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Shareholder rewards consist of two primary avenues: Buybacks and dividends. Some companies use or other to reward investors. Others use both. Of course, there’s the dubious bunch of corporations that neither pay dividends nor repurchase their own shares.
Additionally, buybacks and dividends are two of the three components of shareholder yield with the third being debt reduction. While some companies use both dividends and repurchase programs to compensate investors, these are often viewed as competing strategies.
Indeed, there advantages and disadvantages to both. With buybacks, the benefits include potential shrinkage of shares outstanding, possibly leading to increased earnings per share. Then there’s flexibility. Simply because a company a company says it’s going to buy back $1 billion in stock doesn’t mean it has to. Additionally, buybacks are more tax-efficient for investors than dividends.
On the other hand, dividends are long-term obligations for companies and ones not to be trifled with at that. Plus, investors must pay taxes on those payouts. However, dividends offer investors the power of compounding when reinvested. Buybacks don’t. Additionally, among other positive traits, dividends help investors keep pace with or beat inflation.
Buyback Debate
One thing is for certain: Buybacks draw more scrutiny than dividends and that’s the case for a number of reasons. Some investors would rather see that cash spent on acquisitions, dividends and research and development while politicians believe the cash should be used to create more jobs. That criticism is rarely aimed at dividends.
“On their face, buybacks are usually well received. In addition to signaling management’s confidence in the future, share repurchases reduce a company’s shares outstanding,” according to ProShares research. “All else equal, with fewer shares publicly trading, remaining shareholders' stock shares represent an increased ownership interest in the company. Earnings per share (EPS) also generally increases, which can boost near-term share prices.”
While buybacks are not “bad”, there’s a compelling case for the right dividend strategies, namely consistent rates of payout growth.
“Dividend growth strategies have become popular core portfolio building blocks across market capitalization segments, geographies and even sectors,” adds ProShares. “While buyback strategies are less common as a stand-alone allocation, some advocate for combining stocks that pay dividends with those that execute buybacks in a concept called total shareholder yield.”
Steadiness Matters
As noted above, companies don’t have to fulfill their buyback promises and they’re rarely taken to task when the repurchase program doesn’t “go all the way.”
Additionally, while companies use buybacks as a way of telling investors there’s value in their shares, corporations themselves are often quite bad at finding that value. They execute buybacks when share prices are elevated and dial back that spending when markets swoon. Hence, buyback activity often tracks broader market performance. Dividend payers don’t have that luxury and that’s a positive for investors.
“Over time, dividends have been more stable than buybacks, and arguably represent a stronger and more lasting signal by management in their confidence in the future growth of their business. Management teams are far more reticent to eliminate a dividend, and investors in turn have come to take dividend cuts as a greater “tell” on underlying business health,” concludes ProShares.