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Share Repurchases and Stock Valuation Models

22 Pages Posted: 6 Dec 2007  

John D. Stowe

Ohio University

Dennis W. McLeavey

CFA Institute; University of Rhode Island College of Business Administration

Jerald E. Pinto

CFA Institute

Date Written: December 3, 2007

Abstract

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

Stowe, John D. and McLeavey, Dennis W. and Pinto, Jerald E., Share Repurchases and Stock Valuation Models (December 3, 2007). Available at SSRN: https://ssrn.com/abstract=1051281 or http://dx.doi.org/10.2139/ssrn.1051281

John D. Stowe (Contact Author)

Ohio University ( email )

640 Copeland
Athens, OH 45701
United States
(740) 593-9439 (Phone)
(740) 593-9539 (Fax)

Dennis W. McLeavey

CFA Institute ( email )

915 East High Street
Charlottesville, VA 22902
United States

University of Rhode Island College of Business Administration ( email )

Kingston, RI 02881
United States

Jerald E. Pinto

CFA Institute ( email )

915 East High Street
Charlottesville, VA 22902
United States

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