The following article was written by our guest blogger Angie Picardo. She's a staff writer for NerdWallet and likes to inform my readers about share buybacks and the sense behind.
There are, of course, a number of ways for shareholders to benefit from the stocks they own of any given company. Generally speaking, companies want to keep investors happy because they want their stock to be perceived as valuable (and to actually be valuable!) and so they can make a profit themselves. Most investors are familiar with dividends and the benefits they impart to the shareholder. Whether it is from dividend growth or dividend yields, shareholders do expect to make some money over stocks that they hold over time. Most companies respect that and try to keep their profits growing so that dividends can increase, but sometimes, the market becomes diluted with the shares of a particular company, and that’s where share buybacks come in.
Share repurchases, sometimes known as share buyback programs, can be a bit of a divisive issue for investors: some people have strong feelings about them. Share repurchases are essentially what they sound like; they happen when a company decides to repurchase some of its shares from its stockholders. Companies conduct share repurchases primarily because they have concluded that they have too many shares on the open market. When they decided to repurchase the shares, they can either make offers directly to the shareholders or buy them on the open market. Once the company reacquires the shares, they are cancelled or kept as treasury shares. This limits the amount of shares available to the public.
One way that share repurchases are good is that they raise the value for the remaining stock holders. By buying up its shares, a company ensures that whatever shares remain are worth more. For example, if the company is valued at $100 million and has a million shares, each share is worth $100. But, if the company buys up half of the shares, each share still on the market has doubled in value to $200 each. If a company you hold shares in begins offering share repurchases, it may be worthwhile to wait out the process because your stocks may go up. However, a stock buyback is essentially an admission by the company that the stock is undervalued, which would make it an optimal time to sell.
When it comes to comparing dividends and repurchases, there are a number of factors to consider. First of all, dividends are never guaranteed. Even if the company has been offering a consistently growing dividend year after year, it could stop at any time, this is just part of the inherent uncertainty to the stock market. Choosing to stay with a dividend also depends on the type of dividend you receive and how predictable it is. If you’ve been receiving a high dividend yield, it may be a good time to cash out and take the repurchase while things are good. If you have a dividend growth that is dependable and has been for some time, it may be more beneficial to stick with the stock and let the dividends keep rolling in.
Another way to think about whether to stick with dividends or accept a repurchase offer is to consider whether or not you were going reinvest your dividends back into the company. Allowing the company to repurchase your shares is essentially reinvesting in the company because the value of the rest of your shares will increase. Accepting your regularly scheduled dividends, rather than a share repurchase, is a way for you—the investor—to maintain a certain level of control and flexibility over your money and investments. Trusting a company to buy your shares back is granting them autonomy to do what they think is best for the company. If you prefer being in total control, keeping your shares and accepting dividends may be for you.
To sum up, while there is no guarantee that you will always receive dividends on your shares, many companies pride themselves on offering them consistently, and will likely continue to do so. If you feel optimistic about your dividend situation and like maintaining full control of your shares, going with dividends is probably the right choice for you. A share repurchase is a good idea if you were planning on reinvesting your dividends back into the company anyway or if you are concerned that your shares are becoming undervalued.
Angie Picardo is a staff writer for NerdWallet. Her mission is to help investors stay financially savvy and save money with Nerdwallet's best rewards credit cards.