Here at Dividend.com, we are dead set against the idea of
company stock buybacks. That's not just simple bias, though - read
on to learn why buybacks are a colossal waste of company money and
how investors are much better served with higher dividends.
The Drawbacks of Buybacks
Company buybacks occur when a company decides to repurchase
shares of its stock either on the open market, or directly from
shareholders in private transactions. Companies partake in share
buybacks as a way of "investing" in their company with their excess
cash flow. Many investors erroneously believe that share buybacks
are somehow profitable to them, but in reality they are designed to
benefit the corporation and its insiders - not shareholders.
EPS Numbers Too Low? Just Buy a Bunch of Shares
Buying back shares is a common technique to artificially increase
earnings per share (
). This process helps the company meet or exceed analysts'
estimates, as well as the company's own internal company targets.
Share repurchases can also help temporarily keep a stock's price
afloat - not because the market believes the stock is of high
quality, but simply because the company is throwing its own money
at its own stock.
More Money for Insiders
Big surprise: hitting those EPS targets often results in hefty
bonuses for executives. Also, companies often buy back shares
directly from insiders looking to cash in on lucrative stock
options. Finally, companies may even resort to buying back shares
only to reissue them to employees as bonuses. "Borrowing from Peter
to pay Paul" ring a bell?
Financial Risks Abound
Corporations can put themselves at substantial risk when buying
back shares. Since buybacks are often seen as a one-off event,
companies are willing to risk substantial sums on the practice.
Additionally, what happens when a company buys back a bunch of
shares before the stock falls significantly? That money floats up
to a place we like to call "buyback heaven."
Company Pays Itself Instead of Shareholders
A public company is supposed to act in the best interest of its
shareholders. Buybacks, on the other hand, are an artificial means
to a financial end for insiders, and a crutch used to beef up a
company's per-share profits. These effects provide zero benefit to
investors who used their hard-earned money to invest in a
Now here's a novel idea. If a company is so averse to dividends
for some reason, why not spend excess cash to expand operations?
Maybe make a smart acquisition or two? Legitimately growing the
company's revenue and profits is always a welcome move for
Dividends are the Answer
Although some may think that a company paying dividends is a
weakness, showing that the company needs to entice investors to
invest in the company, dividend payments are much more profitable
to investors than company buybacks are.
Confidence and Stability
When a company pays solid dividends, it shows the firm is confident
in its future cash flows. The corporation is comfortable in its
ability to afford ongoing payouts to shareholders. Unlike buybacks,
which can start or stop at any time, most U.S.-based companies have
a pretty firm dividend policy. The ongoing nature of dividends is
another reason they rise above buybacks.
Let the Shareholders Buy Back Shares - If They So
Dividends allow shareholders the opportunity to invest back into
the company. Many long-term investors choose to automatically
reinvest their dividends into additional company shares, and most
major companies offer DRIPs (dividend reinvestment programs) to
make this process easy. While shareholders have zero control over
when company management decides to waste money on buybacks,
dividends offer the flexibility of collecting cold, hard cash, or
buying more company shares.
Hands are Tied (In a Good Way)
Higher dividend payments prevent companies from retaining too much
cash, which can then be wasted on foolish ventures like share
repurchases and ill-conceived acquisitions. Instead, the company is
focused on executing its business and keeping shareholders happy
with steadily increasing dividends.
Dividends: The Ultimate Reward
What's more attractive than owning an asset that pays you regularly
- simply for owning it? Dividends are a great "thank you" to
shareholders and the single best way to attract a solid long-term
investor base. This process decreases share price volatility,
improves company visibility, and attracts all kinds of
shareholders, from mom-and-pop investors to big-time fund
The Bottom Line
Although many investors may think that buyback programs are
benefiting them, intentions are often in favor of the company
itself, and more specifically company insiders. Dividends on the
other hand ensure direct payment to the shareholder, with much less
risk than share buybacks. Any way you slice it, offering dividends
is simply the right thing for the companies to do.
Be sure to visit our complete recommended list of the
Best Dividend Stocks
, as well as a detailed explanation of
our ratings system here