When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
Dividend vs Buyback: Pros and Cons
Dividends and share buybacks are the most direct ways a company returns money to its shareholders. So as a shareholder, you better know about them! This article explores dividends' and buybacks' definitions, differences, pros, and cons.
QUOTE
"I believe that stock buybacks done right are an incredible tool to increase shareholder value."
Big ideas
- Dividends provide a steady stream of income and attract income-focused investors, while buybacks enhance shareholder value by reducing outstanding shares and signalling confidence in the company's future.
- Buybacks have grown in popularity among corporations. Some large companies offer dividends and have stock buyback programs.
- When considering dividends vs. buybacks, investors should assess their income needs, growth potential, and the financial health of the company.
What is a dividend in the stock market? How do they work?
Picture this: you're an investor, and you hold shares of a company. Well, a dividend is like a little gift from that company to you—a reward for being a shareholder. Dividends are the portion of a company's profits that are directly distributed to its shareholders. Think of it as a way for the company to share its success with you.
Now let's break down how dividends work. When a company declares a dividend, it sets a specific amount per share to be paid out to its shareholders. This payment can be made in cash or additional shares of stock, known as stock dividends. Dividends are typically paid on a regular basis, such as quarterly or annually, providing you with a consistent stream of income.
As a random example, picked among the companies that start with an ‘A’ - let's look at Accenture (NYSE: ACN). Accenture has 18 years of raising its dividend in a row. In 2023, it declared an annual cash dividend of $4.48 per share.
If you owned ten ACN shares you would have received $44.80 in dividends at the end of the year. The 2023 dividend has risen above the $3.38 per share payout over the last fiscal year (LFY) seen in the Trading 212 app.
While this example is for illustrative purposes only, it is important to remember that past performance doesn’t guarantee future results.
Now let's break down how dividends work. When a company declares a dividend, it sets a specific amount per share to be paid out to its shareholders. This payment can be made in cash or additional shares of stock, known as stock dividends. Dividends are typically paid on a regular basis, such as quarterly or annually, providing you with a consistent stream of income.
As a random example, picked among the companies that start with an ‘A’ - let's look at Accenture (NYSE: ACN). Accenture has 18 years of raising its dividend in a row. In 2023, it declared an annual cash dividend of $4.48 per share.
If you owned ten ACN shares you would have received $44.80 in dividends at the end of the year. The 2023 dividend has risen above the $3.38 per share payout over the last fiscal year (LFY) seen in the Trading 212 app.
While this example is for illustrative purposes only, it is important to remember that past performance doesn’t guarantee future results.
These are the advantages of dividends and why people like them
- A steady income stream
Income-focused investors like dividends because they offer the prospect of regular cash flow. Dividend-paying companies particularly appeal to retirees who need an income to support their lifestyle once they stop working. Even for working people, dividends can offer a convenient way to supplement your main income. - Attracting long-term investors
Paying out a consistent and rising dividend over time tends to attract more investors, boosting the value of the shares over the long term. Blue-chip stocks like Procter & Gamble (PG) and Coca-Cola (KO) are respected in markets for their reliable dividend payments, making them popular choices for investors. - Demonstrates strength
If a company can afford to pay money out to shareholders, it should mean it's a financially healthy company, instilling confidence in investors. Having a strong dividend history sign:als its ability to generate sustainable profits and distribute them to shareholders. Johnson & Johnson (JNJ) has a good reputation for its long-standing history of increasing dividends.
Nothing is perfect; there are some disadvantages of dividends
- Taxes
Dividends are subject to tax in most jurisdictions - and of course - paying tax reduces your overall returns. That makes it important to consider the tax implications of ‘taking money out’ of your investments for your long-term strategy.
Tax rules vary depending on individual circumstances and your country and jurisdiction. - Dividend cuts
A company can decide at any time to cut or suspend its dividend. This is not a nice experience for investors and will usually negatively affect sentiment and, normally, the stock price too. This happened a lot during the 2008 financial crisis when a lot of companies reduced or eliminated their dividend payments to conserve cash and navigate the downturn in business - Opportunity cost
Necessarily, using cash for one purpose means it cannot be used for another. Paying out a dividend limits a company’s ability to invest in growth opportunities. Direct returns to shareholders can even be interpreted as a negative for companies in high-growth industries where reinvesting profits back into the business may yield higher returns than distributing them as dividends.
