How are stock buybacks any worse than dividend payouts to investors?
I get how they are logistically different, but to me, whether you give the investors cash that they use to buy more stock, or you internally increase the value of a stock by buying it back with company funds, the result is the same – Investors get richer at the cost of investment.
Not saying buybacks aren’t bad, but I guess I just don’t understand the hate relative to dividend payments.
In: 98
A lot of people dislike both. It’s easy to get upset at an airline that’s bailed out in 2001, spends billions on dividends/buybacks 2002-2019, and then is bailed out again in 2020.
Reasons to dislike buybacks specifically:
* Tax avoidance as compared to dividends. People get mad that corporations avoid taxes.
* Buybacks “allow” companies to issue more stock as compensation, which can muddle a company’s profitability and make a company look more profitable. Some people complain that companies do buybacks to make it look better when they give the CEO $$$$$ through stock
* Companies that initiate buybacks pretty inherently have non public information about themselves. If I buy/sell stock because I know top secret information, it’s illegal insider trading. Companies shouldn’t be able to do insider trading either.
Edit- wanted to add one more note here:
Stock buybacks are tax advantaged, as many people have brought up. A dividend is immediately taxable, a buyback passes value on that’s not immediately taxable. This is great for investors with taxable holdings of the company (investors with brokerage accounts, executives with stock holdings). One downside is that there’s fees companies pay to conduct stock buybacks. Not huge fees, but some commission to execute it.
A lot of people mostly don’t have taxable stock holdings. They have 401ks, or IRAs, or pension funds. For them, the tax benefit of a stock buyback is MEANINGLESS. They wouldn’t pay taxes on the dividends, they lose out a little from the fee for the buyback, they’d be better off with a dividend. If you only have stocks in a 401K (which is a large percent of America) then stock buybacks is just extra fees for you so rich investors and corporate executives get to delay paying their taxes.
A lot of people dislike both. It’s easy to get upset at an airline that’s bailed out in 2001, spends billions on dividends/buybacks 2002-2019, and then is bailed out again in 2020.
Reasons to dislike buybacks specifically:
* Tax avoidance as compared to dividends. People get mad that corporations avoid taxes.
* Buybacks “allow” companies to issue more stock as compensation, which can muddle a company’s profitability and make a company look more profitable. Some people complain that companies do buybacks to make it look better when they give the CEO $$$$$ through stock
* Companies that initiate buybacks pretty inherently have non public information about themselves. If I buy/sell stock because I know top secret information, it’s illegal insider trading. Companies shouldn’t be able to do insider trading either.
Edit- wanted to add one more note here:
Stock buybacks are tax advantaged, as many people have brought up. A dividend is immediately taxable, a buyback passes value on that’s not immediately taxable. This is great for investors with taxable holdings of the company (investors with brokerage accounts, executives with stock holdings). One downside is that there’s fees companies pay to conduct stock buybacks. Not huge fees, but some commission to execute it.
A lot of people mostly don’t have taxable stock holdings. They have 401ks, or IRAs, or pension funds. For them, the tax benefit of a stock buyback is MEANINGLESS. They wouldn’t pay taxes on the dividends, they lose out a little from the fee for the buyback, they’d be better off with a dividend. If you only have stocks in a 401K (which is a large percent of America) then stock buybacks is just extra fees for you so rich investors and corporate executives get to delay paying their taxes.
Very simple.
Let’s say I own 1% of a company worth $10,000,000. My investment is worth $100,000, but only if I sell.
The company does great and profits $1,000,000 for the year. As I’m part owner to that company, I should realistically be part owner of the profits. My share of the profit is $10,000, which is a significant chunk of change.
But they don’t do a dividend distribution.
Okay, so maybe they’ll take the cash on hand and use it to invest in growth so they do better the next year, or they pay the employees more to maintain better retention?
Well, no. They decide to do a stock buyback. So the $10MM on the open market becomes $9MM.
Well, that’s good, because my share is now larger on the open market, right?
Nope.
Because the company is gifting those shares to employees, more specifically board members. So there’s still $10,000,000 in shares, I still own 1%, but the entire amount of profit just went into the pockets of the board of directors.
