Share buyback

As well as issuing new shares, companies sometimes buy back existing ones.

Updated March 2019

There are two main ways for a company to return cash to its shareholders (other than selling itself and returning the cash to its owners). One is to pay a dividend. The other is for the company to use the money to buy back its own shares and cancel them. This leaves the shareholders who don't sell with a bigger chunk of the company than before.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

So you could argue that if an investor reinvests their dividends, and that buybacks and dividends are treated equally by the tax authorities (not always the case), and that they happen at the same time, then they are the same thing. The end result is that the investor owns a bigger chunk of the company than before.

In reality, there are differences in tax treatment that can make buybacks more appealing for some investors. But that aside, as financial analyst and author Michael Mauboussin pointed out in a piece on buybacks written for Credit Suisse in 2014 (they've been controversial for a while), "the most fundamental difference between buybacks and dividends may be the attitude of executives". Management teams hate cutting dividends because they know investors hate it. As a result, dividend payouts are less volatile (they go up and down a lot less) than share prices. But buybacks are more flexible they fall when the market falls, and rise when it goes up.

Advertisement
Advertisement - Article continues below

It's this element of discretion that makes us favour dividends over buybacks. As noted above, management teams are no better at market timing than other investors. Throw in the added distraction (for some) of being able to influence their pay packets by boosting buybacks, and you have a recipe for poor decision making. Dividends are transparent and impose an element of discipline; buybacks are often opaque and overly manipulable. Given that we're dealing with human beings, we know what we prefer.

Advertisement

Most Popular

Visit/investments/property/601065/what-does-the-coronavirus-crisis-mean-for-uk-house-prices
Property

What does the coronavirus crisis mean for UK house prices?

With the whole country in lockdown, the UK property market is closed for business. John Stepek looks at what that means for UK house prices, housebuil…
27 Mar 2020
Visit/economy/uk-economy/601063/the-uks-bailout-of-the-self-employed-comes-with-a-hidden-catch
UK Economy

The UK’s bailout of the self employed comes with a hidden catch

The chancellor’s £6.5bn bailout of the self employed is welcome. But it has hidden benefits for the taxman, says Merryn Somerset Webb.
27 Mar 2020
Visit/personal-finance/mortgages/601045/coronavirus-what-it-means-for-your-mortgage-or-your-rent
Mortgages

Coronavirus: what it means for your mortgage or your rent

Ruth Jackson-Kirby looks at all the key questions for owners, renters and landlords affected by the coronavirus crisis.
29 Mar 2020
Visit/economy/uk-economy/601055/debt-jubilee-will-our-debts-be-written-off
UK Economy

Debt jubilee: will our debts be written off?

The idea of a "debt jubilee" – general society-wide cancellation of debt – goes back to Biblical times. Could it happen again? And would it really do …
28 Mar 2020