Dividend VS. Share buyback
In this article I would like to discuss the differences and dangers of both methods.
Many swear by shares that drive "BuyBacks" and thus want to achieve a tax deferral effect and rising prices. Others again probably do not see the money only as numbers in the broker, but ggfs rather directly on the account or otherwise invest.
In principle, both methods are similar. A dividend is paid out of the capital of the company, which is reduced by the dividend. This can be seen well on "EX-days". With a BuyBack, the company buys back its own shares from the capital. This usually increases the share price, as there are fewer shares in circulation and the value of the company is distributed over fewer shares.
But this is where the first problems can arise.
In the U.S., much value is placed on a regular and constant dividend, since many investors need this money to live on and rely on it. Many companies manage this mostly without problems and can increase the dividend annually. The most reliable are considered the dividend aristocrats [1].
To hold this title must be paid a dividend for at least 25 years without interruption. This for advancement in any funds or ETFs.
However, in bad years, companies may have to go into debt to pay a dividend in order to hold their stock.
Some companies survive this "hole" and can continue to pay dividends reliably. For example, some have managed to pay a dividend consistently for over 50 years.
Paid out capital is of course missing for new investments or similar. So if you rely on dividends, you should not expect big jumps in share prices.
They are usually only a guarantee for a solid company that has its business field and dominates it or generates good earnings.
In the case of share buybacks, the whole procedure serves as an indirect dividend to shareholders.
But even here there are dangers that should not be ignored.
Share buyback programs are particularly popular in the USA. The main reasons for such measures are:
- Share price maintenance
- Imminent takeover: own shares are acquisition currency
- Improvement of balance sheet ratios, such as return on equity (earnings per share increase)
A prominent example of a company that has never paid a dividend and yet has left an above-average positive earnings record for its shareholders over decades is Berkshire Hathaway. Among technology stocks, too, there are numerous companies, such as Alphabet (Google), which have left their shareholders with an excellent earnings record even without regular dividend payments.
Shareholders who keep their shares also benefit from a higher share price. Because there are fewer shares in circulation, there is usually also a higher dividend.
In the case of share buybacks, there is also the question of whether the shares concerned are effectively cancelled after the transaction. The positive effect for shareholders is only given if the number of outstanding shares is effectively reduced and the company's stake for existing shareholders increases accordingly. In some cases, share buybacks serve to compensate for the dilution caused by the steady issue of new shares under employee stock option programs (dilution effect). In this case, at least the dilution due to the lower number of outstanding shares is lower. There is no blanket recipe for assessing this, as the granting of employee shares and options serves as an important element in the remuneration and motivation of management, particularly in Anglo-Saxon countries.
So attention must be paid here to the framework in which this takes place. For example, a buyback can only be a compensation and the share price remains unimpressed by the buyback, since for a certain period of time, the same number of shares is again in circulation.
Share buybacks are also controversial among some experts, especially with regard to the long-term perspective of a company. The following arguments are often cited:
No economic added value - Short-term price increases only serve to keep shareholders happy. However, share buybacks actually speak for a certain lack of ideas on the part of corporate management. The corporation later lacks money that it could invest in new projects, machines or research, for example.
Detrimental to growth - If investments are not made in the long term, this can have a negative impact on the company's growth. For example, because the competition develops further and the stock corporation is eventually left behind. In addition, money that flows into buyback programs may be lacking as a financial cushion for the company in times of crisis.
Bonus for the Board of Management - Sometimes the compensation of board members in a company is variable and depends, for example, on the company's success on the stock market. This means that some board members can collect more money if share prices rise after a share buyback.
Investment bubble - Share buybacks can also be financed through debt. That is, the company borrows to buy back shares from shareholders. This only works well as long as the company continues to make a profit. If it fails to do so, it will no longer be able to service loan interest in the medium term and will get into financial difficulties.
US companies are particularly active in share buybacks. A calculation by "Handelsblatt" shows that the 500 largest U.S. corporations spent $1.3 trillion (1.17 trillion euros) on share buybacks and dividends in the past year 2019. The companies' net profits were $1.1 trillion (€986 billion) in the same period. Apple alone bought back shares worth $327 billion in recent years, according to the calculation.
CONCLUSIONS:
I don't think we need to talk about the advantages and disadvantages of dividends. These should be known to everyone who invests in this direction. That's why I went into more detail about the buybacks.
Buybacks are not always a good sign, but can also have negative effects.
However, if you are looking for share price growth rather than cash flow, you are in good hands with solid companies that are actively buying back shares under positive conditions!
The best is of course the mixture of both for my "strategy"!
Less shares, more dividends 😍
On the whole, everyone has to decide for themselves what they prefer here. However, should know and understand the pros and cons of both options.
[1] https://aktienfinder.net/dividenden-aristokraten
Sources:
https://blog.onvista.de/was-sind-dividenden-und-aktienrrepurchases
https://www.financescout24.de/wissen/ratgeber/aktienrueckkauf
