Buybacks vs. Dividends
from May/June 2006
Though the point is sometimes obscured, dividends and share repurchases are precisely equivalent ways of distributing cash to shareholders. Consider a company that has a market capitalization of $1 billion and wants to give $30 million back to shareholders. It can pay the money out as a dividend equal to 3% of the market cap, or repurchase 3% of the outstanding shares.However it pays out the money, the value of the company’s shares will drop by the $30 million paid out, to $970 million. With a dividend, the stock price falls by the amount of the dividend per share. If the company repurchases $30 million of its shares instead, the price of a share doesn’t change, but the aggregate value of the stock left outstanding declines by the same $30 million. In one case, all shareholders split the $30 million in dividends. In the other, only shareholders who sell shares to the company get the cash.
In the repurchase, shareholders who want the payout can sell 3% of their shares. That gives them the same cash they would have received with a dividend. And their percentage ownership of the company hasn’t changed; they have 3% fewer shares, but there are 3% fewer shares outstanding. For them, the only difference is the number of shares they now own. The percentage ownership of those who hold onto their shares rises by the same amount it would if they reinvested the dividend in additional shares.
Neither action creates wealth for shareholders. Both the dividend and the repurchase convert $1 billion of equity value into $970 million of equity and the $30 million of cash paid out. What’s more, the price of the stock at the time of a repurchase is irrelevant. Consider the consequence if the shares subsequently rise by 50%. Shareholders who sell 3% of their shares miss out on that much of the gain, but their ending position is identical to what it would have been with a dividend. A shareholder with $100 of stock who pockets the $3 dividend or sells $3 of shares will wind up with $3 in cash and stock worth $145.50. A $100 shareholder who doesn’t sell comes out exactly where he or she would have been with a reinvested dividend—with shares worth $150. The same is true if the stock drops 50% after the payout. The situations of individual shareholders will differ, of course, because few if any will sell in exact proportion to the repurchase. But if the company is going to make the payout in one form or another, the aggregate position of its shareholders (apart from the personal taxes they have to pay) will not be affected by the choice of a dividend or a repurchase.
