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Technology Stocks : Dell Technologies Inc. -- Ignore unavailable to you. Want to Upgrade?

To: Geoff Nunn who wrote (47405)	6/13/1998 2:39:00 AM
From: Chuzzlewit	Respond to of 176387

Geoff, perhaps I worded my reply too loosely. The general model is to compare paying cash dividends to shareholders versus stock repurchases. There are two general reasons why share repurchases can work. The first is essentially the argument that the stock of the company is undervalued, and investing in the firm using share repurchase enhances shareholder value. The second has to do with the fact that there is a differential tax treatment between dividends and capital gains. Let's take a hypothetical. Suppose we have a company capable of paying $1 per year in dividends as a perpetuity. For ease of computation let's assume a 10% discount rate, and let's assume that a dividend is due now. Then the value of the dividend stream will be $11 ($1 for the current dividend plus $10 for the capitalized stream). Let's assume that the firm elects to forgo paying the dividend and instead uses the cash to repurchase shares on the open market. That will result in a dividend stream of $1.10 (again with a present value of $11). However, one year from now the price of the stock will rise to $12.10. Now, from the perspective of the shareholder, he must pay taxes on dividends received, while taxes due to capital gains are deferred until the sale of the security. This in effect creates an interest free loan from the government. In addition, capital gains are taxed at a lower rate. Therefore, all other things being equal, investors would prefer to hold stocks that do not pay cash dividends and instead repurchase their shares. Hence, the price is bid up. Perhaps I am begging the question when I say that the choice is between share repurchase and a cash dividend. You have correctly pointed out that retaining the cash will increase eps. I will have to sit down at the computer and analyze it from the perspective of that alternative, but superimposing a growth model on it. Stay tuned. One error I think you are making in your analysis (although it doesn't affect the results here) is that you are using backward p/es and for calculating prospective results. If we are dealing with a perpetuity, then a trailing p/e of 50 is equal to a forward p/e of 33.3. TTFN, CTC