dividends and repurchases

dividends vs repurchases

Dividends - cash payments from the firm to all shareholders

Repurchases - cash payments from the the firm only to shareholders who sell their shares back to the firm

How do firms signal future earnings with payouts

Increasing dividends - signal higher future earnings

Decreasing dividends - signals lower future earnings

Stock dividends vs stock splits

Stock dividends - gives existing shareholders more shares instead of cash

Stock splits - divided existing shares into more pieces to lower stock price

They don’t affect firm value

What are the 3 types of share repurchases

ATO

Open market - firm repurchases its own shares on the open market like any other investors

Tender offers - company offers to buy back a specific number of shares at a fixed price above market price

auctions - company sets a price range and shareholders submit the price they are willing to sell at. The company then chooses the lowest price

Compare and contrasting Dividends and Repurchases

Dividends

• Cash holdings - decrease because money is being paid to shareholders

• Equity - no change

• Firm value - no change

• Shares outstanding - no change

• Share price - slight drop because stock falls by the amount of dividend paid

Repurchases

• Cash holdings - decrease because you pay for shares form shareholders

• Equity - decrease

• Firm value - no change because no value is created or lost

• Shares outstanding - decrease because you buy back shares

• Share price - increases because it signals undervaluation or excess cash

What happens to the stock price when the firm starts to trade ex-dividend

Dividends increase so stock prices decrease

How can investors make dividends that the firm doesn’t pay, or unmake dividends that the firm does pay

Homemade dividends and undividends

• when the company doesn’t pay dividends, investors can sell a portion of shares each year

• When the company does pay dividends, investor can buy more shares with the portion of dividends they receive yearly

What is the most common feature of dividends policy

Dividends smoothing - dividends remain consistent no matter the fluctuations in profit

How do stock prices react to changes in payout policy

Increased dividends = positive market reaction, stock prices go up

Decreased dividends = negative market reaction, stock prices go down

Repurchases = stock is undervalued, stock prices increase

Pros and cons of dividends

Pros

• Signals strength

• Reduces agency costs because managers pay shareholders

Cons

• Double taxation

• Cash drain

• Signals weak growth opportunities

Pros and cons of repurchasing

Pros

• One time events

• Signals undervaluation

• Increases eps

Cons

• Can be poorly timed

• Signals lack of growth ideas

• Only shareholders who sell receive cash

When should a firm pay dividends instead of repurchasing

Dividends are better when the firm:

• Is stable

• Wants to reward all shareholders

• Wants to signal long term strength

Repurchases are better when:

• Flexibility is needed

• The stock is undervalued

• Temporary surpluses of cash