Dividend vs Buyback -- key differences
Companies often use two methods to reward their shareholders – paying dividends and buying back the shares. An increasing number of companies prefer to use a combination of both approaches, thus improving the shareholders’ return. However, there has always been a debate regarding which is better. The dividend payment returns the amount for the current year.
Simply put, the dividend payment is when the company pays all its shareholders' cash according to the proportion of shares they hold, irrespective of their requirements. A buyback is when the company returns money to a particular shareholder, which removes the chances of any future returns on the share. However, investors can refuse to participate in the decision or change their shareholding pattern.
What is a dividend in the stock market?
Dividends are a share of profits that the company pays to its shareholders at regular intervals. It distributes a company's net earnings in cash or stocks/shares. Moreover, the dividend paid by a company affects the shareholder's return on investment (ROI). They are mainly distributed quarterly but can be paid at regular intervals, such as monthly, quarterly, or annually. The Board of Directors is responsible for selecting the eligible shareholders and the dividend amount.
Various companies offer dividend payments to their shareholders, and they hold voting rights to approve. However, startups and high-growth firms, like the technology sector, retain their profit and reinvest it to foster growth. Therefore, investors prefer buying stocks and shares of those companies which pay dividends in cash so that their gains are not affected.
And, what exactly are stock dividends?
A stock dividend in the stock market is when the company decides to pay its shareholders by giving additional shares instead of cash. It is done when the company wants to reward its shareholders but also intends to refrain from interfering with its cash balance.
What is buyback in the stock market?
A buyback which is also called a share repurchase is when a company buys its shares in the stock market from its existing shareholders. It is the company's self-investment in which it purchases its outstanding shares to reduce the available number of shares in the open market.
A repurchase is done for various reasons, such as to increase the value of remaining shares available by reducing the supply, positively inflating earnings per share and the stock's value, or preventing shareholders from controlling a majority stock. As a result, the buyback increases the stock's earnings per share (EPS) while the price-to-earnings ratio (P/E) decreases or the stock price increases.
A share repurchase can show the investors that the business has sufficient cash for emergencies and a low probability of getting hit by economic troubles.
Differences between Dividend and Buyback of shares
The difference between dividends and buybacks are as follows:-
- A dividend is when a company pays a proportion of its net profit to shareholders in the form of cash, stocks etc. Buyback is when a company purchases shares from existing shareholders usually at a higher price to reward them.
- A dividend payment is made at regular intervals, monthly, quarterly, or annually. A buyback is a one-time action that rewards the shareholders for their investment in the company.
- Dividends are not guaranteed amounts, i.e., the dividend a company will pay depends on the profit earned. Sometimes, a company may reinvest the profit earned and choose not to reward the shareholders. A buyback is a guaranteed sum the company will pay the shareholder once announced.
- Dividends may not provide a shareholder with long-term profits. However, dividends are good if you want to build wealth over time, but these are not applicable for capital gains. Buybacks are profitable for the shareholder in the long run, as the company buys the shares at a higher rate. Also, buybacks offer higher capital gains over time.
- The tax implication on a dividend is different, and it depends on the income slab. A buyback has a uniform tax rate implicated in the shareholder's earnings.
Advantages and disadvantages of Dividends
Advantages of Dividend:
Dividends are a source of income for the shareholders, and when a company pays out regular dividends, it boosts the investors' confidence and denotes business stability.
A company that pays regular dividends attracts more investors as compared to a company that has an irregular reward pay-out structure.
Dividends reduce the tax burden on the investors, as the company deducts the tax while distributing the amount.
Disadvantages of Dividends:
The major drawback of a dividend is that the company may run out of cash by paying regular rewards to shareholders. As a result, long-term growth is compromised.
Companies aren't obligated to pay dividends to their shareholders. They can refrain from rewarding to reinvest the profit for the company's growth, directly affecting the shareholders' income.
Dividends increase the tax burden on the company as they need to pay tax on the profit they will deliver to the stockholders.
Advantages and disadvantages of Buybacks
Advantages of Buyback:
Buybacks improve company valuation because when the company feels its shares are undervalued, they purchase them back at a higher rate.
Buybacks are a tax-effective method of rewarding shareholders.
The reduction in the number of outstanding shares increases the company's earnings per share (EPS).
Disadvantages of Buybacks:
The buyback causes a reduction in the number of shares in the market, resulting in a downfall in supply.
Buybacks can give inaccurate estimates of the valuation of the company.
The sudden increase in share price increases ratios such as EPS and ROE, generating false signals to the investors.
Both dividends and buybacks are good ways of rewarding the shareholders, but a shareholder can opt for what's best for them as per their income needs. For example, dividends are better if a shareholder expects regular income over a more extended period. However, investors looking for long-term gains should opt for a company that pays out using a buyback or share repurchase option.
Moreover, if a company wants to attract more investors, it must pay out dividends regularly to the stockholders. Meanwhile, they should be aware that this might drain the cash out of the company, and reinvestment of profit for the company's growth would be difficult. On the other hand, if the company evaluates that its outstanding shares are undervalued, it can repurchase them.
Q. What is better, a Dividend or a Buyback?
It depends on your investing preferences and income goals. For example, a dividend stock is attractive for investors who expect regular income, while investors prefer buybacks when they want long-term capital gains.
Q. Is share buyback beneficial for investors?
A share buyback is beneficial for investors when they want to profit long-term from your investment.
Q. What advantage does a share buyback have for the company?
Share buybacks provide the company with cash to reinvest. As a result, the stock's market value increases earnings per share (EPS) and the return on equity (ROE).
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