Question

Explain what happens to the stock price of Best Buy if payout comes

in the form of
(a) cash dividend

(b) repurchase

Answer 1

Solution:

Impact of cash dividends on stock price of BestBuy:

A cash dividend is a very simple transaction that simply involves the outgo of cash from company's account to the shareholders in lieu of dividends proposed by the board of directors. At any given time, the stock price of any company reflects value of all assets of a company and if any asset is reduced for any reason, the stock price goes down.

When a company pays dividends, the cash is transferred from company to shareholders, which results in reduction of company's assets. So, it results in proportionate reduction in the share price of the company called as 'ex-dividend'. In other words, the impact of outgo of cash from company's balance sheet is adjusted in the stock price and it falls to become ex-dividend.

Impact of share repurchases buy BestBuy:

The buyback of shares results in reduction of total number of shares of the company which means higher earnings per share in future for the remaining shares. This is generally seen as a vote of confidence as the company is investing funds in its own shares. Therefore, in the short-term impact of repurchases is generally positive as market looks forward to future growth being attributable to the remaining lesser number of shares.

However, if the company does buyback at an extremely expensive price, than it could result in negative impact on its stock price in mid-term to long-term. This is because shareholders see it as inefficient use of company's liquidity instead of investing it in other avenues that would have offered higher returns on investment.