Delta Widget, Inc. has just made you a tender offer to buy back its
shares of stock, which you bought from your broker a few years ago. The
stock price hasn?t grown as expected and the tender offer is just
slightly over market value. It's tempting to take the offer. On the
other hand, when Delta Widget buys its own stock back, there will be
less stock outstanding, and that could help boost its price.
The dilemmas of investing - will they never cease?
To
weave our way through this problem, let?s first examine the two ways a
company can initiate a buyback program, or "stock repurchase agreement"
as it's often called. The first way is to make a tender offer to its
shareholders. A "tender offer" is simply an offer to its current
shareholders to "tender" (i.e., sell) some portion of their shares back
to the company. The company states the number of shares it is willing
to buy, at what price, and for what period of time. This is one way
that is often used to buy back stock from smaller shareholders.
The
second way is for the company to buy its own stock on the open market,
at whatever market price the shares command. When the company announces
this type of program, it will usually state the number of shares it
offers to buy, and the length of time it will keep the offer open.
If
Delta Widget, Inc. were to announce such a program, it might announce
that it intends to buy back $50 million worth of its stock over a
two-year period. Since the company doesn?t know what the price per
share will be over the next two years, the repurchase program will be
expressed as a dollar amount rather than a set number of shares.
Whatever method is used by a company, the real question is why the company wants to buy back its stock in the first place?
The
answer to that question is rather simple. Let's suppose that, before
the buyback, Delta Widget had a market capitalization of $250 million,
that it had 10 million shares outstanding, and that the market price
per share was $25.00. Under this scenario, each share of stock would
represent .0000001 of company ownership.
If the company spends
$50 million to buy its shares back at $25 per share, it will be able to
repurchase 2 million of its shares. That will leave 8 million shares
outstanding. In that case, each outstanding share would then represent
.000000125 of company ownership. Theoretically, the price per share
would then be $31.25 (8 million x .000000125). Not a bad increase at
all!
Naturally, not all companies are motivated to increase share
value in this manner. Instead, a growing reason for repurchase plans is
to reduce the number of shares outstanding, as opposed to increasing
the price per share. Companies that have liberally doled out stock
options to employees in the past, now find themselves offering buyback
programs because the exercise of the stock options has increased the
number of the company's outstanding shares. An increased number of
outstanding shares can adversely affect important ratios, like earnings
per share and price/earnings (P/E), all of which can negatively impact
share price.
A repurchase plan can also cause problems if a
company overpays for its own stock. If natural market forces or a
business downturn creates a decline in stock price, the company will
not only have failed to increase stockholder value, but it also will
have consumed much-needed capital, capital that could have been used
for other business purposes.
In the final analysis, the
evaluation of a stock buyback plan is nothing more than an evaluation
of the company itself. If the company's stock price is undervalued and
buying back some stock will result in an overall reduction in the
number of shares outstanding, then holding on to your shares could be a
good bet. On the other hand, if it appears that company management is
trying to manipulate the stock price to make the company appear better
than it really is, then you should think about divorcing yourself from
the company.
Glenn ("Chip") Dahlke, a senior contributor to the Living Trust Network, has 28 years in the investment business.
He
is a Registered Representative of Linsco/Private Ledger and a principal
with Dahlke Financial Group. He is licensed to transact securities with
persons who are residents of the following states: CA. CT, FL, GA, IL.
MA, MD. ME, MI. NC, NH, NJ, NY.OR, PA, RI, VA, VT, WY.
If you have any questions or comments, Chip would love to hear from you. You may contact him at dahlkefinancial@sbcglobal.net. You may also contact him at the Living Trust Network. Its web site is http://www.livingtrustnetwork.com.
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