Dividend Reinvesting vs. Share Buybacks

 

I came across this little tidbit, and I was almost floored by not only the title, but by the article in general.

http://www.forbes.com/sites/baldwin/2013/03/18/dumb-idea-dividends-are-good-for-you/

I know that buybacks are very important for companies to perform. It is no secret that companies buy there stock on the open market to reduce share count and to “artificially” pump earnings. I enjoy a good discussion just like the next guy, but this article was no discussion. It was simply one man’s thoughts on how a stock will perform, over time, exactly the same whether it offers a dividend or just buys back the equivalent shares. I tend to disagree a bit.

First, I know how dividends are treated when they are distributed and that is exactly why I want them. When I get a dividend, I get actual cash that is used for purchasing more stock at hopefully a lower price than I paid for it prior-though not always. With a buyback, I get no cash and no extra shares- that is a lose lose for me all the way around. The author goes into an HP rant and basically proves how my theory actually works better.

1.  With a buyback, an investor has 100 shares that are worth $40.00 each- total value $4000.00.  After the buyback, the shares collapse to $16.00 and his value is $1600.00.  The company used lots of cash (5% of its Market value) to buy 5% of its shares back at the high price of $40.00 and then after all is said and done, the shareholder now has 100 shares worth $1600.00. Now that shareholder needs cash…. lets say $200.00. Now, he has to sell 14 shares or so and ends up with 86 shares left after the sale and commission. Even if he reinvests at this point, the result is actually lower than if he let it ride because of commissions and fees. Also, there is no compounding in effect with this strategy.

2. Now with a dividend, the investor has 100 shares that are worth $40.00 each- total value $4000.00. After the dividend of $2.00, the shares collapse to $15.20 and the value before the dividend reinvestment is $1520.00. Now the investor takes the $200.00 and reinvests the money in the stock (or the stock of another company) and is able to purchase about 13 shares at $15.20. In the end after the commissions and fees (there should be very little or none in a reinvestment program), he has 113 shares worth $1717.6. Now the same stock that paid the investor $200.00 last quarter will now be able to possibly pay him $226.00, and he has more shares by almost 1/3 than he would if the company just bought back shares.   This strategy makes quite good use of compounding which has been called by Einstein, “the most powerful force in the universe.”   I will go with door number 2 Johnny!!!

The above was a very basic description, and it did not take the tax consequences into consideration.  Either way, I would end up with more money with the dividend payout if we are just comparing the 2 processes as stated. I have been doing the same thing that is outlined and it works. I have never really been fond of companies selling low and buying high like they do, most of the time, when they do buybacks. Also, I do not remember many companies buying back much of anything when the market tanked a few years back. It is only after the market starts to progress that the companies need to use the cash horde in order to pump the numbers to fit the estimates.

Any thoughts would be greatly appreciated

Keep cranking,

Robert the DividendDreamer

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About dividenddreamer

Doing what I can to make the best of today and the most of tomorrow.
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4 Responses to Dividend Reinvesting vs. Share Buybacks

  1. I think buybacks can be very important to creating value for shareholders if properly done. Most companies have regularly scheduled buybacks like they do with dividends. Which I think is a bad idea since you’re buying at whatever price and time.

    Companies like CACC, TJX, ROST, and ADT are greatly reducing their share count, which does boost earnings, but since there less shares then the shares become more valuable. Plus, it’s more tax-efficient.

    i think in the end, it comes down to management. Do you trust management enough to buyback their shares at appropriate prices? I don’t trust QCOM’s management given that the outstanding share count is increasing rather decreasing, even after billions have been spent on buybacks. But I do trust the companies listed above.

    Great post, thanks for sharing!

    • Hey Henry, just got finished eating some of the best sushi in town. Thanks for putting the idea in my head with the wonderful pictures on your blog. I took my wife and kids there for our anniversary.

      Thanks again,

      Robert

  2. Tawcan says:

    I think both buybacks and dividend increase are important. Buybacks can create more values for shareholders. A lot of companies are just buying back shares when the money should be used on other things. Buying back shares is a little bit cheating when it comes to accounting. It reduces the number of shares so it effectively increases the EPS as well.

    Dividend increase just shows the shareholders that the company cares about the shareholders. After all, we all like to receive extra money in our pocket.

    • Management is probably always buying back at higher prices than when the shares were issued. I think I will do a little research on that to see how efficient most companies are at buying back shares at better prices than they were issued.

      Keep cranking,

      Robert the DividendDreamer

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