Post #1 The Problem of Excess Cash? Dividends vs Stock Buybacks

Sometimes a few companies find themselves in a bit of trouble. They are sitting on billions of dollars of retained earnings and feel the need to return these to the shareholders. Alas, they don't have any alternative investment opportunities and the earnings must go to the owners.

In this precarious situation, they typically have two choices: reward shareholders directly with cold hard cash (dividend) or indirectly compensate them by buying back their own stock (stock buyback).

Dividend

noun: an individual share of something distributed: such as a share in a pro rata distribution (as of profits) to stockholders

Merriam-Webster Dictionary

A dividend is a cash payment of a share of profits by a company to its shareholders. A dividend is a sure sign of money making ability of a company and usually signifies that the company is performing well.

According to S&P: Since 1926, dividends have contributed approximately 32% of total return for the S&P 500, while capital appreciations have contributed 68%. That ought to tell you something: when you look at historical stock charts and calculate money you could have made while investing in a stock: don't forget to add in the mighty dividends. 

Stock Buyback

noun: the act or an instance of buying something back especially: the repurchase by a corporation of shares of its own common stock usually on the open market.

Merriam-Webster Dictionary

Stock Buybacks (also known as repurchase) occur when a company decides to repurchase its own outstanding shares. When a company buys back its own shares, the total number of outstanding shares reduces, raising the ownership of existing holders and boosting metrics like Earnings Per Share which has the potential to augment the share price in the future.

Warren Buffet lays down for the following conditions for effective buybacks:

Dividends were very popular in 70's and 80's but buybacks have been seeing more prevalence in recent times. This is due to the fact that buybacks are more tax friendly at the hands of shareholders than dividends. That said, buybacks can sometimes be abused by company management for a host of ill intentions - a topic we will cover in a future edition.

Till then take care!!

Disclaimer: The contents of this article are for information and educational purposes only and should not be construed as specific investment, accounting, legal, or tax advice.