Time is running out.
Congress has 42 days to decide what they're going to do about
the "Bush Era" Tax cuts. If they don't act by December 31st,
incometaxes will rise across the board.
Long-term capital gains could also increase. If the tax cuts
aren't renewed, capital gains rates could go up to as much as 20%.
And for people in the top income (single filers making over
$200,000 and $250,000 for join filers), you could also pay an extra
3.8%Medicare tax on allinvestment income.
In other words, the top tax rates could be as high 43.4% for
dividends and 23.8% for capital gains.
Inmunicipal bonds .
However you play it though, the tax hikes will affect some of
our favorite dividend-paying companies. Right now, dividends and
capital gains are both taxed at the same 15% rate. That could
change. In the face of risingdividend taxes, companies could favor
share buyback over dividend increases.
Both share buy-backs and dividends can support the share price.
Dividends add value by distributing cash to shareholders. Buy-backs
also add value. Whenmortgage trust
Annaly Capital (
said on October 16 that the company would buyback up to $1.5
billion of itsshares , the shares closed nearly 2% off
The response was not unique. Research consistently finds that
small repurchase programs produce an average share price increase
of 2%-3% on the day of the announcement. Larger buybacks of 15% or
more of the shares see prices increase by an average 16%, according
to a report by management consulting firm McKinsey &
A few reasons are generally cited for the positive affect of
buybacks on share performance. By reducing the supply ofoutstanding
shares while demand remains intact, buybacks can boost the share
The reduced share count can also trigger an increase in
per-share dividends, which in turn helps lift the share price. But
above all, a buyback signals that management believes the stock is
undervalued, and the buyback sends a particularly strong signal
when management is personally buying shares.
Both dividends and buybacks reduce the value of the company's
equity by the same amount, but buybacks are more tax-efficient for
For example, let's say a company has two million outstanding
shares trading at $10 a share, for amarket cap of $20 million. It
pays out $1.50 per share in dividends, for a total of $3
The value of each share declines by the amount of the dividend
to reflect the decrease in the company's assets resulting from the
dividend payout. Each share is now worth $8.50, giving the company
amarket cap of $17 million.
Instead, if the company were to use the same $3 million to buy
back shares, it would have 300,000 fewershares outstanding . That
leaves 1.7 million shares outstanding, reducing the market cap by
$3 million to the same $17 million.
However, taxes make a big difference. Under the new tax regime,
investors could be taxed up to 43.4% on the dividends. They would
get to keep just $0.85 per share ($1.50 * (1-0.434)). The rest goes
to Uncle Sam. In contrast, investors who sell their shares back to
theissuer and realize capital gains on the buyback would be taxed
at most at the 23.8% rate.
Buybacks aren't foolproof. If the stock is already fully-priced,
for example, shareholders could take acapital loss if they sell the
shares back to the company. If management uses buybacks to appear
to raise per-shareearnings by reducing outstanding shares, while
not in fact increasing return on equity, the buyback can send a
false signal to investors.
In any case, if dividends are taxed asordinary income , you may
want to consider high-yield stocks with tax-advantageous share
buyback programs in the works.
With these points in mind, I ran a screen on my company's
Bloomberg terminal for companies with stocks yielding at least 5%
that recently announced plans to buy back shares.
Here's what I found...
To be fair, the shares of all of these companies have
underperformed the S&P 500 over the past year thanks to
dividend cuts, negative earnings surprises, management changes, or
Action to Take -->
Of all these companies, Annaly's $1.5 billion buyback program, to
take place over the next 12 months, is one of the largest and most
rapid. It will reduce the share count by about 10%, which could
help the company regain a more solid footing in a challenging low
interest rate environment for mortgage REITs. With their
double-digityield , these shares are worth keeping an eye on.
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