What are stock buybacks? Definition and examples
A stock buyback (also known as a share buyback) is when a company repurchases its own outstanding shares from the market. You could call them a ‘reverse stock issue’. It's like the company saying, "Hey, we believe our shares are undervalued, so we're buying them back!"
When a company begins a program of buying back its shares, the total number of outstanding shares available in the market fall. This effectively consolidates ownership, and as a result, the remaining shareholders have a larger ownership percentage of the company.
Apple, Inc. (NASDAQ: AAPL) started buying back its shares in 2012 and has been actively buying them ever since in a revolving buyback program. The stated reason is that CEO Tim Cook and his team believe that AAPL stock is undervalued, and therefore, it has been repurchasing them from the market. Apple's buyback program has reduced the number of outstanding AAPL shares and has been instrumental in increasing earnings per share, boosting shareholder value. One of the single biggest beneficiaries of these buybacks has been a legendary investor and Big Apple investor Warren Buffett.
When a company begins a program of buying back its shares, the total number of outstanding shares available in the market fall. This effectively consolidates ownership, and as a result, the remaining shareholders have a larger ownership percentage of the company.
Apple, Inc. (NASDAQ: AAPL) started buying back its shares in 2012 and has been actively buying them ever since in a revolving buyback program. The stated reason is that CEO Tim Cook and his team believe that AAPL stock is undervalued, and therefore, it has been repurchasing them from the market. Apple's buyback program has reduced the number of outstanding AAPL shares and has been instrumental in increasing earnings per share, boosting shareholder value. One of the single biggest beneficiaries of these buybacks has been a legendary investor and Big Apple investor Warren Buffett.
Source: Stockbuybackshistory.com. Past performance doesn’t guarantee future resultsA list of large stocks with a dividend and buyback policy
Below is a non-exhaustive list of blue-chip companies that are operating both dividends and buyback policies.
Company | Ticker | Dividend Yield | Buyback Program |
AAPL | 0.62% | $90 billion (announced in April 2021) | |
MSFT | 0.82% | Ongoing buyback program | |
JNJ | 2.48% | $10 billion (announced in April 2021) | |
PG | 2.42% | $15 billion (announced in April 2021) | |
JPM | 2.45% | $30 billion (announced in May 2021) | |
V | 0.61% | Ongoing buyback program | |
MA | 0.49% | $6 billion (announced in December 2020) | |
KO | 3.01% | Ongoing buyback program | |
PFE | 3.57% | Ongoing buyback program | |
INTC | 2.67% | $20 billion (announced in October 2020) |
Now that we have a good grasp of dividends and buybacks, let's compare and contrast these two methods of returning capital to shareholders. We can break it down into three parts: purpose, ownership impact and flexibility.
Purpose: Dividends are a direct distribution of a company's profits to shareholders, providing them with a regular income stream. On the other hand, buybacks involve repurchasing shares from the market, which can enhance shareholder value and signal confidence in the company's future.
Impact on Ownership: Dividends do not impact ownership percentages, as they are distributed to all shareholders on a per-share basis. In contrast, buybacks reduce the total number of outstanding shares, resulting in a higher ownership percentage for remaining shareholders.
Flexibility: Dividends provide a steady income stream, while buybacks offer the potential for capital appreciation as the company's stock price may rise due to a decrease in the number of outstanding shares.
Purpose: Dividends are a direct distribution of a company's profits to shareholders, providing them with a regular income stream. On the other hand, buybacks involve repurchasing shares from the market, which can enhance shareholder value and signal confidence in the company's future.
Impact on Ownership: Dividends do not impact ownership percentages, as they are distributed to all shareholders on a per-share basis. In contrast, buybacks reduce the total number of outstanding shares, resulting in a higher ownership percentage for remaining shareholders.
Flexibility: Dividends provide a steady income stream, while buybacks offer the potential for capital appreciation as the company's stock price may rise due to a decrease in the number of outstanding shares.
Ever wondered why companies embark on share buybacks? On first look, they look like a ‘shady’ financial manoeuvre. However, there are several reasons behind this strategic move.
Undervalued Shares: Companies may believe that their shares are trading at a price lower than their intrinsic value. By repurchasing shares, they can provide immediate value to existing shareholders and signal confidence in the company's prospects.
Capital Allocation: Companies may choose to return capital to shareholders through buybacks rather than dividends as it provides more flexibility. Buybacks allow companies to adjust the amount and timing of capital returned based on market conditions and their financial position.
