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Repurchase versus Dividend Analysis
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After a stock goes ex-dividend (e.g. the financial obligation for the company
to pay the dividend to the holder), the stock price should drop. To calculate the
amount of the drop, the traditional method is to view the financial effects of the
dividend from the perspective of the company. Since the company has paid say $x in
dividends per share out of its cash account on the left hand side of the balance
sheet, the equity account on the right side should decrease an equivalent amount.
This means that a $x dividend should result in a $x drop in the share price.
An open market share repurchase has no real effect on the stock price. Example, a firm
with $100 in machinery plus $100 in cash that has 20 shares outstanding is worth $10
a share ($200/20 shares). If they use that $100 cash to buy 10 of the outstanding shares
for $10 each, they now have $100 in machinery only to divide across 10 public shares
for a value of...$10 per share ($100/10 shares). However, buybacks normally signal
that management believes that the stock price is undervalued and also have the effect
of reducing the P/E ratio both of which make the stock more attractive to investors.