3.1 Impact of Price/Earnings (P/E) Ratio
To analyze the impact of the two options on Glass Ltd based on the P/E ratio, we first need to calculate the P/E ratio for the current situation and see how each option would affect it.
Current Situation:
- Earnings (EPS): R3.90
- Market Value of Share: R40
- P/E Ratio = Market Value / EPS = R40 / R3.90 = 10.26
Option 1: Pay out the full R225,000 as a cash dividend
If Glass Ltd pays out the entire profit as dividends, there will be no retained earnings left. The shareholders will receive cash, but the overall company can be perceived as less profitable because no profit is retained for growth or reinvestment. The impact on the P/E ratio can be calculated as follows:
- EPS remains the same for that year: R3.90
- P/E Ratio might decrease slightly depending on investors' perceptions about future growth potential.
Dividends are typically preferred by shareholders seeking immediate returns. However, since Glass Ltd has been erratic in paying dividends recently, paying out entire profits could signal financial distress or reduce investor confidence in future earnings, potentially reducing the stock's market price.
Option 2: Implement a share buyback/repurchase for R225,000
A share buyback means the company buys back its own shares, effectively reducing the number of shares outstanding.
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If it uses R225,000 to repurchase shares at R40 per share: \[ \text{Number of shares repurchased} = \frac{R225,000}{R40} = 5,625 \text{ shares} \]
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Assuming the current number of shares outstanding before the buyback is derived from the market value of share capital of R620,000: \[ \text{Current number of shares outstanding} = \frac{R620,000}{R40} = 15,500 \text{ shares} \]
After the buyback, the number of shares outstanding becomes: \[ \text{New number of shares} = 15,500 - 5,625 = 9,875 \text{ shares} \]
New EPS Calculation after Buyback:
The earnings remain at R225,000, but now divided among fewer shares: \[ \text{New EPS} = \frac{R225,000}{9,875} \approx R22.78 \] Thus:
- New P/E Ratio: \[ P/E = \frac{R40}{R22.78} \approx 1.75 \]
Conclusion for 3.1
The buyback is generally seen as a favorable strategy by the market, as it can signal to investors that the company believes its shares are undervalued and it can help assist in increasing the EPS and P/E ratio over time. It may improve investor confidence and attracts growth-oriented investors who value shares for their potential future growth rather than immediate cash returns.
3.2 Impact of Price Per Share
From the perspective of price per share, if Glass Ltd opts for the share buyback, it effectively reduces the number of shares available in the market, potentially increasing the share price due to reduced supply— assuming demand stays constant.
Price Per Share Post-Buyback:
Investors might anticipate this increase in share price over time due to the higher EPS resulting from the buyback.
In contrast, paying out the full profits as a dividend might not have a beneficial long-term impact on the share price, as it signifies less retained earnings for future growth.
Thus, if the analysis is based purely on price per share, the buyback option is preferable as it tends to enhance the price due to a better EPS outlook and the market sentiment leaning towards buybacks.
3.3.1 Type of Shareholder/Investor Attracted
Glass Ltd likely attracts income investors who prefer dividends or growth-oriented investors who seek long-term capital appreciation.
- Implications for such investors: Income investors may be disgruntled given the recent erratic dividend policies, leading to demand for greater clarity and stability in fiscal policy. Growth-oriented investors may prefer the buyback as it suggests the company’s confidence and focuses on capital appreciation, aligning with their interests.
3.3.2 Concerns an Investor Might Have
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Erratic Dividend Payments: The inconsistency in dividend payments may signal potential issues in cash flow management and raise concerns regarding the company’s operational efficiency or profitability sustainability.
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Debt Levels: With current liabilities exceeding current assets, investors may worry about liquidity issues. The non-current liabilities being greater than non-current assets also indicate potential solvency concerns.
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Profitability: The company's profit after dividends could be insufficient for reinvestment, thus potentially stunting growth and limiting its ability to compete in the market over time.
Overall, while share buybacks might improve earnings per share in the short term, the overall financial health, as indicated by leverage and liquidity ratios, could pose significant concerns for investors.
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