Apratim, I think if you look over this paragraph you'll see what I'm getting at:
In the second case, if the share price remains the same, the net company value is 9000 as now there are 90 shares. But the shareholder has no cash in hand. Therefore, to compensate the shareholder, the share prices need to rise to 111 approx. so that they can sell part of the total holdings to raise the cash.
You have begged the question (i.e., assumed your conclusion).
If the shareholder received a cash dividend, the dividend is taxed as ordinary income. If the company uses the cash to repurchase shares it is effectively a dividend reinvestment plan, and the reinvestment is taxable, although the taxes are deferred because they are capital gains taxes. But lets strip tax considerations away for a moment and just consider two scenarios: the first in which a company dividends out all of its earnings, and the second in which a company uses the proceeds to purchase its own stock.
Assuming steady earnings of $1 per share on a stock worth $10 we have a perpetuity of $1, and assuming a discount rate of 10% we get a value of $10. Now, applying the same arithmetic to reinvestment, we get a stream of increasing share prices: $1.00, $1.10, $1.21 ...
But if you value the expected share price n years out using the 10% discount rate you will find that it is exactly $10. In other words, neglecting taxes, there is no creation of shareholder value by stock repurchase.
Reality is a little bit different. First, many shareholders believe that there is value creation, and thus, this is a self-fulfilling prophesy (at least for the short-run). Second, there is the perception that when a company repurchases its own shares it believes them to be "undervalued", and thus share prices are bid up (again for the short-term). Finally, there is the very real situation of tax differentials. Not only are dividends taxed at a higher rate, but capital gains taxes are deferred indefinitely. This differing treatment ought to lead to a relatively higher valuation for the company that reinvests in itself.
TTFN,
CTC |
