Share Repurchases and Stock Valuation Models
22 Pages Posted: 6 Dec 2007
Date Written: December 3, 2007
Share repurchases have grown rapidly in recent years, frequently exceeding total cash dividends since 1997. Some analysts have argued that incorporating repurchases into a discounted cash flow framework leads to higher equity valuations and expected return estimates and, further, that traditional dividend discount models (DDMs) may be obsolete. We disagree. We demonstrate that the objection to the DDM is based on a logical error in which the analyst is not accurately accounting for the effect of share repurchases on investors' future cash flows. We compare a traditional DDM and a correctly specified discounted total cash flow model (TCFM) and show that for either a constant-growth type model or a more general framework, the valuations and rates of return are the same. Importantly, a TCFM can be used instead of, or in addition to, a DDM, and the selection of model can be based on the quality of theinformation applicable to a particular situation.
Keywords: share repurchases, stock valuation models, discounted dividend model
JEL Classification: G12, G35
Suggested Citation: Suggested Citation