Dividend Vs Share Buyback: Which Is Better?

Once companies start paying dividends or increase the payout, it becomes difficult for them to cut dividends. Reducing dividends could signal investors that the company is not doing well financially. It encourages the management to be more responsible with the capital. It also prevents the management from hoarding large piles of cash.

Share buybacks

In the last few years, companies are increasingly using stock buybacks as a way to return cash to shareholders. In the share buyback process, a company uses the excess cash to purchase its own shares in the open market or directly from shareholders. The company fixes the amount earmarked for buybacks, the buyback price, as well as the offer period.

Generally, the buyback price is set at a premium to the current market price. It incentivizes investors large and small to participate in the buyback program by selling their shares to the company. Companies often buy back their own shares when the management feels that the stock is undervalued.

It’s important that investors pay attention to the price at which a company buys back its shares. Repurchasing shares in a bull market at sky high valuations will not be that accretive to earnings in the long run.

Buybacks reduce the total number of outstanding shares. After the buyback, each remaining share has a greater percentage ownership in the company. It boosts the share price as well as earnings per share (EPS). It makes it easier for the company to meet or exceed analysts’ expectations.

Buybacks gained momentum in 1982 after the enactment of Rule 10b-18. The rule allowed corporate management to repurchase shares without facing stock price manipulation charges. Share buybacks are more tax-efficient than dividends as a means to return capital to shareholders. While dividends are taxed at 15% to 20%, there is no additional tax on buybacks.

Stock buyback is a tedious and time-consuming process. It involves restrictions on the issuance of new shares for a specific period, hiring investment bankers, submitting disclosures to stock exchanges, and maintaining a certain debt-to-equity ratio.

View single page >> |

Disclaimer: This article is NOT an investment recommendation, Please see our disclaimer - Get our 10 free ...

more
How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.