Comment, question or quotation of the day

21-11-2019 : Question from one of our readers

Assume  that the cost of capital of a company is 10%. If it has a 15% project but still wants to evaluate whether buying back shares wouldn't be more interesting, how does it calculate the profitability of a share buyback to decide what it does with its cash? How is the profitability of these share buybacks assessed?       The rate of return on a share buyback corresponds to the company's cost of equity. Indeed, this is the discount rate that equals the present value of all future dividends estimated to the value of the share today. Indeed, by buying back shares, it is as if the company were investing in its own shares in the same way as a new shareholder.     However, this figure is not very useful, contrary to appearances. Indeed, you cannot compare it with the rate of return on your cash or that of a company investment because the risk levels of these investments are not the same, a condition that must be respected in order to be able to compare rates of return between them.   In your example, if the company can make an investment that pays 15% when its cost of capital is 10%, you should not hesitate to make it, regardless of whether or not it also does a share buyback. As for the decision whether or not to buy back shares, it will depend fundamentally on the excess cash available to the company, its prospects of being able to use it in attractive investments in the coming years, and finally its perception of the significant undervaluation of the market value of its share (the stock market price for a listed company) in relation to its estimate of the intrinsic value of its share.   More details in chapter 36 of the Vernimmen.

20-11-2019 : Quote of the day

“Hedge funds are to the asset management industry what talkies have been to the silent movie in the film industry.”
Patrick Fauchier, founder of an hedge fund



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The Vernimmen.com Letter

Number 124 of November 2019

News : Financial analysis of listed groups in West Africa

Statistics : Liquidity and debt of top 60 groups worldwide

Research : CSR and competition: can socially responsible companies survive?

Q&A : How can a borrower manage the duration of a bond flexibly?

COMMENTS : Comments posted on Facebook