In stock investing, there are two ways in which companies offer rewards to their investors — dividends and share buybacks. When companies have surplus cash, they pass it on to their shareholders by paying dividends or buying back shares.
Both the methods are indicative of the company’s will to make use of the available funds and enhance shareholder value. The main difference between dividend payment and share buyback is that the first represents a definite return, which will be taxed in the current timeframe, whereas a share buyback represents an uncertain future return on which tax is deferred until the shares are sold.
Before jumping to question of whether share buyback better or dividend payment from an investor’s perspective, one needs to understand that in today’s environment, this is no longer a question of either or prospect for investors. Instead one needs to consider what they mean.
We need to understand that dividends are straightforward, cash in hand. Share buybacks are indirect. Both dividends and buybacks can help increase the overall rate of return from owning shares in a company. Paying dividends or share buybacks make a potent combination that can significantly boost shareholder returns.
Market dynamics have really changed over the past few decades. Share buybacks have become a lot more prominent and have, in fact, eclipsed dividends as a means of returning cash to shareholders. So, share buybacks are really big in today’s market and have actually substituted dividends in the recent past because till last year, dividend distribution tax was very high. This year, while the same tax has been passed on to shareholders, it is still a little more beneficial for promoters to go for share buyback.
To conclude, an investor must ask himself: which is better for him. Investors planning to invest in stocks on either theme should review his needs and appetite carefully. For someone looking for regular income, the dividend option will be good, while the buyback option can be beneficial for those looking for long-term gains.
If one is looking to build wealth over time, then share buyback could be a better option than dividend payouts, because earnings per share tenders to rise when the floating share count falls. Nevertheless, both are efficient ways of rewarding shareholders where a company can choose the method that is best suited for its shareholders and itself.
(DK Aggarwal is the CMD of SMC Investment and Advisors)