Dividend vs Share Buyback : Which is better ?

Dividend vs Share Buyback

Why the US market is trading upward even as investors big and small are selling?

According to an article from Fortune, most people assume what has kept the market afloat this year after sinking 11% at the start of the year was a mixture of better news out of China, oil prices stabilizing, and indications that the Fed won’t raise rates as much as a thought. But the real thing buoying the market could be something else: stock buybacks.

“Corporate repurchases are the main source of net demand for US stocks,” a team of Goldman Sachs analysts led by David Kostin noted in report out in early April 2016. Demand stemming from stock buybacks will help push up share prices—boosting the S&P 500 to a flat return of 2100 by the end of 2016 as the markets contend with weak growth and a messy earnings outlook, according to the Goldman analysts.

image credit to businessinsider.sg

Stock buybacks, in which companies buy back their own stocks and reduce the number of shares on the market, surged to $561 billion in 2015—a 40% increase from the year-earlier and the highest since 2007’s $721 billion. And that figure is expected to rise another 7% for 2016 to $600 billion, according to Goldman Sachs.

< base on the above chart, companies seem to buy back their own share when the stock price is increasing and less buying activities during GFC ?? whereby to maximize shareholders value, companies should buy during a crisis and depress time. >

Concept explained : Share Buyback  by Investopedia

What is a 'Buyback'

A buyback, also known as a repurchase, is the purchase by a company of its outstanding shares that reduces the number of its shares on the open market. Companies buy back shares for a number of reasons, such as to increase the value of shares still available by reducing the supply of them or eliminate any threats by shareholders who may be looking for a controlling stake ( a strategic move by controlling shareholders ).

A buyback allows companies to invest in themselves. By reducing the number of shares outstanding on the market, buybacks increase the proportion of shares owned by enduring investors. 

A company may feel its shares are undervalued and buy them back to provide investors with a return, and because the company is bullish on its current operations. A buyback also boosts the proportional share of earnings a share is allocated; all else equal, this boosts the valuation of stock even if it maintains the same price-to-earnings (P/E) ratio.

Another reason for a buyback is for compensation purposes. Companies often award their employees and management with stock rewards and stock options; to make due on the shares and options, companies buy back shares and issue them to employees and management. This helps to avoid the dilution of existing shareholders. Activist investors can also argue for buybacks when a company's stock has not performed in line with the greater market or its industry.

Dividend vs Share Buyback: Which is better?

Companies reward their shareholders in two main ways—by paying dividends or by buying back their shares. An increasing number of blue chips are now doing both: paying dividends and buying back shares, a potent combination that can significantly boost shareholder returns. But which alternative is the better one for investors?

What’s a Dividend?

Dividends are a share of profits that a company pays at regular intervals to its shareholders. Investors like dividend payers because dividends form a major component of investment return, contributing nearly 43% of total returns for U.S. stocks s ( S&P 500 ) since 1926, according to Standard & Poor’s (capital gains account for the other two-thirds). Companies typically pay out dividends from after-tax profits. Once received, shareholders must also pay taxes on dividends, albeit at a favourable tax rate in many jurisdictions. 

"The Little Book of BIG Dividends " providing good info and strategies on dividend investing. "The idea of investing for dividends sounds rather quaint-something your grandfather did in the olden days. So it might surprise you that from 1926 to present, dividends have accounted for 43% of the total return of the S&P 500 index ！”

"Dividends are ultimately paid out of a company's profit, so pay attention to the relationship between these two."

" One way to hedge against inflation is to focus on stocks that are to boost their dividends on a regular basis."

" Reinvesting dividends may be the only way some of us buy during a down market ."

What’s a Buyback?

A share buyback refers to the purchase by a company of its shares from the marketplace. The biggest benefit of a share buyback is that it reduces the number of shares outstanding for a company. This usually increases per-share measures of profitability like earnings-per-share (EPS) and cash-flow-per-share, and also improves performance measures like return on equity. These improved metrics will generally drive the share price higher over time, resulting in capital gains for the shareholders. However, these profits will not be taxed until the shareholder sells the shares and crystallizes the gains made on the shareholdings.

In the US context, share buyback is having better tax treatment than dividend as capital gain and dividend are taxable , but here in Singapore, such tax advantage on share buyback over dividend does not exist.

As such, I would prefer company paying out their FCF in dividend instead of buying back their own share ( if the company does not have any idea on where to deploy their excess cash for better return ). I have seen some companies buying back their share even with double-digit PE at purchase price, which I don’t see the rationale and value creation for shareholders.

In the case of dividend, I could decide whether to put back the money to the same company or buying other undervalue the company and also could decide when to deploy my capital back to the market.

Regardless of a share buyback or dividend payout, shareholders must take note that the money should come free cash flow instead of debts.

Why Dividends Matter :

Quoted from Investopedia,” One of the simplest ways for companies to communicate financial well-being and shareholder value is to say "the dividend check is in the mail." 

Dividends, those cash distributions that many companies payout regularly to shareholders from earnings, send a clear, powerful message about future prospects and performance. A company's willingness and ability to pay steady dividends over time - and its power to increase them - provide good clues about its fundamentals.”

Of course, not all high dividend yield company are good to BUY, one needs to be aware of the “value trap “ in buying high yield stocks, not all high yield dividend are sustainable and we need to ensure that the dividend payout from free cash flow and not the debts or other forms of “creative accounting “.

I have to admit that as a retail investor, I succumbed to such trap few times, in buying counters such as Sabana REIT, Asian Pay TV and HPH which their share price has gone down much more than whatever dividend I have collected .

Dividend Update :

Since we are on the topic of dividends, allow me to update my dividend collected in 3 Qtr 2016 :

-          a) TTL dividend collected in 3 Qtr 2016 = $47,884

-           b)  Total dividend decreased in 3 Qtr  due to Accordia (payout in June and Dec) as you may notice that  Accordia contributed about 7% of my total portfolio.

-         c)  Dividend receive in a coming quarter shall decrease in view of decreasing dividend payout from REIT and blue chips expected under such challenging economics condition.

Base on above, in case of USA, dividend return contributed nearly 43% of the total market return since 1926, but for me, since my holding is mostly income stocks ( may refer to “My Portfolio “ for more detail ), dividend contributed about half of my total return.

How about you, what is your dividends return over your total return on investment?

Cheers!

Quote Of The Day :

"The only thing that gives me pleasure is to see my dividend coming in." --John D. Rockefeller.