies that use  stock options as an important component of employee compensation usually  repurchase shares and the secondary market and then use those shares when  employees exercise their options. This technique allows companies to avoid  issuing new shares. Repurchases have three principal advantages  disadvantages, stockholders may not be indifferent between dividends and  capital gains, and the price of the stock might benefit more from cash dividends  than repurchases. Cash dividends are generally dependable, but repurchases  are not. the selling stockholders May. May not be fully aware of all the  implications of a repurchase or they may not have all the pertinent information  about the corporation's present future activities. However, in order to avoid  potential stockholders suits, firms generally announce repurchase programs  before embarking on the corporation may pay too much for the repurchase stock to the disadvantage of remaining stockholders. If the firm seeks to acquire a  relatively large amount of its own stock, then the price may be bid above its  equilibrium level and then fall after the firm ceases to repurchase its operation,  so it might get bid up over equilibrium, creating a sell off opportunity, and the  price will decrease to maintain that equilibrium level when all the pros and cons  on stock, repurchases versus dividends have been totaled. Where do we stand? This is our conclusion, because of the deferred tax on capital gains, meaning,  while we're invested in a stock and we are having that stock appreciating price  and offering capital gains, we won't have to pay the tax on those capital gains  until we actually sell the stock, and then that tax year will pay out taxes, right?  So taxes are deferred as we hold the stock until we actually sell it and realize a  capital gain, then we have to pay the tax. This advantage is reinforced by the  fact that repurchases provide cash to stockholders who want cash, while  allowing those who do not need current cash to delay its receipt. On the other  hand, dividends are more dependable, and thus are better suited for those who  need a steady source of income. The danger of signaling effects requires that a  company not have volatile dividend payments, which would lower investors  confidence in the company and adversely affect its cost of equity and its stock  price. However, cash flows if companies do not pay out their dividend regularly,  investors are going to think there's a problem with the company, and that they  are struggling to maintain free positive cash flow, positive free cash flow, so they need to make sure they're distributing out in dividends, the full dividend as much as possible, so that they don't trigger negative sentiment towards their company  in the market, and that way lose investors and cause a reason for disinvestment 

in the on the other hand, dividends are more dependable, and thus are better  suited for those who need a steady source of income. The danger of signaling  effects requires that a company not have volatile dividend payments which  would which would lead lower investor confidence in the company and  adversely affect its cost of equity. So we need to have the proper dividend  distribution through the residual model to get around this problem, a company  can set a dividend low enough to keep dividend payments from constraining  operations, and then use repurchases on a more or less regular basis to  distribute excess cash. Such a procedure will provide regular, dependable  dividends, plus additional cash flow to those stockholders who want it so they  can always issue out their dividend, but keep it a little bit lower so we don't put a  strain on cash. And with the excess cash that we create from keeping a low  dividend, we can go back in the market and repurchase shares. Repurchases  are also useful when a firm wants to make a large shift in its capital structure,  wants to distribute cash from one time event such as the sale of a division, or  wants to obtain shares for use and employee option plan. 



Last modified: Tuesday, February 25, 2025, 2:29 PM