You may read in the popular financial press that a share repurchase is beneficial because it causes earnings per share to increase. As we have seen, this will happen. The reason is simply that a share repurchase reduces the number of outstanding shares, but it has no effect on total earnings. As a result, EPS rises.
However, the financial press may place undue emphasis on EPS figures in a repurchase agreement. In our preceding example, we saw that the value of the stock wasn’t affected by the EPS change. In fact, the price earnings ratio was exactly the same when we compared a cash dividend to a repurchase.
Because the increase in earnings per share is exactly tracked by the increase in the price per share, there is no net effect. Put another way, the increase in EPS is just an accounting adjustment that reflects (correctly) the change in the number of shares outstanding.
In the real world, to the extent that repurchases benefit the firm, we would argue that they do so primarily because of the tax considerations we discussed before.
a Why might a stock repurchase make more sense than an extra cash dividend?
b Why don’t all firms use stock repurchases instead of cash dividends?