Share Buyback vs Dividend

Share buybacks and dividends are the two main methods available to companies for returning profits to their shareholders. Whilst both are intended to reward shareholders the manner in which they do so differs. But which is better?

In this article, we will examine the difference between share buyback vs dividend and explore which, if either, is more beneficial to shareholders.

What Is a Dividend?

Probably the better understood term of the two, a dividend is the distribution of part of a company’s earnings to eligible shareholders. These are most commonly paid to shareholders as cash, but can also be distributed in the form of additional shares in the company.

The latter of these, stock dividends, require additional shares to be issued which has the effect of diluting shareholders. For the purposes of this article, we will focus on cash dividends, which is typically what people are referring to when talking about dividends.

What Is a Share Buyback?

A share buyback, or share repurchase, is when a company uses cash to buy back its own shares from the market. These repurchased shares are consequently removed from the market and absorbed back into the company, which reduces the number of outstanding shares. 

Benefits and Disadvantages of Dividends 

The benefit of dividends should be obvious. As well as investors potentially benefitting from share price appreciation, dividend stocks allow shareholders to collect cold, hard cash, often on a regular basis.

This then means that investors can do as they please with the cash, whether that be buy more shares in the company, buy shares in a different company, spend it or save it.

Many of the disadvantages of dividend payments also apply to share buybacks, namely the fact that any money returned to shareholders, whether by dividend or buyback, is not reinvested into the company to help grow the business.

Furthermore, neither are ever guaranteed, even a company which has consistently paid dividends for more than 20 years can halt dividends in the face of a challenging operating environment.

However, with respect to dividends, they can lead to an increased tax burden for investors, as dividend income is usually subject to tax. 

Share Buyback Benefits

Whilst the benefits of dividend payments should be immediately clear, the benefits of share buybacks may not be. Unlike dividends, there is no immediate payoff, but there are potential benefits. 

A share buyback reduces the number of outstanding shares on the market. This has a number of implications for the company and its existing shareholders. 

1. Removing shares from circulation reduces the level of supply in the market which tends to provide a boost to price of the remaining shares.
2. The decrease in outstanding shares means that remaining shareholders’ stake in the business (when viewed as a percentage) will increase without them having to do anything.
3. A lower share count will improve some of the metrics which investors use to analyse companies, such as Earnings per Share (EPS). This can help fuel share price appreciation in the future.

Share buybacks also signal that management is confident in the business and believe that its shares offer good value which can improve investor sentiment. Furthermore, unlike dividends, share repurchases don’t have immediate tax implications for shareholders, as they are not receiving any cash (unless they are selling their shares back to the company).

So far so good then. But what about the negatives? 

Disadvantages of Share Buyback 

Share buybacks can only create value for investors if they are conducted under the right circumstances and for the right motivation.

Most importantly, stock buybacks only benefit shareholders, and indeed the company itself, if the current share price represents good value. If the share price is too high, and the company overpays for their own shares, this is beneficial to no body, except the people selling their shares. As a result, the company will waste more money buying fewer shares.

Another potential red flag for investors is if a company is only buying its shares in order to improve its financial metrics. This may be being done to mask a slowdown in the company’s growth.

Share Buyback vs Dividend 

Reading through other articles published on this topic, many seem to come down too heavily on one side or the other. Some appear to totally discount stock buybacks. To steal a quote from legendary investor Warren Buffett:

“When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).” 

When it comes to share buyback vs dividend, the “better” option depends not only on the individual investor and their goals, but also on the company and its current market valuation.

Let’s start by saying that whilst capital returns, in any form, are generally well received by investors, there are also instances where neither dividends nor share repurchases are in anyone’s best interest.

For example, some companies, and indeed their shareholders, may be better served by investing excess profits back into the company to fuel future growth or using it to pay down debt.

As for a share buyback vs dividend, for investors who are looking to generate additional income from their investments, dividends are naturally likely to be the favoured method of capital return. As discussed earlier, receiving cash allows each investor to make their own decision as to how to use that money.

However, dividend payments are usually subject to tax. Share buybacks are, therefore, often seen as a more tax efficient method of returning capital to shareholders, particularly if the shareholder would only use the dividends to reinvest in the company anyway.

By reducing its outstanding shares, continued shareholders will see their stake in the company increase without paying any tax or doing anything else. However, this approach only makes sense when a company has ample cash to do so, and when management perceives its share price to be undervalued.

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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.