To: Jack Clarke who wrote (15536 ) 4/23/1998 8:34:00 PM From: Zeev Hed Read Replies (2) | Respond to
Jack, take the last quarterly report of MRK and compare their performance to the last quarter, you will see that their buy back program was instrumental in their sustaining the growth they have achieved. A buyback reduces the number of shares outstanding, and thus the same profits are distributed over fewer shares increasing the earning per shares of the remaining shares. Look at this slightly differently. A company may decide that the "correct" way to use earning is to distribute half of them as dividends and use the other half to continue growth of the company. Now, they come to a second decision, they can decide to pay out all the 50% of earning as a cash dividend, the holders will end up with only 25% of these earnings as cash paying out the other 50% to the fed and the states (at least in many states where the tax rate on dividends is 10%). So, they decide to pay out only 20% (or 10% of total earnings) as a cash dividend and with the other 80% (40% of total earnings) they buy back shares. If a company has a PE of let say 20, the earnings are 5%, thus in this case, they would pay a cash dividend of .5% and buy back stock with 2%, the actual return (with 50% tax rate) is 4.5%, a very nice way of avoiding paying taxes to uncle Sam and the states, and mind you, not a shabby return relative to "growthless" treasuries at 5.75% (give or take). The owner of stock that had about 1% of the share, now has 1.02% of the stock and that happened without having to pay taxes. In other words, if that owner wanted to reinvest its dividends in the company itself (as many companies are now offering), he gets twice as much of the shares than he would have if the company gave out a cash dividend of 2.5%. Specifically, in the same example, if all the dividend is paid out in cash, the holder of 1% will end up with about 1.0125%, but when the company buys back the shares in the market, the same holders end up with 1.0225%.
