How To Evaluate A Share Buyback

How To Evaluate A Share Buyback

Over the last month, IT companies have announced to ๐๐ฎ๐ฒ ๐๐๐๐ค ๐ฌ๐ก๐๐ซ๐๐ฌ, and companies’ share prices have increased after this corporate action.

๐๐จ๐๐ฌ ๐๐ฎ๐ฒ๐ข๐ง๐  ๐๐๐๐ค ๐ฌ๐ก๐๐ซ๐๐ฌ ๐๐๐ ๐ฏ๐๐ฅ๐ฎ๐ ๐ญ๐จ ๐ ๐๐จ๐ฆ๐ฉ๐๐ง๐ฒ?
In my view, ๐ฌ๐ก๐๐ซ๐ ๐๐ฎ๐ฒ๐๐๐๐ค๐ฌ ๐๐จ ๐ง๐จ๐ญ ๐๐๐ ๐ฏ๐๐ฅ๐ฎ๐ in the longer term because share buyback as a corporate action does not impact a company’s cash flows.

I have taken an example of a firm with the following financials to substantiate my above hypotheses.

Earnings = \$700.00
Shares outstanding = 1000
EPS = 0.70
Share price = \$9
P/E ratio =12.85

The company decides to ๐ซ๐๐ฉ๐ฎ๐ซ๐๐ก๐๐ฌ๐ ๐ฌ๐ก๐๐ซ๐๐ฌ ๐๐ง๐ ๐๐จ๐ซ๐ซ๐จ๐ฐ๐ฌ ๐ฆ๐จ๐ง๐๐ฒ ๐ญ๐จ ๐๐ฎ๐ง๐ ๐ญ๐ก๐ ๐๐ฎ๐ฒ๐๐๐๐ค.

Debt to fund buyback = \$1,000
% of shares repurchased = 10%
Price/share for share repurchase = \$10
Interest rate on debt = 5%
Tax saving on debt = 25%
Interest expenses due to share repurchases = \$37.50

Thus after the buyback, the adjusted share count is 900, and the adj. earnings are \$662.50

Thus, the revised EPS after buyback = 0.74, which isย ๐.๐๐% ๐ก๐ข๐ ๐ก๐๐ซ ๐ญ๐ก๐๐ง ๐๐๐๐จ๐ซ๐ ๐๐ฎ๐ฒ๐๐๐๐ค.

At the P/E ratio of 12.85, the share price has to increase from \$9 to \$9.50 after share buyback, reflecting a price increase of 5.7%

๐๐ ๐ญ๐ก๐ ๐/๐ ๐ซ๐๐ญ๐ข๐จ ๐๐จ๐๐ฌ ๐ง๐จ๐ญ ๐๐ก๐๐ง๐ ๐, ๐ญ๐ก๐ ๐ฌ๐ก๐๐ซ๐ ๐ฉ๐ซ๐ข๐๐ ๐ฐ๐ข๐ฅ๐ฅ ๐ข๐ง๐๐ซ๐๐๐ฌ๐ ๐๐ฒ ๐%. ๐๐จ๐ฐ๐๐ฏ๐๐ซ, ๐ฐ๐ข๐ญ๐ก ๐๐ง ๐ข๐ง๐๐ซ๐๐๐ฌ๐ ๐ข๐ง ๐๐๐, ๐ญ๐ก๐ ๐๐๐๐ญ ๐ก๐๐ฌ ๐๐ฅ๐ฌ๐จ ๐ข๐ง๐๐ซ๐๐๐ฌ๐๐, ๐๐ซ๐ข๐ง๐ ๐ข๐ง๐  ๐๐จ๐ฐ๐ง ๐ญ๐ก๐ ๐/๐ ๐ซ๐๐ญ๐ข๐จ. ๐๐ก๐ฎ๐ฌ, ๐ญ๐ก๐ ๐ฌ๐ก๐๐ซ๐ ๐ฉ๐ซ๐ข๐๐ย ๐๐ญ ๐ญ๐ก๐ ๐ฅ๐จ๐ง๐ ๐๐ซ ๐ญ๐๐ซ๐ฆ ๐ฐ๐ข๐ฅ๐ฅ ๐ง๐จ๐ญ ๐ข๐ง๐๐ซ๐๐๐ฌ๐ ๐๐ฎ๐ ๐ญ๐จ ๐ญ๐ก๐ข๐ฌ ๐๐จ๐ซ๐ฉ๐จ๐ซ๐๐ญ๐ ๐๐๐ญ๐ข๐จ๐ง

However, if the company ๐๐ฎ๐ง๐๐ฌ ๐ญ๐ก๐ ๐๐ฎ๐ฒ๐๐๐๐ค ๐ญ๐ก๐ซ๐จ๐ฎ๐ ๐ก ๐ข๐ญ๐ฌ ๐๐๐ฌ๐ก ๐ซ๐๐ฌ๐๐ซ๐ฏ๐๐ฌ, it implicitly admits that it does not have investment opportunities that exceed its cost of capital. Thus, the management returns the excess cash instead of reinvesting it in projects with lower returns.

Thus, ๐บ๐๐๐๐ ๐๐๐๐๐๐๐๐๐๐๐ ๐๐๐๐ ๐๐๐๐๐ ๐๐ ๐ ๐๐๐๐๐๐ ๐๐๐ ๐๐๐๐๐๐๐๐ ๐๐๐๐๐ ๐๐๐๐๐๐๐๐๐๐๐, ๐๐๐ ๐๐๐๐ ๐๐๐๐ ๐๐๐ ๐๐๐๐๐ ๐๐๐๐ ๐๐๐๐๐ ๐๐๐๐๐๐๐๐๐๐๐ ๐๐ ๐๐๐๐๐๐๐๐๐๐ ๐๐๐๐๐๐ ๐๐๐๐๐.

Some companies ๐ฃ๐ฎ๐ฌ๐ญ๐ข๐๐ฒ ๐ฌ๐ก๐๐ซ๐ ๐๐ฎ๐ฒ๐๐๐๐ค๐ฌ ๐๐๐๐๐ฎ๐ฌ๐ ๐ญ๐ก๐๐ฒ ๐๐๐๐ฅ ๐ฆ๐๐ซ๐ค๐๐ญ๐ฌ ๐ก๐๐ฏ๐ ๐ฎ๐ง๐๐๐ซ๐ฉ๐ซ๐ข๐๐๐ ๐ญ๐ก๐๐ข๐ซ ๐ฌ๐ก๐๐ซ๐๐ฌ. But, again, ๐ป๐ผ ๐๐ฎ๐น๐๐ฒ ๐ฐ๐ฟ๐ฒ๐ฎ๐๐ถ๐ผ๐ป ๐ต๐ฎ๐ฝ๐ฝ๐ฒ๐ป๐, ๐ฏ๐๐ ๐๐ฎ๐น๐๐ฒ ๐๐ฟ๐ฎ๐ป๐๐ณ๐ฒ๐ฟ ๐ต๐ฎ๐ฝ๐ฝ๐ฒ๐ป๐ from one set of shareholders who sell the shares to those who hold them.

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• […] If NPV of future growth opportunities >0, income stock becomes growth stock. If the company cannot identify projects with NPV>0, it should ๐ซ๐๐ญ๐ฎ๐ซ๐ง ๐ญ๐ก๐ ๐๐ฑ๐๐๐ฌ๐ฌ ๐๐๐ฌ๐ก ๐๐ฅ๐จ๐ฐ ๐ญ๐จ ๐ฌ๐ก๐๐ซ๐๐ก๐จ๐ฅ๐๐๐ซ๐ฌ ๐๐ฌ ๐๐ข๐ฏ๐ข๐๐๐ง๐๐ฌ ๐จ๐ซ ๐๐ฎ๐ฒ๐๐๐๐ค. […]