Question

Assume a company wants to return some of its significant cash stockpile to stockholders and has never before paid a dividend. Explain under what circumstances you would choose each of the following options and any negative considerations you may need address: Stock Repurchase Begin payment of a regular dividend Stock split or stock dividend

Answer 1

A stock Repurchase is when a company repurchases or buys back its own shares from the market. A repurchase reduces the total number of outstanding shares and thus increases ownership of the shareholders in the company. A company might repurchase its own shares when the market discounts its shares too steeply. A buyback or repurchase generally sends the signal that the company thinks its own shares as a good investment and encourages investment from the marketplace. Other reasons a company repurchases its own shares might be to improve financial ratios, reduce dilution of shares, increase shareholder value.

A company begins payment of a regular dividend when it is sure that it can continue to maintain the payment of dividends in the foreseeable future. Dividend cuts are viewed as a negative signal, whereas dividends payment are viewed as a positive signal as it conveys the message that the company is doing well and wants to share its profits with the investors. When a company has a cashflow available to distribute to its investors, and expects to maintain the cash distribution in the future, it begins a payment of regular dividends.

A stock split is when a company divides its existing shares into multiple shares. It does create any real value as the number of outstanding shares increases due to a stock split but the price per share decreases proportionately. A company chooses to split its stock if it thinks that the price of the share is too high. A stock split increases liquidity as it divides the shares into multiple shares with lower prices, making it feasible for investors with less money to invest in the company.

A stock dividend is the distribution of the company's shares as dividends rather than cash dividends. A company may want to share its profits with the investors but doesn't have the liquid cash required to do so, in which case, it may adopt a stock dividend policy. Another motive behind a stock dividend could be that the company may need additional funds for multiple investment opportunities and cannot afford to distribute its cash; a stock dividend increases the total capital of the company without paying hefty costs of brokerage, commission or floatation costs to increase its capital.