| June 25
Which is a better choice dividends or buyback of shares?
A company rewards its shareholders for equity Investment in its stock mainly
in two ways: Dividends and Buybacks of Shares. For illustration, say a company
has earned surplus reserves and has no positive growth projects to invest in,
where will the funds flow? Under these scenarios in Equity trading India the company
prefers paying dividends or purchases their own shares from the investors.
So what are Dividends and Buyback of shares?
Dividends are the incentives given to the
shareholders of the company’s after-tax earnings. They are usually paid
regularly on a quarterly basis; however special dividends are also given by
several companies. The dividend payment helps in making the company attractive
as there are many investors who are drawn towards dividend-paying companies.
However, buyback of shares is a repurchase of its
own shares by the issuing company in order to reduce the number of shares
outstanding. The main intent behind the process is to increase the price of the
remaining stock. The companies undergo the buybacks either by a tender offer or
by open market purchase.
So, which is the
Buyback of shares takes a lead when it comes to
evaluating on the basis of taxes. In India, the dividends are taxed at 3
levels: first it is an after-tax cash flow given by the companies, second it is
taxed again at the company level by a tax called Dividend Distribution Tax and
finally it is taxed for the third time in the hands of investor if the amount
is more than Rs10 lakhs in a year in share trading India. Whereas, in the case
of buybacks the investors are taxed for long-term capital gains only making it
much more economical.
- What message does a company
Buybacks signify that a stock is undervalued and
the company wants to signal the future potential growth opportunities, the
share price is expected to increase. Whereas, the dividends provide no such
When companies pay dividends, their stock prices
tend to go down and so are the valuation parameters like P/E. However, in the
case of buyback of shares, the number of outstanding shares go down and so the valuation
parameters like Earnings per shares, cash flows per shares go up. Such improved
ratios symbols for an increase in the share prices.
Investors are easily able to gather information
about the company’s upcoming dividends payment through many sources, whereas
information related to buyback of shares is a little hard to find.
While seeing from an investor’s eyes both the
dividends as well as buybacks of shares seems to be lucrative in terms of
capital gains. While evaluating comparison, each one has its advantages and
disadvantages, however, buyback of shares seem to be winning this race. The
buyback of shares are tax-efficient as well as provides signals of a growing
company. As rightly quoted by Mr. Warren Buffett for the company owners: