Chuz, I wasn't arguing Dell should hold cash. I said I favor stock buy backs. I was simply pointing out that a stock buy back doesn't necessarily raise EPS, and may in fact lower it. Given my assumptions, when Dell takes money out of an interest bearing account, it gives up a yield of 3.5%. This was income that, being above Dell's average EPS of 2%, causes the revised average to fall.
Let's assume the price of Dell stock is $100 and the p/e is 50. If the company takes $100 out of cash and uses it to retire one share of stock, it saves $2 in earnings otherwise claimed by that share. But taking $100 out of cash costs $3.50 in foregone interest income. This means the aggregate income which the remaining shares are entitled to falls by $1.50, causing a decline in EPS.
To be sure, a stock buy back is actually retiring a stream of EPS, which although currently only $2, is expected to grow. That's why a buy back can be good policy, even though it may depress EPS for a time. |