Earnings Management: Some companies use buybacks as a tool to manage their earnings per share. By reducing the number of shares outstanding, they can boost earnings per share, making the company appear more attractive to investors.
Undervalued Shares: Companies may believe that their shares are trading at a price lower than their intrinsic value. By repurchasing shares, they can provide immediate value to existing shareholders and signal confidence in the company's prospects.
Capital Allocation: Companies may choose to return capital to shareholders through buybacks rather than dividends as it provides more flexibility. Buybacks allow companies to adjust the amount and timing of capital returned based on market conditions and their financial position.
Earnings Management: Some companies use buybacks as a tool to manage their earnings per share. By reducing the number of shares outstanding, they can boost earnings per share, making the company appear more attractive to investors.
Should you choose stocks with buybacks or dividends?
Ah, the million-dollar question: which is better for investors? As usual, the answer depends on your investment objectives, risk tolerance, and financial goals. It also depends on the unique position of the company.
Let's weigh the factors to consider when making this decision.
- Income Needs:
If you rely on regular income from your investments, dividends may be more suitable for meeting your financial needs. Dividends provide a consistent stream of cash flow, especially for income-focused investors. - Growth Potential:
If you focus more on long-term growth and capital appreciation, buybacks may be more attractive. By reducing the number of shares, buybacks can increase ownership stakes and potentially increase the company's stock price. - Company Fundamentals:
Assess the financial health and stability of the company. A company with a strong track record of consistent dividend payments and healthy growth prospects may be an attractive choice for dividend-focused investors. Conversely, companies with undervalued shares and a commitment to buybacks may be appealing to investors seeking capital appreciation.
Deciding whether a company you’re about to invest in should be engaged in share buybacks requires careful consideration of various factors, including financial metrics, management behaviour, and the company's overall strategy.
1. Financial metrics
1. Financial metrics
- Assess the company's cash flow generation capacity to determine if it has sufficient funds to support share buybacks without compromising its operations or future growth prospects.
- Evaluate the company's debt levels and obligations. If a company has excessive debt, it is vulnerable and should probably prioritise debt reduction over share buybacks.
- Consider the company's current valuation. If the stock is undervalued and repurchasing shares is an efficient use of capital, it may be favourable to pursue buybacks.
2. Management behaviour
- Analyze the historical capital allocation decisions of the company's management. If they have a track record of effectively deploying capital and generating value through buybacks, it may indicate a suitable environment for share repurchases.
- Assess the ownership stake of company insiders. If management has a significant stake in the business, they may be more motivated to make shareholder-friendly decisions, including share buybacks.
3. Company strategy
- Consider the company's growth prospects and available investment opportunities. If the company has limited avenues for value creation through internal investment or acquisitions, share buybacks may be an attractive option to enhance shareholder returns.
- Evaluate the company's dividend policy. If the company consistently pays dividends and has surplus cash beyond dividend obligations, share buybacks can be a viable way to return excess capital to shareholders.
- Assess the company's long-term strategic goals and the role share buybacks play within that framework. If the company prioritises reinvestment in the business or strategic initiatives, buybacks may not align with its objectives.
How to deal with stock buybacks and dividends
Here are some practical tips to help you navigate the ‘buybacks and dividends’ waters.
Before investing in a company, conduct thorough research on its dividend history, buyback programs, financial performance, and growth prospects. Understand the company's capital allocation strategy and evaluate whether it aligns with your investment objectives.
Remember that diversification is of utmost importance to investing. Consider including a mix of dividend-paying stocks and companies engaged in buybacks to create a well-rounded portfolio.
Stay up-to-date on changes to dividend policies or significant buyback programs because these can impact the company's financial outlook and might challenge your original reason for owning the stock.
Before investing in a company, conduct thorough research on its dividend history, buyback programs, financial performance, and growth prospects. Understand the company's capital allocation strategy and evaluate whether it aligns with your investment objectives.
Remember that diversification is of utmost importance to investing. Consider including a mix of dividend-paying stocks and companies engaged in buybacks to create a well-rounded portfolio.
Stay up-to-date on changes to dividend policies or significant buyback programs because these can impact the company's financial outlook and might challenge your original reason for owning the stock.
Tax rules for stock buybacks and dividends
Understanding the implications of stock buybacks and dividends on your taxes is crucial.
Tax rules vary depending on individual circumstances and your country and jurisdiction.
Here are a few general points to consider:
Dividend payments are normally subject to taxation in most jurisdictions. The tax rate can vary based on factors such as the type of dividend (ordinary dividends vs. qualified dividends) and the recipient's tax bracket. It's never a bad idea to check with a tax accountant to determine the applicable tax rules for dividends.