Worse yet, it went into their pockets without being taxed. *They won’t owe taxes until they sell.*
Now keep track of this bit.
The board has now amassed 10% voting control. 55% of the rest of the shareholders (most of which don’t actively vote) would have to unify to change the board. And the board gets to vote on their own pay, and direct the company to buy more stock to give to the board.
So I still own only 1% of the company. And all of the profit goes to a handful of people. So why do I own 1% of the company?
Very simple.
Let’s say I own 1% of a company worth $10,000,000. My investment is worth $100,000, but only if I sell.
The company does great and profits $1,000,000 for the year. As I’m part owner to that company, I should realistically be part owner of the profits. My share of the profit is $10,000, which is a significant chunk of change.
But they don’t do a dividend distribution.
Okay, so maybe they’ll take the cash on hand and use it to invest in growth so they do better the next year, or they pay the employees more to maintain better retention?
Well, no. They decide to do a stock buyback. So the $10MM on the open market becomes $9MM.
Well, that’s good, because my share is now larger on the open market, right?
Nope.
Because the company is gifting those shares to employees, more specifically board members. So there’s still $10,000,000 in shares, I still own 1%, but the entire amount of profit just went into the pockets of the board of directors.
Worse yet, it went into their pockets without being taxed. *They won’t owe taxes until they sell.*
Now keep track of this bit.
The board has now amassed 10% voting control. 55% of the rest of the shareholders (most of which don’t actively vote) would have to unify to change the board. And the board gets to vote on their own pay, and direct the company to buy more stock to give to the board.
So I still own only 1% of the company. And all of the profit goes to a handful of people. So why do I own 1% of the company?
Because they sound complex and are different than they used to be. They also have the effect of announcing executive compensation and reducing executive taxation. Executives paid in stock are taking on risk and aligning interests with shareholders though.
They do benefit investors through improved tax treatment. A dividend is taking the assets of the company and giving it to owners. That dividend is taxed at ordinary income rates, and doesn’t necessarily benefit the owner/investor. That is especially true if the investor is near their peak earnings. The dividend is a taxable event that comes regardless of the investors individual need. Imagine a US worth a million dollars and has 10,000 shares. Each share is worth $100. There is 10,000 in cash in the company above the companies needs. The company can give those assets to the shareholder ($1 per share). Now the company is worth $990,000 and each share is worth $99 and the investor has 1 share + $1. The investor has to pay taxes on that share of up to 50% in some states. The investor has 99.50 and the government has $0.50.
With a share but back, that same company takes the $10,000 and buys 100 shares. The company is still worth $1,000,000, but now there are only 9,900 share holders. The value of each share went up since each share represents a very slightly larger piece of the company, and the cost is now $101.10. No tax is due to the shareholders, but tax is due by those who sold their shares to the company. A tax will eventually be due at a lesser capital gains rate (0-28% federal plus state tax), but it’s not due until a time the shareholder chooses to sell.
For a retired living on their assets, it doesn’t make much difference, but to somebody actively bringing in income, a dividend payment actually hurts returns.
For those that want others to pay more taxes, shareholder buybacks look bad. Companies have to be careful with growing too fast or expanding outside their core competencies, so the grow the business argument may or may not be applicable. Proctor and Gamble is great at toothpaste but can only sell so much. Once they’ve got product in the whole hygiene aisle, becoming an AI company probably isn’t a great idea, even if another company can do well there. Regarding employee pay, it is generally set by the market and while some companies make huge profits per employee, others are losing money and don’t have the option of reducing employee pay.
**TL:DR**: Because often times it can become something of a grift for upper management to get bonuses at the expense of the longer term future of the company.
Because it skews the incentives of the Management and board. Many CEOs and the like are compensated with bonuses based on things like growing a companies Earnings per share, or growing the share price. Doing stock buybacks is an easy way for management to artificially boost those things, without having to focus on creating real value through innovation and great business. So it can often become a major problem of capital misallocation that benefits a CEO, who is likely to jump ship in a couple years, instead of focusing on the business long term. Even to the point where companies borrow tons of money, and actually buy back shares with borrowed money. No company takes out loans to pay dividends though, those actually have to come from profit.
