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DIVIDEND & SHARE REPURCHASES :BASICS TEAM MEMBERS: HiraNiazi Maaz Ahmed Siddiquie Ali Hamza Jan 2021
TABLE OF CONTENT 10.1. Describe regular cash dividends , extra dividends , liquidating dividends , stock dividends , stock splits, and reverse stock splits, including their expected effect on shareholder’s wealth and a company’s financial ratios; 10.2.Describe dividend payment chronology , including the significance of declaration , holder-of-record, ex-dividend , and dividend payment dates; 10.3.Compare share repurchase methods; 10.4.Calculate and compare the effect of a share repurchases on earnings per share when 10.5.The repurchase is financed with the company’s excess cash and 10.6.The company uses debt to finance the repurchase; 10.7.Calculate the effect of a share repurchase on book value per share ; 10.8.Explain why a cash dividend and a share repurchase of the same amount are equivalent in terms of the effect on shareholders wealth, all else being equal.
CONCEPTS 10.1. Describe regular cash dividends , extra dividends , liquidating dividends , stock dividends , stock splits, and reverse stock splits, including their expected effect on shareholder’s wealth and a company’s financial ratios;
INTRODUCTION • A dividend is a pro rata distribution to shareholders that is declared by the company’s board of directors and may or may not require approval by shareholders. • A repurchase of stock is a distribution in the form of the company buying back its stock from shareholders. • The board of directors determines the company’s payout policy. • Cash dividends and share repurchases are both methods of distributing cash to shareholders. • The effects on financial ratios and on shareholders’ investment returns are different between these two methods. • These distributions may provide information about the company’s future prospects. • Issuing companies cannot deduct distributions to shareholders for tax purposes.
BASIC TYPES OF CASH DIVIDENDS • Regular cash dividends • Dividend Reinvestment Plan • Extra Dividend or Special Dividend • Liquidating Dividend • Stock Dividend • Stock splits
BASIC TYPES OF CASH DIVIDENDS REGULAR CASH DIVIDEND DIVIDEND REINVESTMENT PLAN (DRP): • A regular cash dividend is a cash dividend paid at regular intervals of time • The regular intervals may be any frequency, but the most common are quarterly, semiannually, or annually. • Tendency of companies is to maintain or increase dividends. • Often viewed as signals of management’s assessment of the company’s future (that is, whether the company can maintain the dividend in the future). • Companies prefer not to cut or reduce the dividend. • A dividend reinvestment plan (DRP) is a program that permits investors to reinvest cash dividends automatically into the stock of the issuing company. • The shares provided in exchange for the cash dividends may be acquired in the open market by the issuer or may be newly issued shares. • Advantages to the issuer: • Encourage owners with smaller holdings to accumulate shares. • “Raise” new equity capital without flotation costs. • Advantages to the investor: • Cost averaging of share purchases. Opportunity (in some cases) to buy shares at a discount from market value. • Disadvantages to the investor: • Record keeping Dividends are taxed when “received,” whether reinvested or not.
Extra dividend (or special dividend): • Liquidating dividends: An extra dividend (or special dividend) is a dividend that is either paid by a company that does not pay dividends regularly or paid by a company in addition to a regular dividend. Example: Whole Foods Market announced a $2 special dividend in December This was in addition to its $0.20 per quarter cash dividend. Motivation: Pay out in strong years without investors expecting an increased dividend. A liquidating dividend is a distribution of cash to shareholders when Going out of business, or Selling a portion of the business, or Paying a dividend when retained earnings are not positive.
Stock dividend • A stock dividend is the distribution of additional shares of stock to shareholders on a pro rata basis. - Also known as a bonus issue of shares. • Generally stated as a percentage of current shares outstanding. • A stock dividend does not change a shareholder’s proportionate ownership, the shareholder does not receive cash, and there are no tax consequences. • Advantages for the issuer: • More shares outstanding and, therefore, potential for more shareholders. • Lowers the stock’s price, which may make it more attractive as an investment. • No economic effect.
