Share repurchases vs dividends
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Many corporations compensate their shareholders in two ways - through dividends or stock buybacks, and some companies are doing both.
However, there is a debate on which is better for shareholders - stock buybacks or dividends.
Executives, investors, and the media often promote the idea that stock buybacks generate more value than dividends. However, this is not necessarily true.
While share repurchases may increase a company’s earnings per share, they do not necessarily translate into higher value for shareholders compared to dividend payments for a fairly valued company.
For example, let’s say a company earns $100, has a P/E ratio of 15 on core earnings, and has $100 in excess cash that can be distributed as either dividends or share repurchases.
If the company chooses to pay dividends, shareholders receive $100, and the company’s equity value remains at $1500.
If the company chooses to repurchase shares, the selling shareholders receive cash, and the remaining shareholders have shares with a higher value, but they do not receive any cash.
Overall, there is no change in underlying value, just a change in the mix of shareholders.
Note that earnings per share increase mechanically; it has nothing to do with underlying value creation. If your company pays out a dividend, shareholders retain their shares and receive cash.