What effect does a share repurchase have on the stock price?
Thinking about it logically, there should be the same amount of Net Income, but less shares outstanding, so stock price should go up (assuming P/E ratio stays constant).
But Schweser says that the stock price will remain the same, because although there are fewer shares outstanding after the repurchase, the assets and market value of equity should decrease by the total dollar amount of the repurchase (source: bottom of page 82 of 2015 CFA L1 Schweser Book 4).
It is important to check out what is the source of the money you will repurchase the stocks with. The problem says that SPI has a net profit (net income) of 100 million and will reinvest 70% (70million), the remaining 30 million will be used as a “dividend” in the form of stock repurchase.
Assets and equity will increase by 70 million, but the number of shares outstanding has decreased accordingly, so the price remains constant.
EPS should be calculated with 70million of net profit and the new amount of # shares outstanding, then the EPS does not change and the P/E does not change.
However, in the real life, share repurchases may have an impact on the investors’s expectatives about the company. Investors could think that management is repurchasing stocks because they are undervalued, so a higher price could come.
This is actually something that has baffled me for a long long time now.
It makes totally sense to me that the stock price would remain constant, fewer shares, lower equity. However: Every source I find states that stock price usually increases. Why would that be? I have heard it a thousand times before, it is almost like common knowledge. Is this really just expectations driven, e.g. behavioral finance? Or is it due to demand and supply in the short run (and one would expect the market to correct this in the long run and revert to the intrinsic value)?