GeoffF100 wrote:csearle wrote:No ambiguity. If on the other hand you witness that "returned" (ha ha) cash going into a share buyback, you receive zero cash. The share might go up; might go down. There is zero discernible correlation.
If a dividend was paid, the price it would fall by the price of the dividend on the xd date. After a buyback, barring volatility, the share price should remain unchanged. In practice, there will be volatility. The share might go up; might go down. That happens always, but not as the result of a buyback.
It is the same situation with an accumulating fund. The dividends are reinvested, but the number of units remains the same. The price of the income units falls by the value of the dividend on the xd date. The price of the accumulation units remains the same, again barring volatility.
Nobody claims that accumulation units do not reinvest dividends because the price of a unit does not go up when a dividend is paid. Why do they make that mistake with buybacks?
To get one's head around dividends vs buybacks it is essential to keep the value of the business and the price of the shares as separate entities. People default to
share price = value of the business because most of the time the number of shares is constant but they are NOT equivalent if the number of shares is changing!. With buybacks you have to abandon this shortcut.
So let's contrast what happens to an idealised company with dividends vs buybacks. The value of our company is the market price multiplied by shares outstanding; it is also the discounted value of the expected cashflows, and of course near-term cashflows are not discounted to any relevant extent for the purposes of this discussion especially in our low-yield environment. Also, we assume for simplicity our business performance is perfectly smooth, dividend payment (or buyback) policy is set perfectly by an infallible board and the economy does not affect the business valuation [in other words we strip out the very volatile noise which normally swamps and hides the price effect of dividends and buybacks].
Let us consider the situation between consecutive near-term dividend payments. In our simplified model the underlying value of the business is constant from one dividend period to the next. On the ex date a dividend has been declared but shareholders are no longer entitled to receive it. Thus the business will pay out one less near-term cashflow to holders compared to the previous day and the business value falls by the amount of the dividend. (Since the previous ex date of course the company has traded and accumulated distributable profits as usual to meet the dividend payment.) What happens in between the two ex dates? All the future cashflows are getting nearer day by day so their discounted value rises a little each day; thus the business value rises steadily over the dividend period. [If the dividends were paid in small amounts daily rather than in infrequent lump sums the business value would remain constant from day to day.]
Now, since the number of shares is constant in this scenario, the share price also will be seen to rise steadily over the dividend period until ex date when it drops by the amount of the dividend back to its value at the previous ex date. Anyone familiar with bonds will recognise this as exactly what happens to the price of a perpetual bond.
The value of the business and the share price don't vary from one ex-date to the next.What happens with buybacks? Let's say that a single dividend is replaced by a buyback of the same value. In terms of the business finance nothing changes: trading is as in previous periods, creating distributable profits; cash is paid out in the same amount as previous dividends. It stands to reason then that the value of the business will be the same as the dividend case immediately prior to the buybacks. However by the end of the buyback program the situation will be different:
remaining shareholders will not have received a cashflow that they would have received had a dividend been paid. However, they will be entitled to a higher proportion of all the future dividends because there are now fewer shares, i.e. all future cashflows will increase in proportion to the number of shares bought back. Since we know the value of the business is unchanged we deduce that the missed cashflow is the same value to remaining shareholders as their increased future cashflows. Since the number of shares remaining is smaller, the price of each share has risen in similar proportion. Future dividend per share is higher, but the price is also higher so dividend yield is unchanged.
The price per share has risen permanently, but in what manner? Well, the market doesn't know the exact timing of purchases but can form a view and adjust the share value progressively upwards accordingly. If that view turns out to have been inaccurate when buyback results are published then the share price might adjust for the mismatch at the time of the announcement.
With a buyback, the value of the business is unchanged at the end of each buyback period, but the number of shares has decreased and the share price increased in proportion to the buyback, and future dividend per share is higher.GS