Dividends vs share buybacks

Dividends and share buybacks or share repurchase are similar in terms of their objective i.e. to reward shareholders for their trust and patience. Dividends are one of the most common practices that we come across. It is simply the distribution paid to shareholders. A share repurchase is a corporate action, where the company buys back its own shares. Thus, the outstanding number of shares is reduced and with this, a lesser supply of stocks is expected to drive the stock price higher resulting in capital gains for the shareholder. And hence, both can be thought of as the same actions of rewarding the shareholders, it’s just that the ways of doing it are different.  

Dividends  

Dividends, either paid in cash or in the form of stocks, are called stock dividends. Usually, it’s the board of directors, who declare the number of dividends to be paid. They can be regular dividends, special dividends, or liquidating dividends. Regular dividends are those, which have a consistent schedule; for example, a quarterly dividend paid by the company. Special dividends are those, which are irregular or extra in nature. If a company has a history of payout ratio of 10 per cent cash dividends yearly and suddenly it pays 25 per cent, then that extra dividend is referred to as a special dividend. A payout ratio is calculated as dividends to earnings. Liquidating dividend is rarely seen; it’s when the company wants or is forced to shut the business and the proceeds are paid to shareholders. If you want to be eligible for dividends, you must buy shares of the company two days before the holder of the record date, assuming T+2 settlements.   

Share buybacks  

It is a transaction, where a company buys back its own shares. It utilises corporate cash to carry out the transaction. The shares that have been bought back are called treasury stock, which can be seen in the ‘changes in equity’ statement. However, the treasury stock is not used for the calculation of earnings per share. Share repurchases are becoming increasingly popular in the markets. It indicates that management has increased trust in the company by buying back its own shares. There are many ways to carry out the transaction. It can be done in the open markets, buying at the prevailing prices. A tender offer can be made for buying at a fixed price and at a premium to market prices. The company can also negotiate directly with large shareholders for a buyback.   

What’s the difference?  

Dividends are taxable when received at both corporate and personal levels. For share repurchases, taxes deferred as capital gains are realised when the stock is sold. Also, share repurchase may be tax advantageous if taxes for capital gains are lower than dividend tax. Another major difference is that share buybacks are at the discretion of the management. It may not buy it back to the extent as promised; however, there are obligations to pay as promised in case of dividends. The shareholder is assured of a cash reward in the form of a dividend but cannot be assured of capital gains due to share repurchase. There is an old saying, ‘a bird in the hand is worth two in the bush’. However, both methods of rewarding the shareholders are effective and boost the morale of shareholders.