Stock repurchase may be viewed as an alternative to paying dividends in that it is another method of returning cash to investors. A stock repurchase occurs when a company asks stockholders to tender their shares for repurchase by the company. There are several reasons why a stock repurchase can increase value for stockholders. First, a repurchase can be used to restructure the company's capital structure without increasing the company's debt load. Additionally, rather than a company changing its dividend policy, it can offer value to its stockholders through stock repurchases, keeping in mind that capital gains taxes are lower than taxes on dividends.

Advantages of a Stock Repurchase
Many companies initiate a share repurchase at a price level that management deems a good entry point. This point tends to be when the stock is estimated to be undervalued. If a company knows its business and relative stock price well, would it purchase its stock price at a high level? The answer is no, leading investors to believe that management perceives its stock price to be at a low level.

Unlike a cash dividend, a stock repurchase gives the decision to the investor. A stockholder can choose to tender his shares for repurchase, accept the payment and pay the taxes. With a cash dividend, a stockholder has no choice but to accept the dividend and pay the taxes.



At times, there may be a block of shares from one or more large shareholders that could come into the market, but the timing may be unknown. This problem may actually keep potential stockholders away since they may be worried about a flood of shares coming onto the market and lessening the stock's value. A stock repurchase can be quite useful in this situation.

Disadvantage of a Stock Repurchase
From an investor's perspective, a cash dividend is dependable; a stock repurchase, however, is not. For some investors, the dependability of the dividend may be more important. As such, investors may invest more heavily in a stock with a dependable dividend than in a stock with less dependable repurchases.



In addition, a company may find itself in a position where it ends up paying too much for the stock it repurchases. For example, say a company repurchases its shares for $30 per share on June 1. On June 10, a major hurricane damages the company's primary operations. The company's stock therefore drops down to $20. Thus, the $10-per-share difference is a lost opportunity to the company.



Overall, stockholders who offer their shares for repurchase may be at a disadvantage if they are not fully aware of all the details. As such, an investor may file a lawsuit with the company, which is seen as a risk.

Price Effect of a Stock Repurchase
A stock repurchase typically has the effect of increasing the price of a stock.


Example: Newco has 20,000 shares outstanding and a net income of $100,000. The current stock price is $40. What effect does a 5% stock repurchase have on the price per share of Newco's stock?

Answer: To keep it simple, price-per-earnings ratio (P/E) is the valuation metric used to value Newco's price per share.

Newco's current EPS = $100,000/20,000 = $5 per share
P/E ratio = $40/$5 = 8x

With a 2% stock repurchase, the following occurs:
Newco's shares outstanding are reduced to 19,000 shares (20,000 x (1-.05))
Newco's EPS = $100,000/19,000 = $5.26


Given that Newco's shares trade on eight times earnings, Newco's new share price would be $42, an increase from the $40 per share before the repurchase. (Read more about stock repurchases in Market News That Seems Promising But Isn't and Top Perks Warren Buffett Gets When Purchasing Equities.)



Stock Dividends And Stock Splits

Related Articles
  1. Investing

    Behind U.S. Equities' Declining Buybacks and Dividend Payments

    Learn what a decline in share repurchases and dividend payouts by corporations means for equity markets, and whether it is a cause for long-term concern.
  2. Investing

    Wal-Mart's Share Repurchase Isn't All Good

    Wal-Mart announced huge internal investments along with an aggressive share repurchase program that isn't as good as it initially sounds.
  3. Insights

    The Share Buyback Report: The Industrials Sector (GE, MMM)

    Analyze share repurchase data for the industrials sector to identify factors that are driving trends over time and buybacks by companies in the sector.
  4. Investing

    Skyworks Announces $500 Million Stock Repurchase

    Along with a Q1 earnings beat, Skyworks announces a newly approved stock repurchase plan.
  5. Investing

    Repurchase Agreement

    A repurchase agreement is the equivalent of a short-term collateralized loan. An owner of marketable securities sells those securities to a buyer for cash. As part of the deal, the seller agrees ...
  6. Investing

    The Share Buyback Report: The Telecom Sector (T, VZ)

    Examine telecommunications sector share repurchase data to identify which companies and catalysts drove buyback trends between 2006 and 2015.
  7. Investing

    What's Your Stock's Repurchase Premium?

    Take a closer look at your favorite stock's statement of equity; you never know what you're going to find
  8. Investing

    The Share Buyback Report: The Utilities Sector

    Explore historical share repurchase data for the utilities sector to learn how cash dividends and valuations drove buyback activity by company over time.
  9. Investing

    The Share Buyback Report: The Consumer Staples Sector

    Analyze share repurchase data for the consumer staples sector. Identify the factors that influence buybacks over time and project future activity.
  10. Insights

    United Reconsiders Stock Buyback (UAL)

    United is rethinking its $2 billion share repurchase program because of increased labor and fuel costs.
Frequently Asked Questions
  1. What are the Differences Between Ex Works (EXW) and Free On Board (FOB)?

    Learn about Ex Works and Free on Board, the main difference between these Incoterms, and the responsibilities of buyers and ...
  2. What are Common Examples of Monopolistic Markets?

    Discover what causes real instances of market monopoly, how it persists and where monopoly privilege is most common in the ...
  3. What is the gold standard?

    The gold standard is a monetary system where a country's currency or paper money has a value directly linked to gold, but ...
  4. What's the most expensive stock of all time?

    The most expensive publicly traded stock of all time is Warren Buffett’s Berkshire Hathaway.
Trading Center