Example: Stock dividend Dwight Craver owns 100 shares of Carson Construction Company at a current price of $30 per share. Carson has 1,000,000 shares of stock outstanding, and its earnings per share (EPS) for the last year were $1.50 . Carson declares a 20% stock dividend to all shareholders of record as of June 30. What is the effect of the stock dividend on the market price of the stock, and what is the impact of the dividend on Craver's ownership position in the company?
ANSWER: The effect of the stock dividend is to increase the number of shares outstanding by 20%. However, because company earnings stay the same, EPS decline and the price of the firm's stock drops from $30 to $25. Craver's receipt of more shares is exactly offset by the drop in stock price, and his wealth and ownership position in the company are unchanged.
Reverse stock split: Stock split: A reverse stock split is the proportionate reduction in the number of shares. A reverse stock split has the opposite effect of the traditional, or forward, stock split: It reduces the number of shares, with the expectation of increasing the stock price. A 1:2 reverse stock split results in half the number of shares outstanding after the split. The goal may be to increase the share price to make it more attractive for institutional investors. Reverse stock splits are most common for companies in financial distress. It is not permitted in some countries. • A stock split is a proportionate increase in the number of shares outstanding. • Stated in the following form: • Number of new shares : Number of old shares • So, 2:1 means that for each share held before the split, the shareholder holds two shares after the split. Stock splits do not affect the dividend yield or the dividend payout ratio. • Accounting: Memorandum entry, no change in accounts. • The announcement is generally viewed as a positive signal.
EFFECT OF REVERESE STOCK SPLIT ON FINANCIAL RATIOS: Effects on Financial Ratios Paying a cash dividend decreases assets (cash) and shareholders' equity (retained earnings). Other things equal, the decrease in cash will decrease a company's liquidity ratios and increase its debt-to-assets ratio, while the decrease in shareholders' equity will increase its debt-to-equity ratio. Stock dividends, stock splits, and reverse stock splits have no effect on a company's leverage ratios or liquidity ratios. These transactions do not change the value of a company's assets or shareholders' equity; they merely change the number of equity shares.
DIVIDEND PAYMENT PROCEDURES 10.2.Describe dividend payment chronology, including the significance of declaration, holder-of-record, ex-dividend, and payment dates.
DIVIDEND PAYMENT CHRONOLOGY • Declaration date: The date the board of directors approves payment of the dividend. • Ex-dividend date: The first day a share of stock trades without the dividend. The ex-dividend date is also the cutoff date for receiving the dividend and occurs two business days before the holder-of-record date. If you buy the share on or after the ex-dividend date, you will not receive the dividend. • Holder-of-record date: The date on which the shareholders of record are designated to receive the dividend. • Payment date: The date the dividend checks are mailed out or when the payment is electronically transferred to shareholder accounts.
MORE ON STOCK DIVIDEND Before, ex-dividend date, the stock is said to trade “with dividend” and afterwards the stock trades “ex dividend” • The ex-dividend date convention removes any ambiguity about who is entitled to the dividend. • The stock price will be affected when the stock goes “ex”. Illustration: • A share is selling for $ 10 • BoD declares $ 1 dividend per share, and record date is Tuesday, June 12 (Sunday being off-day in market) • Ex-Date – Friday (June 8) • You buy stock on last hour of Thursday (June 7). You’ll get $ 1 dividend. • You buy stock as the market opens on Friday (June 8). You wont get $ 1 dividend. • What happens to the value of stock overnight ?
10.3:Compare share repurchase methods 10.4.Calculate and compare the effect of a share repurchases on earnings per share when 10.5.The repurchase is financed with the company’s excess cash and 10.6.The company uses debt to finance the repurchase; 10.7.Calculate the effect of a share repurchase on book value per share
SHARE REPURCHASE • A Share repurchase is the transaction in which the stock issuer buys back its shares from investors. Also known as a share buyback. Once repurchased, the shares become treasury shares (or treasury stock).Share repurchases are restricted by regulations in some countries. • Examples of restrictions: • Canada limits repurchases to 5%.Shareholders must approve repurchase in the United Kingdom, France, and Germany. • Motives for repurchasing shares include the following: • Signal that the stock is undervalued. • Flexibility of distributing cash without the expectation of cash dividends. • Tax efficiency when the tax rate on capital gains is less than that of cash dividends. • Offset share increases from executive stock options.
