Share buybacks and Dividends Flashcards
what should we consider when deciding whether to distribute dividends or perform a share buy back?
from Q16.22
- Companies Act requires you to:
- pass the solvency and liquidity test (dividends or buyback).
- for buyback, you need to have a directors authorisation and confirmation of the passing of the solvency and liquidity test - Check if it is an unlisted company that has contributed Tax Capital because they can then avoid Dividends Tax through a Buyback or speical Dividend. It will however result in a decrease in the base cost for sahreholders of their shares.
- Dividends are charged 20% tax as a withholding Tax
- If listed on the JSE, they must comply with the buyback rules of the Jse
- The share price is unaffected by a buyback because the equity decreases with the number of shares in proportion but dividends causes the equity to decrease without th number of shares, thereby resulting in the value of the company dropping
- If a buyback happens, future earnings per share could be higher but this is purely cosmetic becuase the sahre numbers went down
- A share buyback will signal to the public that management thinks the shares are undervalued, which could be positive
from Q16.22
When considering how much to distribute in a share buy back or dividends, what should be considered?
from Q16.22 and D01
- much have our profits increased by?
- How much Cash would be left over?
- Studies show that Holding excess Cash in the company sometimes results in businesses squandering it or predators coming after the company who want to change the directors - what our future Cash flows look like?
- whether the cash forecasts display that there will be sufficient Cash to continue this dividend with increases in the future without comprising on investments because we do not want to experience unnecessary transaction costs to raise more finance. - Can we support this dividend in the future?
- Will you be able to raise finance if needed to do so to pay dividends or perform a share buyback
- What are the current market conditions?
- If the market is looking poor, it can be much safer to not pay dividends incase you need the excess money - Will our shareholders be pleased if we pay out dividends?
from Q16.22 and D01
what are some considerations about borrowing money to pay dividends
from Q16.22
- Do you have insufficent cash flows to pay out dividends without borrowings
- Do you have positive profits sufficent enough to pay interest on borrowings
- Will it bring you closer to the optimal Capital Mix?
- What is your level of gearing (riskyness of business)
from Q16.22
How will a share buyback and dividends affect your Cost of capital?
from Q16.22
They have the same effect. They reduce the Cash under control of the entity to provide cash to shareholders.
The market value of the firm will fall but all of the fall is in the equity component of the firm and therefore the fearing level will increase, thereby making the business more risky. This in turn will casue Shareholders to be compensated further for the increased risk which will cause the the cost of equity to be “risk adjusted” and increase
however either could cause the firm to breach covenants and have to pay out money to banks. If loan covenants are in palce over the value of the firm. since dividends cause the value of the firm to drop
from Q16.22
What is the residual approach in terms of dividend payments?
When a company first priorities its capital expenditure/investments and what what is remaining afterwards, pays out dividends
Should Companies Follow a dividend payout policy? and follow a specific one?
Having no policy causes shareholders to have a lack of certainity in the company and can discourage them from buying shares. However which one they follow, depends on the shareholders and the company.
What types of Dividend Policies are there?
- Constant Dividend
- When you pay out a a specific certain amount every year irrespective of your profit - Constant Payout Ratio
- When you consistently payout a certain percentage of your profit - Residual approach
- When a company first priorities its capital expenditure/investments and what what is remaining afterwards, pays out dividends
