Dividendy
Buybacks vs. Dividends: How Companies Return Cash to Shareholders
Key takeaways
- A buyback (share repurchase) reduces the number of shares outstanding and increases each shareholder's stake in earnings.
- A dividend is immediate income; a buyback is a hidden increase in value — the tax outcome differs.
- Buybacks are more popular in the US — a company can stop them at any time, whereas cutting a dividend signals problems.
- For a passive investor, the key metric to watch is total return (TSR), not just the dividend yield.
Companies have two main ways to return free cash to shareholders: pay a dividend or repurchase their own shares on the market — a so-called buyback.
How a buyback works
The company uses earnings to purchase its own shares on the stock exchange. It then cancels those shares or holds them in treasury. The result: fewer shares outstanding, meaning each remaining share represents a larger stake in the company. The EPS (earnings per share) metric automatically rises — even without growth in total earnings.
Dividends vs. buybacks: the tax perspective
In the Czech Republic, dividends are subject to a 15% withholding tax at all times and immediately — the time test does not apply to them. A buyback, by contrast, does not increase your taxable income until you sell the share. If you hold it for more than three years, the gain from the sale is exempt from tax in the Czech Republic. From a tax perspective, buybacks are therefore generally more advantageous for long-term investors.
Why companies prefer buybacks
- Flexibility: a buyback can be stopped at any time without stigma; cutting a dividend sends a bad signal to the market
- Tax neutrality for investors: the shareholder pays tax only when they decide to sell
- Signalling: management is saying "we believe our shares are undervalued"
What to monitor as an investor
Instead of looking at dividend yield alone, monitor Total Shareholder Return (TSR) — the combined effect of dividends, share price, and buybacks. Companies such as Apple or Microsoft return a large part of their value through share repurchases, while their dividend yield looks low. For a comparison of dividend strategies see also the overview of Dividend Aristocrats or the comparison of Aristocrats vs. high-yield ETFs.
FAQ
What is a buyback in simple terms?
The company purchases its own shares on the stock exchange and cancels them. This reduces the number of shares outstanding — each remaining share then represents a larger stake in the company and earnings per share (EPS) rises.
Are buybacks more advantageous than dividends?
From a tax perspective, yes — in the Czech Republic you always pay 15% tax on dividends, whereas a gain from selling shares after the time test (3 years) may be exempt. A buyback thus defers the tax liability to the point when you decide to sell.
Can a company stop a buyback?
Yes, at any time and without significant market impact. That is the main advantage over a dividend — cutting a dividend is perceived by the market as a very bad signal, while pausing a buyback is normal.
How do you tell if a buyback is good?
The company should be buying shares at a reasonable price — ideally below intrinsic value. Track the P/E ratio at the time of the buyback announcement and the historical record. Buybacks at excessive prices (for example in tech stocks in 2021) can destroy value.