Dividends vs buybacks: which returns more to you?
A dividend sends cash to your account. A buyback uses the same cash to buy back shares, so each share you keep owns a bigger slice of the company. Before tax, the two can be worth the same to you. The differences are when you pay tax, and what price the company pays for its own shares.
The short answer
Both are ways a company hands spare cash back to its owners.
- Dividend: the company pays cash to every shareholder. You get it whether you want it or not, and in a taxable account you usually owe tax that year.
- Buyback: the company buys its own shares on the market and retires them. You get no cash. But there are fewer shares, so each of yours owns more of the company. You owe nothing until you sell.
Neither is free. A dividend lowers the share price by about the payment. A buyback only helps you if the company pays a fair price. More in dividend investing explained.
Side by side
| Dividend | Buyback | |
|---|---|---|
| What you get | Cash | A bigger slice of the company |
| Do you choose? | No, everyone gets it | Yes, you choose when to sell |
| Tax timing (taxable account) | The year it's paid | When you sell shares |
| Share price | Drops by about the payment | No drop; fewer shares |
| Company can stop it | A cut is big news | Quietly, any quarter |
| Main risk | A cut, with a price drop | The company overpays |
A worked example with $10,000
Here's a made-up company, Fieldstone (hypothetical, not a trade idea). It's worth $100 million, with 1,000,000 shares at $100. You own 100 shares, $10,000.
Fieldstone has $4 million of spare cash to return. Here are three ways it could go.
| Dividend of $4 a share | Buyback at $100 | Buyback at $125 | |
|---|---|---|---|
| Shares retired | 0 | 40,000 | 32,000 |
| Shares left | 1,000,000 | 960,000 | 968,000 |
| Company value after | $96 million | $96 million | $96 million |
| Value per share | $96 | $100 | $99.17 |
| Your 100 shares | $9,600 | $10,000 | $9,917 |
| Cash in your hand | $400 | $0 | $0 |
| Your total | $10,000 | $10,000 | $9,917 |
| vs the dividend | — | $0 | −$83 |
How the buyback columns work:
- At $100: $4 million ÷ $100 = 40,000 shares retired. $96 million ÷ 960,000 shares = $100 a share.
- At $125: say the shares trade above what the business is worth, and the company buys anyway. $4 million ÷ $125 = 32,000 shares. $96 million ÷ 968,000 shares = about $99.17.
The dividend and the fair buyback both leave you with $10,000 before tax. The overpriced buyback leaves you with $9,917. A buyback at too high a price moves value from the shareholders who stay to the ones who sell.
Where taxes change the answer
In a taxable account, the dividend's $400 is taxed this year. The buyback isn't taxed until you sell.
In the US, qualified dividends are taxed at one of three rates (0%, 15%, 20%), depending on your income. Source: irs.gov. At a 15% rate, the $400 costs $60 now, leaving $340. With the fair buyback, that $60 stays invested until you sell, and then you pay capital gains tax on your gain.
In Canada, dividends from Canadian companies are grossed up and get a dividend tax credit. The gross-up for eligible dividends is 38% (taxable amount = 138% of the dividend). A buyback gain is a capital gain when you sell. Which is cheaper depends on your province and income. The Canadian dividend tax calculator runs the dividend side.
Inside a TFSA, RRSP, IRA or 401(k), the timing difference mostly disappears. Neither route is taxed while the money stays in the account.
Why companies pick one or the other
- Dividends are sticky. Once a company pays one, cutting it hurts the price. So companies only promise what they're sure they can keep paying.
- Buybacks are flexible. A company can buy a lot in a good year and nothing in a bad one. No one notices a pause the way they notice a cut.
- Buybacks can hide dilution. Some companies buy back shares mostly to soak up shares handed out as staff pay. The share count barely falls. Check whether the total share count is actually going down year after year.
What to check as an owner
- Is the share count really falling? Compare it with three years ago.
- What price is the company paying? Buybacks at high prices, funded with debt, are the costly kind.
- Is the dividend covered? Use the dividend payout ratio calculator.
- Total return. Add dividends and price change together. That's what you actually got. See Total return.
If you sell covered calls on a stock, the dividend matters to the option price and buybacks don't directly. See the wheel strategy.
Questions
Are buybacks better than dividends?
Before tax, a buyback at a fair price is worth about the same to you as a dividend. In a taxable account, the buyback delays the tax. But a buyback at too high a price costs the owners who stay.
Do buybacks raise the share price?
Not by magic. Fewer shares means each one owns more of the company, so the value per share can hold up while the company's cash goes down. Whether the price rises depends on the business.
Why does the price drop after a dividend but not after a buyback?
A dividend moves cash from the company to every owner at once, so each share is worth about that much less. A buyback pays only the sellers, and there are fewer shares left to share the value.
Are buybacks taxed?
For you, only when you sell your shares and have a gain. The company may face its own rules. Your tax on the gain depends on your country and account type.
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