Anyone who invests in the stock market wants to make money. Of course, the most traditional way to do this is buying a stock low and selling it after it increases in value: a capital gain. However, investors can, and do, make money from their investments in other ways, including buybacks and dividends. Anyone who invests in the stock market needs to understand his or her options when it comes to buybacks and dividends, including how these two options work and their differences.
Important Differences to Understand
While some investors might be under the impression that these are essentially the same thing, the fact is there are some important differences between the two.
Dividend – According the definition from The Economic Times, a “dividend refers toa reward that a company gives to its shareholders. Dividends can be issued in various forms, such as cash payment, stocks or any other form.” Its board of directors decides a company’s dividend and it requires the shareholders’ approval.
Buyback – Meantime, Investopedia defines a buyback this way; “A buyback is the purchase by a company of its outstanding shares that reduces the number of its shares on the open market.”
Investors Enjoy Dividends
In reality, almost all investors enjoy receiving a dividend. However, not all companies pay them. Typically, a new company just starting out would prefer to take its gains and put them back into the company. Older, more established companies are more likely to pay a dividend. In any case, investors love to receive them. Not only does it put cash in their hands, but it can also serve to increase or preserve confidence in the company as a viable growth option going forward.
Buybacks Might Hurt More Than Help
Buybacks have become increasingly popular over the last decade and many investors consider them an excellent alternative to dividends. Companies complete buybacks for several reasons. One factor that companies like about buybacks is that shareholders do not have a vote in the matter. Only corporate executives determine buybacks and many believe these are the people that benefit the most. Another reason companies complete buybacks is to save themselves when they are going to miss earnings. This can give a false outlook and make things look better than they really are.
The Downside to Buybacks
Companies also tend to fund Buybacks with debt and not with increased earnings. Thus, buybacks often hurt a company in the long run. The company goes into debt in order to make the earnings report or share price lookbetter, but shareholders lose their shares without any say.
Dividends Offer Many Benefits
On the other hand, a dividend is often a sign of quality and growth in the company offering it. They are also typically paid with earnings and not with debt. Thus, when a company is making regular dividend payments that usually indicates it has consistent and regular cash flow. It’s also a positive sign of the stock’s overall quality and future growth. Additionally, shareholders not only get cash in hand, but theyalso keep their shares. Lastly, companies that pay dividends also tend to be the most stable when the market is down and the strongest when the market is on the rise. Thus, although they might seem similar on the surface, dividends appear to be much more useful and reliable than buybacks.