How do share buybacks affect FCFE, and should I adjust my valuation model when a company repurchases its own stock?

Question

AcadiFi · Accepted Answer

Share buybacks are economically equivalent to dividends — both return cash to shareholders. But in an FCFE model, the treatment requires careful handling to avoid double-counting or missing the value transfer.

**Key Principle: FCFE Is Cash Available, Not Cash Distributed**

FCFE represents the total cash available to equity holders regardless of how it is distributed. Whether the company pays dividends, buys back stock, or hoards cash, FCFE is unchanged:

FCFE = $2.4 billion (unaffected by distribution choice)

**The Buyback Adjustment in Practice**

**Worked Example — Stratton Industries:**

| Item | Year 0 | Year 1 | Year 2 | Year 3 |
|---|---|---|---|---|
| FCFE | $2,400M | $2,520M | $2,646M | $2,778M |
| Dividends paid | ($800M) | ($840M) | ($882M) | ($926M) |
| Share repurchases | ($1,200M) | ($1,260M) | ($1,323M) | ($1,389M) |
| Cash retained | $400M | $420M | $441M | $463M |
| Shares outstanding (M) | 500 | 482 | 465 | 449 |

**Approach 1: Total FCFE Model (Recommended)**

Discount total FCFE at the cost of equity to get total equity value, then divide by current shares:

- PV of total FCFE + terminal value = $48.2 billion
- Divide by 500 million shares = **$96.40 per share**

This approach does not need to model the declining share count — it captures total value to all current equity holders.

**Approach 2: Per-Share FCFE Model**

If you want to model per-share cash flows, you must:
1. Project annual buyback amounts
2. Calculate shares retired each year using the projected stock price
3. Compute FCFE per share on the declining share base
4. Discount per-share FCFE — but adjust the terminal value per share for the lower share count

This is more complex and introduces circular logic (buyback depends on price, price depends on buyback).

**Why Approach 1 Is Preferred:**

- Avoids circularity
- No need to predict future stock prices for buyback share retirement
- Consistent with how institutional investors think about aggregate equity value
- Buyback versus dividend split is irrelevant to total value (Modigliani-Miller)

**Common Exam Trap:**

Do NOT subtract buybacks from FCFE. FCFE already reflects the cash available before any distributions. Subtracting buybacks would double-count the cash outflow:

- FCFE = NI + Dep - Capex - ΔWC + Net Borrowing (no buyback deduction)
- Distributions (dividends + buybacks) come OUT of FCFE but do not reduce it

**Analytical Considerations:**

1. Companies with heavy buybacks often have lower dividend yields but higher total shareholder yield.
2. Buybacks at prices above intrinsic value destroy value for continuing shareholders.
3. Compare total payout ratio (dividends + buybacks) / FCFE to assess sustainability.

Explore FCFE modeling techniques in our CFA Level II equity valuation course.

How do share buybacks affect FCFE, and should I adjust my valuation model when a company repurchases its own stock?

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