In Puuilo’s case, a 50% ROE and 28% ROI naturally strongly support share buybacks. The P/E is moderate \\approx 20
If we assume:
- EPS (current): €0.54
- EPS growth: 5% per year (just to keep it conservative)
- Dividend tax: 25.5%
- P/E: 20
The company can:
- Pay the entire €0.54 as a dividend
- Use €0.54 for share buybacks at a P/E ratio of 20.
Initial Setup (P/E = 20):
$$\nShare\ price = P/E \times EPS = 20 \times 0.54 = €10.80.\n$$
Dividend Scenario:
If the company pays €0.54 of EPS as a dividend:
- Gross dividend: €0.54
- Net result after taxes:
$$\n0.54 \times (1 - 0.255) \approx €0.401 \text{ per share}.\n$$
When EPS grows by 5% per year, the dividend also grows. In Year 2:
$$\nEPS = 0.54 \times 1.05 = 0.567,\n$$
and net return after taxes:
$$\n0.567 \times (1 - 0.255) \approx €0.422.\n$$
In the long run, you get a growing dividend stream, but each dividend is immediately reduced by 25.5% due to taxation.
Buyback Scenario:
Let’s assume the company uses its money for share buybacks instead:
$$\nNumber\ of\ shares\ bought = \frac{0.54}{10.80} = 0.05 \ (5\%).\n$$
The number of shares decreases by 5%, which increases the ownership stake in the company’s earnings.
When earnings grow by 5% and the number of shares decreases by 5%, earnings per share (EPS) grow by more than 5%. More precisely:
-
Let the total profit in the first year be \( E \), where \( EPS = 0.54 \) means that
$$\nE = 0.54 \times S,\n$$
where \( S \) is the number of shares. -
In the second year, total profit grows:
$$\nE_{2} = E \times 1.05.\n$$ -
The number of shares decreases:
$$\nS_{2} = S \times 0.95.\n$$ -
New EPS:
$$\nEPS_{2} = \frac{E \times 1.05}{S \times 0.95} = \frac{1.05}{0.95} \times EPS = 1.1053 \times EPS.\n$$
When EPS_{1} = 0.54 ,
$$\nEPS_{2} \approx 0.54 \times 1.1053 = 0.5969.\n$$
Comparison to the dividend scenario: in the second year, earnings per share would only be:
$$\nEPS_{2} = 0.567.\n$$
Share Price:
- Buybacks:
$$\nPrice_{2} = 20 \times 0.5969 \approx €11.94.\n$$ - Dividends:
$$\nPrice_{2} = 20 \times 0.567 \approx €11.34.\n$$
After just one year, in the buyback scenario, the share price is about 5.3% higher, although capital gains tax has not been paid.
Conclusion:
With a moderately low P/E ratio of 20 and stable 5% EPS growth, the tax advantage and compounding benefits of buybacks are significant compared to dividends. In the long run, the difference in after-tax wealth can become substantial, making buybacks a more advantageous option for long-term shareholders. In Puuilo’s case, profits must be distributed anyway. The company simply does not have enough investment opportunities to maintain one of the highest current ROEs found on the Helsinki stock exchange list.