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Dividend: Cash Vs. Stock Repurchase



Procter & Gamble Co. announced a $1 billion stock repurchase program, the first of its kind at the company. P&G also declared a 12.5% boost in its quarterly dividend. (WSJ, July 11, 1996)



I would like to use this news to look at the merits of "stock repurchase" and its relationship to dividends.


Definitions and Implications of Dividend and Stock Repurchase

Dividend is a distribution of value to shareholders. Using this definition of dividend, then "stock repurchase" is just one form of dividend. Can you see the connection?

When a company buys back its own shares it has to offer a price higher than the current stock price, otherwise investors have no incentive to sell their stock. Buy offering a price higher than the market’s, the company is distributing value to its existing shareholders. Note that "dividend" is used in a generic sense of value-distribution as well as a cash distribution, the most common form of dividend. You should also note that cash dividends are paid on a regular basis unless the company explicitly announces an on-time increase in dividends. The latter is referred to as a "special dividend."

The main advantage of stock repurchase over dividends is that the latter is a one-time distribution. An increase in dividend is promised to the shareholders, such that the company would be paying the dividend on a regular basis in the future.

There are two important implications of "expected regular dividend" and "one-time distribution." One is that if a regular dividend is lowered, then investors interpret this act as a bad sign, and thus the price of the stock tends to fall. Because of this built-in expectation, dividend is a burden on the company, as the company feels obligated to satisfy its shareholders’ expectation. On the other hand, stock repurchase is a one-time deal, and thus, shareholders don’t expect it to continue in any regular fashion in the future.


Is An Increase In Dividend Good Or Bad For The Shareholders?

The answer is, it depends. Using the previously stated definition of dividend, paying it suggests that the company must, at least, have "excess" cash on hand. Thus, the question boils down to: what should a company do with its "excess" cash? Such a company has two alternatives: either invest the money in projects (internal expansion or acquisitions) or distribute it to shareholders. The choice between these two alternatives is simple: if the company has good projects (i.e., those with Net Present Value > 0), then it should invest in these projects as they would create value to shareholders. Otherwise, the company should distribute the "excess" cash to shareholders in the form of dividends.

Thus, when a company increases its regular cash dividend it is typically saying one of two things. One, using the "burden" argument outlined above, the company must be saying (or signaling) that it expects to be profitable in the future and thus the increase in dividend is not a "burden." The second scenario, using the "good projects" argument above, is that the investors may interpret the move as a signal that the company does not have profitable projects and thus it is distributing "excess" cash. Obviously, if the market believes the first argument, then stock prices tend to increase; prices decline if they believe that the company is facing the second scenario.


P&G Specifics

Procter & Gamble announced a buyback of about 11 million shares, or under 2% of the 686.4 million shares outstanding. This is a departure from its usual practices. In the past, P&G has repurchased shares but solely to offset dilution caused by issuing stock options to management, such as a repurchase program announced in 1995 to buy as many as five million shares, according to the Journal.

P&G typically spends $500 million to $1 billion a year in acquisitions, but last year, investment in acquisitions totaled about $200 million, notes the Journal.

With regard to cash dividend, it was increased to $1.80 a share, up 20 cents. An increased quarterly dividend of 45 cents a share, up from 40 cents a share, is payable August 15 to stock of record July 19. Note that as a convention, dividend is measured in annual terms. Moreover, when dividends are announced (declaration date), a company has to specify the date of payment, August 15, and a date on which the record indicates ownership of the stock, July 19 (record date). However, a problem could develop if the stock were sold on July 18, one day prior to the record date. There would not be enough time for the sale to be reflected on the stockholder list by July 19. To avoid this problem, stock brokerage companies have uniformly decided to terminate the right of ownership to the dividend four working days prior to the record date. This prior date is the ex-dividend date.

Despite the fact that P&G is in effect investing about $2.8 billion to boost shareholder value with both the dividend payout and share repurchase, Wall Street wasn't too impressed. P&G shares dropped 25 cents to lose at $88.50 a share in New York Stock Exchange composite trading, off their 52-week high of $93.875 a share. This might suggest that investors don’t seem to interpret the move as a signal of better times coming for P&G.

By Alex Tajirian

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