Investment Tips for College Students
Many equity investors focus on companies that are likely to grow over time. However, there are other ways for a company to provide value to shareholders. Among these are dividends and stock repurchases.
As a college student, you have a strong advantage over older investors in that you have
much more time to work with. Time is money when it comes to investing, simply due
to compound interest.
1. Reinvest the funds in the company. Smaller, growth-oriented companies focus on this strategy. When there’s room to grow, most investors would prefer that the company make an effort to expand the business. Reinvested funds are referred to as “retained earnings.”
Many larger companies also follow this strategy. The profits can be spent on:
‣ Research and development.
‣ Opening additional locations.
‣ Purchasing new equipment.
‣ Hiring additional personnel.
‣ Additional marketing.
2. Pay a dividend to the shareholders. Mature businesses with limited opportunities for growth often pay dividends. A common example of a company that pays dividends is utilities. It’s not easy for an electric company to expand into a new city. The customer pool is limited to local residents. The need for marketing is minimal.
‣ Companies that pay dividends often do so very consistently. While a dividend payment isn’t guaranteed, it can come close to many companies.
3. Repurchase outstanding shares of stock. Instead of reinvesting profits or paying a dividend, a company can
also repurchase shares of stock. In theory, this increases the value of the remaining shares.
The best way to spend earnings will vary with the company and the situation. It’s the responsibility of the investor to investigate the matter fully. Consider the economy, the prospects for the company, and the net effect of the decision.
Stock Buybacks
Stock buybacks can benefit the company and the investor.
The advantages of a stock buyback for the company:
1. It provides value to the investor without exposure to a poor economy. Companies are much less interested in
expanding during a poor economic environment. While expansion can be a positive move, it’s not always the best
option.
2. Return on assets and equity is increased. The cash spent on the buyback is an asset and is deducted from the balance sheet. The repurchased shares are usually canceled, resulting in less outstanding equity. The increases in ROA and ROE are attractive to the market. There are also potential benefits to the investors. If a company has announced a buyback, consider giving the stock a second look. You might be on the cusp of a great investment.
The advantages of a stock buyback for the investor:
1. It concentrates on the ownership of the company. If a company has 500 million outstanding shares and buys back 25 million, each share now represents a larger portion of the company.
2. There are tax advantages versus receiving a dividend. Dividend payments are subject to taxes. Any advantages gained via a buyback aren’t fully realized until the stock is sold. In effect, the investor is able to postpone paying taxes on the benefit received.
3. Many of the common stock metrics are improved. Investors are often concerned with earnings per share, growth per share, and so on. These metrics are improved if the company performs at the same level, but there are fewer shares. The stock is more attractive to investors.
4. A stock repurchase often increases the price of the stock. Not only are the metrics improved, but large levels of purchasing activity also drive up the price of the stock. It’s similar to the effect seen when a company is taken over by another.
Companies and investors can both benefit from stock repurchase activity. Keep your eyes open for repurchase announcements. Your online broker will have the information available. It’s not hard to find companies that routinely pay dividends. It’s also not difficult to find companies that have plans to repurchase stock.
Are stock buybacks always a positive sign for the investor? The answer is “no.” Many buybacks only benefit the company or the executives. There are even situations where a buyback provides a poor outcome for everyone involved.
Beware of these situations:
1. Overpaying for a stock isn’t a wise move. In this situation, paying a dividend is a better option for the company.
2. They are doing the stock buyback to hide the fact that they are exercising a large number of stock options. Company executives exercising options can harm investors by increasing the number of shares. Many companies will buy back shares to offset this dilution.
‣ The average investor doesn’t benefit if the company doesn’t decrease the total number of outstanding shares.
3. The company has to borrow money to fund the repurchase. Using borrowed money can be a great move if the cash flow used to service the debt increases over time. If it decreases, this move is a disaster. Borrowing money for this purpose can also damage the credit rating of the company. However, the interest paid on this debt is tax-deductible.
Investors are often excited by the news of a buyback but be careful. Not all buybacks benefit the investors. Some can even
cause harm. Before purchasing stock in a company with plans to buy back stock, always consider the situation and the
motivation for the repurchase. You might be better off avoiding the situation altogether.
HOW TO FIND COMPANIES THAT REPURCHASE STOCK OR PAY A DIVIDEND
If regular income from dividends and stock repurchases sounds attractive to you and fits your goals for your portfolio, talk with your broker or follow these steps:
1. Purchase an appropriate mutual fund or ETF. There are funds that specialize in companies that pay dividends or buy back stock. Look at their history of payouts to the shareowners to see if they’ve been successful in this goal. Some of these funds do very well.
2. Do your research. It’s easy to find which stocks consistently pay a dividend. While stock repurchases aren’t as consistent, you have one advantage: They are slow processes. Companies announce stock buyback plans, and those plans take months, or even years, to execute. The information is easy to find with a minimal amount of work.
Few investments provide a guarantee, though some are less risky than others. Be diligent in your research. Consider the likely benefit to yourself and the overall effect on the company. Dividends and stock repurchases can be a simple strategy to pad your portfolio.