As a kind of by-product of the action taken, stock buybacks can have capital gains tax implications. If a company repurchases its shares from you in the open market at a higher price than your purchase price, you will likely be subject to capital gains tax on the difference in prices. Conversely, the buyback program could boost the price of the shares, and you sell your shares to another investor rather than the company itself, but the effect on your taxes is the same. Note that the tax rules surrounding stock buybacks can be complex and vary depending on the specific circumstances.
Tax rules vary depending on individual circumstances and your country and jurisdiction.
Here are a few general points to consider:
Dividend payments are normally subject to taxation in most jurisdictions. The tax rate can vary based on factors such as the type of dividend (ordinary dividends vs. qualified dividends) and the recipient's tax bracket. It's never a bad idea to check with a tax accountant to determine the applicable tax rules for dividends.
As a kind of by-product of the action taken, stock buybacks can have capital gains tax implications. If a company repurchases its shares from you in the open market at a higher price than your purchase price, you will likely be subject to capital gains tax on the difference in prices. Conversely, the buyback program could boost the price of the shares, and you sell your shares to another investor rather than the company itself, but the effect on your taxes is the same. Note that the tax rules surrounding stock buybacks can be complex and vary depending on the specific circumstances.
Buyback and dividend info in the Trading 212 app
Apart from providing a platform for trading stocks, the app offers a multitude of ways to access information related to dividends and buybacks.
The Trading 212 app provides real-time market data, enabling users to stay updated on stock prices, dividend yields, and other relevant information for making informed investment decisions. The app also allows you to access company-specific pages, where you can find details about dividends, buyback programs, and other essential data. This information helps you evaluate the investment potential of individual companies.
The Trading 212 app provides real-time market data, enabling users to stay updated on stock prices, dividend yields, and other relevant information for making informed investment decisions. The app also allows you to access company-specific pages, where you can find details about dividends, buyback programs, and other essential data. This information helps you evaluate the investment potential of individual companies.
Recap
Your whole raison d’etre as an investor is to earn returns, so understanding dividends and buybacks - the two main forms of direct returns - is essential to make informed decisions.
Dividends are appealing as an income stream for retirees or workers looking to supplement their main income. Buybacks are more about enhancing shareholder value by reducing the number of shares outstanding. There are advantages and disadvantages of both strategies so make sure to think about how they align with your investment goals.
Dividends are appealing as an income stream for retirees or workers looking to supplement their main income. Buybacks are more about enhancing shareholder value by reducing the number of shares outstanding. There are advantages and disadvantages of both strategies so make sure to think about how they align with your investment goals.
FAQ
Q: Which Is better for Investors: stock buybacks or dividends?
The choice between stock buybacks and dividends depends on the situation and what individual investors prefer. Stock buybacks can benefit investors because they reduce the number of shares, having the effect of increasing the value of the remaining shares. Some argue that this is an ‘artificial’ increase in value, while others say ‘if the shares go up, it works for me’.
Dividends provide a source of regular cash returns to shareholders without needing to sell any shares but do not directly affect the share price. Ultimately, the decision between stock buybacks and dividends is yours! It depends on your goals, risk tolerance and the company in question.
Dividends provide a source of regular cash returns to shareholders without needing to sell any shares but do not directly affect the share price. Ultimately, the decision between stock buybacks and dividends is yours! It depends on your goals, risk tolerance and the company in question.
Q: Why do companies buy back shares?
One common motive is a show of confidence in their own stock and create a positive perception in the market. Investors might reasonably interpret a company buying its own shares as a reason to do so too. Share buybacks can also be used to return excess capital to shareholders without issuing a dividend. A company might prefer buybacks if it believes its stock is undervalued.
Q: How to manage stock buybacks and dividends?
You want to make sure companies offer clear guidelines and criteria for initiating buybacks, ensuring they have sufficient cash flow and financial stability to support such activities. Dividend management involves balancing the company's ability to generate consistent cash flow with the desire to reward shareholders.
You can stay up to date and make sure to check on the company's financial position (every year or quarter), its general growth prospects, and the way it chooses to allocate its capital to judge the appropriate timing and magnitude of buybacks.
You can stay up to date and make sure to check on the company's financial position (every year or quarter), its general growth prospects, and the way it chooses to allocate its capital to judge the appropriate timing and magnitude of buybacks.
