“A golden rule, companies must only repurchase its stock if the stock price is trading below its intrinsic value and there are no better investment opportunities available.”
As a follow up to my previous article, Clear Thinking about Share Repurchase by Mauboussin of Legg Mason is a great read on how and why stock repurchases replaced dividends as a major form of shareholder return in the US.Stock repurchases are usually used to boost EPS i.e. earnings per share of companies. The paper shares an in-depth analysis of tax laws governing both dividends and share repurchase and concepts in valuation like the cost of equity, time value of money, etc. Although the paper was published in 2006, nevertheless it’s very insightful and detailed on the subject. Recently, tax on stock repurchases was further revised making them favorable as a mode of shareholder return.
In a nutshell, corporate America is flush with cash but stock repurchases are certainly not the optimum use of capital except in cases wherein the share price is trading below the intrinsic value. Capital investment in research and technology, mergers/acquisitions, debt reduction and optimal use for working capital help companies in gaining long term strategic advantage with a better return to shareholders through stock appreciation apart from the plain vanilla option of dividends.