Board member and big investors are ok with it, because their shares go up, and they can always sell out of their positions later on. But in the longer term, too much focus on buybacks is what leads companies to stagnate and eventually get surpassed by new innovative companies that focus on creating actual value.
**TL:DR**: Because often times it can become something of a grift for upper management to get bonuses at the expense of the longer term future of the company.
Because it skews the incentives of the Management and board. Many CEOs and the like are compensated with bonuses based on things like growing a companies Earnings per share, or growing the share price. Doing stock buybacks is an easy way for management to artificially boost those things, without having to focus on creating real value through innovation and great business. So it can often become a major problem of capital misallocation that benefits a CEO, who is likely to jump ship in a couple years, instead of focusing on the business long term. Even to the point where companies borrow tons of money, and actually buy back shares with borrowed money. No company takes out loans to pay dividends though, those actually have to come from profit.
Board member and big investors are ok with it, because their shares go up, and they can always sell out of their positions later on. But in the longer term, too much focus on buybacks is what leads companies to stagnate and eventually get surpassed by new innovative companies that focus on creating actual value.
Because they sound complex and are different than they used to be. They also have the effect of announcing executive compensation and reducing executive taxation. Executives paid in stock are taking on risk and aligning interests with shareholders though.
They do benefit investors through improved tax treatment. A dividend is taking the assets of the company and giving it to owners. That dividend is taxed at ordinary income rates, and doesn’t necessarily benefit the owner/investor. That is especially true if the investor is near their peak earnings. The dividend is a taxable event that comes regardless of the investors individual need. Imagine a US worth a million dollars and has 10,000 shares. Each share is worth $100. There is 10,000 in cash in the company above the companies needs. The company can give those assets to the shareholder ($1 per share). Now the company is worth $990,000 and each share is worth $99 and the investor has 1 share + $1. The investor has to pay taxes on that share of up to 50% in some states. The investor has 99.50 and the government has $0.50.
With a share but back, that same company takes the $10,000 and buys 100 shares. The company is still worth $1,000,000, but now there are only 9,900 share holders. The value of each share went up since each share represents a very slightly larger piece of the company, and the cost is now $101.10. No tax is due to the shareholders, but tax is due by those who sold their shares to the company. A tax will eventually be due at a lesser capital gains rate (0-28% federal plus state tax), but it’s not due until a time the shareholder chooses to sell.
For a retired living on their assets, it doesn’t make much difference, but to somebody actively bringing in income, a dividend payment actually hurts returns.
For those that want others to pay more taxes, shareholder buybacks look bad. Companies have to be careful with growing too fast or expanding outside their core competencies, so the grow the business argument may or may not be applicable. Proctor and Gamble is great at toothpaste but can only sell so much. Once they’ve got product in the whole hygiene aisle, becoming an AI company probably isn’t a great idea, even if another company can do well there. Regarding employee pay, it is generally set by the market and while some companies make huge profits per employee, others are losing money and don’t have the option of reducing employee pay.
The only differences between the two are:
1. Shareholders can choose whether to participate in a stock buyback. Not so with dividends.
2. Stock buybacks are generally taxed at preferential capital gains rates while dividends are generally taxed at higher ordinary income rates.
3. Dividends are often made at regular intervals, which creates a sort of obligation for the company to continue making that payment in order to avoid signaling financial distress to the shareholders, whereas stock buybacks are generally a one-time thing. Note, however, that companies do also sometimes pay one-time special dividends.
In short (“ELI5”), in most cases people who are against stock buybacks but not dividends just don’t understand what a stock buyback actually is.
The only differences between the two are:
1. Shareholders can choose whether to participate in a stock buyback. Not so with dividends.
2. Stock buybacks are generally taxed at preferential capital gains rates while dividends are generally taxed at higher ordinary income rates.
3. Dividends are often made at regular intervals, which creates a sort of obligation for the company to continue making that payment in order to avoid signaling financial distress to the shareholders, whereas stock buybacks are generally a one-time thing. Note, however, that companies do also sometimes pay one-time special dividends.
In short (“ELI5”), in most cases people who are against stock buybacks but not dividends just don’t understand what a stock buyback actually is.
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