Here we focus on retiring shares through repurchase

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Unformatted text preview: which may have been declining. The use of repurchases to discourage unfriendly takeovers is predicated on the belief that a corporate raider is less likely to gain control of the firm if there are fewer publicly traded shares available. Here we focus on retiring shares through repurchase, because this motive for repurchase is similar to the payment of cash dividends. Stock Repurchases Viewed as a Cash Dividend When common stock is repurchased for retirement, the underlying motive is to distribute excess cash to the owners. Generally, as long as earnings remain constant, the repurchase reduces the number of outstanding shares, raising the 9. If a firm’s stock is selling at a low price—possibly less than a few dollars—many investors are hesitant to purchase it because they believe it is “cheap.” These somewhat unsophisticated investors correlate cheapness and quality, and they feel that a low-priced stock is a low-quality investment. A reverse stock split raises the stock price and increases per-share earnings. 576 PART 4 Long-Term Financial Decisions FOCUS ON PRACTICE Boosting Value with Stock Buybacks In September 2001, the Securities and Exchange Commission temporarily lifted restrictions on stock buybacks in an effort to shore up the downward-sliding stock market. Share repurchases could send a signal to investors that companies considered their shares undervalued. Hundreds of companies, including Allstate, Bank One, and BF Goodrich, soon announced plans to buy back their stock. Many others, such as Boeing, Caterpillar, and General Motors, still had multiyear buyback programs in progress. Many corporations regularly repurchase their shares when prices are down and/or cash flow exceeds suitable investment opportunities. Others move in and out of the market steadily, not just when the price is low. Buybacks give companies flexibility in returning cash to investors. (Dividend increases also return cash to investors, but they create an ongoing expense, and future dividend cuts may adversely affect stock price.) Other benefits include boosting stock price and optimizing capital structure. One survey showed that between 1991 and 1996, companies with buyback programs outperformed similar companies that did not repurchase shares by an average of 23 percentage points for the 4 years following announcement of the program. Companies that repurchased shares to reduce the number of shares outstanding can realize a significant improvement in stock price. In 2000 such companies earned returns that exceeded the Russell 1000 index by an average of 12.5 percentage points. Combining buybacks with higher dividends boosted stock prices even In Practice more. For example, homebuilder KB Home paid out 9 percent of its market capitalization to shareholders and saw its stock price jump over 46 percent for the 12-month period ending April 30, 2001. Not all buyback programs are considered successful. Moody’s Investors Service cited stock repurchases as having contributed to the debt downgrades of Nordstr...
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This document was uploaded on 01/19/2014.

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