Dividends vs share buybacks – what investors need to know | Hargreaves Lansdown (2024)

FAQs

Dividends vs share buybacks – what investors need to know | Hargreaves Lansdown? ›

The key point is that dividends are better for income, while buybacks are more geared towards capital growth. A company is under no obligation as far as share buybacks go. In most cases, it can start and stop repurchasing shares whenever it wants.

Dividends increase the value of shares to some investors, but buybacks tend to drive faster price increases.

The dividends will flow out of retained earnings but the shares outstanding will remain the same. A buyback will reduce the share capital account and reduce the number of shares outstanding in the model. Learn more in CFI's financial modeling courses!

In effect, buybacks “re-slice the pie” of profits into fewer slices, giving more to remaining investors. A stock buyback is one of the major ways a company can use its cash, including investing in its operations, paying off debt, buying another company and paying out the money as a dividend to investors.

Tax-exempt investors would likely prefer a high dividend payout because they do not have to pay taxes on this income, making it an efficient way to receive returns on their investments.

Different investor types tend to have a preference for how excess cash flow is returned. For example, investors who desire supplemental income, such as retirees, often prefer to receive dividends. A dividend is a real cash payment, which the investor can then use to spend however they wish.

Buybacks, in which a company uses cash to repurchase its own shares, have eclipsed dividends as a means of returning cash to shareholders. Repurchases that result in a decline in outstanding shares leave remaining shareholders with a larger ownership stake.

However, share buybacks can also have some disadvantages. Among which is that it can reduce the free float of the company's shares, which lowers the weight of the security in an index. This could subsequently result in index trackers and exchange-traded funds reducing their holdings in the company.

Disadvantages. A criticism of buybacks is that they are often ill-timed. A company will buy back shares when it has plenty of cash or during a period of financial health for the company and the stock market. The stock price of a company is likely to be high at such times, and the price might drop after a buyback.

Aside from the rate at which they're taxed, there's another difference between stock buybacks vs. dividends. The taxes due on buybacks are deferred until capital gains are realized. With dividends, those payments have to be reported on your tax filing at the time they're received.

Why are share repurchases preferred over dividends? ›

Share repurchases usually offer company management more flexibility than cash dividends by not establishing the expectation that a particular level of cash distribution will be maintained. Companies can pay regular cash dividends supplemented by share repurchases.

Public companies use share buybacks to return profits to their investors. When a company buys back its own stock, it's reducing the number of shares outstanding and increasing the value of the remaining shares, which can be a good thing for shareholders.

Company Pays Itself Instead of Shareholders

Buybacks, on the other hand, are an artificial means to a financial end for insiders, and a crutch used to beef up a company's per-share profits. These effects provide zero benefit to investors who used their hard-earned money to invest in a company.

Answer and Explanation:

Dividends are taxed as regular income, while capital gains are typically taxed as a rate is lower and correlates with one's marginal tax rate. Investors who have lower marginal tax rate would therefore prefer dividends over capital gains.

Five of the primary reasons why dividends matter for investors include the fact they substantially increase stock investing profits, provide an extra metric for fundamental analysis, reduce overall portfolio risk, offer tax advantages, and help to preserve the purchasing power of capital.

Due to tax breaks, institutional investors (such as corporations and tax-exempt organizations) also usually prefer high dividends. In addition, institutional investors often have an obligation to invest wisely, and a high dividend payout demonstrates fiduciary responsibility.

If you're mainly investing for long-term growth, you'll probably want to reinvest dividends. Since 1926, dividends have made up a large chunk (about 4 percentage points) of the equity market's 10% average annualized return.

There are a couple of reasons that make dividend-paying stocks particularly useful. First, the income they provide can help investors meet liquidity needs. And second, dividend-focused investing has historically demonstrated the ability to help to lower volatility and buffer losses during market drawdowns.

The dividend yield measures how much income has been received relative to the share price; a higher yield is more attractive, while a lower yield can make a stock seem less competitive relative to its industry.