Profitable companies generate free cash flow and there are 2 basic ways they can spend it. Companies can either invest in the business so that it can grow or defend its markets or it can return the cash to shareholders. When reinvesting in the business, management has a few choices. They can (1) invest in research and development for the production and sale of new or improved products. (2) They can build a new plant and purchase equipment to expand production or improve the efficiency of production and product quality. or (3) spend on marketing and advertising to build the brand and sell more product. (4) If management does not see an opportunity with its current product line, they may buy other companies. If they do this right, they will buy companies that complement their current product line to technological expertise.
If management cannot identify new projects that will generate a return the meets or exceeds the cost of capital, they should return that capital to shareholders and let them invest or send it as they see fit. When returning money to shareholders management can deliver that cash to shareholder through dividends or share repurchases.Historically, companies would
Historically, companies would both reinvest in their business and pay a dividend. If the company is successful, shareholders enjoy a capital gain and collect income over time. Share repurchases have become all the rage ever since the financial crisis. Some argue that this is good for shareholders. Others argue that it is short sited. We say it depends on the situation. In this post, we discuss share repurchases as it applies to McDonald's, the fast-food restaurant.