Direct Negotiation Dutch Auction Tender Offer Buy in the Open Market Fixed Price Tender Offer • Specify the number of shares and the range of prices. • Shareholders determinethe number of shares they will sell back and specify the price within the range. • Negotiate with a specific shareholder. • Method may be used to prevent “activist” shareholder from getting on board. • Use brokers to buy shares. • Method provides flexibility for the company. • Specify the number of shares and the share price. • Buy pro rata if oversubscribed • SHARE REPURCHASE METHODS
SHARE REPURCHASE AND EARNING PERSHARE The Diluting Company is planning a $100 million share repurchase. Its current stock price is $25 per share, and there are 16 million shares outstanding prior to the repurchase. Earnings per share without the repurchase would be $3 per share. What is the earnings per share under each of these two scenarios? Scenario 1: Use idle cash on hand. Scenario 2: Borrow funds at after-tax rate of 7% SOLUTION: Scenario 1: Net income = $3 × $16 million = $48 million (start with EPS and multiply by number of shares outstanding) EPS Scenario 1 = $48 million ÷ (16 million – 4 million) = $4 per share (divide net income by the new number of shares outstanding) Scenario 2: Net income = $3 ×16 million – (0.07 × $100 million) = $41 million (subtract the interest on the borrowed funds to arrive at the new net income) EPS Scenario 2 = $41 million ÷ (16 million – 4 million) = $3.41 per share (divide the new net income by the new number of shares outstanding)
SHARE REPURCHASE AND BOOKVALUE PER SHARE • When the market price per share is greater than the book value per share (BVPS), the book value per share of equity will decrease with a share repurchase. • Continuing the Diluting Company example and adding the book value per share of $20: • Note: Book value per share is less than the market value per share. • Scenario 1: • Book value = ($20 × 16 million) – $100 million = $220 million • BVPS Scenario 1 = $220 million ÷ (16 million – 4 million) = $18.33 per share • Scenario 2: • Book value = ($20 × 16 million) – $100 million – $7 million = $213 million • BVPS Scenario 2 = $213 million ÷ (16 million – 4 million) = $17.75 per share
10.7: • Explain why a cash dividend and a share repurchase of the same amount are equivalent in terms of the effect on shareholders’ wealth, all else being equal.
SHARE REPURCHASE V/S CASH DIVIDEND • If… • The tax consequences of dividends and capital gains are the same and • The information content of cash dividends and stock repurchases is the same. • Then the effects of cash dividends and repurchases on shareholder value will be the same. • Both cash dividends and stock repurchases, if financed the same way: • Reduce assets by the amount of the dividend or repurchase (the dollar amount of the dividend or repurchase). • Reduce equity by the amount of the dividend or repurchase (treasury stock). • Provide investors with the same cash flow.
SUMMARY • Dividends can take the form of regular or irregular cash payments, stock dividends, or stock splits. • Regular cash dividends represent a commitment to pay cash to stockholders on a quarterly, semiannual, or annual basis. • The key dates for cash dividends, stock dividends, and stock splits are the declaration date, the ex-date, the shareholder-of-record date, and the payment date. • Share repurchases, or buybacks, most often occur in the open market. Alternatively, tender offers occur at a fixed price or at a price range through a Dutch auction. • Share repurchases made with excess cash have the potential to increase earnings per share, whereas share repurchases made with borrowed funds can increase, decrease, or not affect earnings per share, depending on the after-tax borrowing rate. • A share repurchase is equivalent to the payment of a cash dividend of equal amount in its effect on shareholders’ wealth, all other things being equal. • Announcement of a share repurchase is sometimes accompanied by positive excess returns in the market when the market price is viewed as reflecting management’s view that the stock is undervalued. • Initiation of regular cash dividends can also have a positive impact on share value.
