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Sigh. Buybacks and dividends are mathematically identical. Well...that's not true. Dividends get taxed harder than buybacks, which is why more and more [institu

Sigh. Buybacks and dividends are mathematically identical. Well...that's not true. Dividends get taxed harder than buybacks, which is why more and more [institutional] investors want companies to switch to buybacks over dividends. I feel like people have been conditioned to get an irrational hatred when they hear the word "buyback" as if it were some evil trick pulled by those evil banksters over in wallstreet. "buybacks are killing capitalism" blah blah. Its pure FUD that comes from finance being complex and the average person not being nearly informed enough about it to parse it correctly. Buybacks and dividends both are ways of returning capital to shareholders. Dividends do it directly, buybacks do it by raising the share price. Example: Company makes 100$ profit and is worth 1000$ @ 1$/unit. You own 100 units of stock. Lets say it pays out everything to shareholders every year, once a year, at the end. It can pay this as a dividend, so you would get 10$ at the end of the year, for a total of 110$. Or it can do buybacks, and buys 100$ worth of units, effectively removing them for existence, and lowering the total number of units to 900. The company still makes 100$ though, and to keep the same ratio of price to earnings, 10 (=1$*1000units/100$), the price of each unit needs to rise to 1.111$, making your shares worth 111$. As you can see, they are pretty much identical, both giving 10% returns, except dividends are taxed much harder so buybacks win. The buyback shares are worth 1$ more, because this is a simplified example and I don't account for compounding, and you would have to continuously collect dividends and reinvest them continuously to get the same result(111$), which more closely approximates what happens in reality. Dividends are just traditional, buybacks are just another way to do the same thing. Your "dividend" is the share price increasing over the course of the year.

mantasm 8y ago
It's a little more complicated than that. Say a company is worth $1000, and has 100 shares outstanding, for a share price of $10. They can pay a dividend of $100, reducing their value to $900 (share price of $9) and paying out $1 per share to shareholders. In the end, the shareholders still have $10 of value per share, but some was forcibly liquidated! Alternatively, the company can do a stock buyback of 10% of their shares. They spend $100 destroying 10 shares. The company is now worth $900 and there are 90 shares outstanding - investors still have $10 worth of value, whether they sold their shares or not. In the end, no value is created in either scenario - capital is just returned to shareholders. This is still a simplification because: 1. Stock prices often rise on the announcement of new dividends/share repurchases for similar reasons. It's a positive signal to investors that either of these things will happen, and affects their valuation of the firm. 2. Investors like capital-efficient businesses, and either of these methods of returning capital can actually create value for investors.
telchar 8y ago
Is it so crazy to want more tax to be collected, especially from the wealthiest who have recently benefited from a $1.5T tax cut? The federal deficit is in the vicinity of a trillion dollars per year currently. Any tax avoidance by gigantic corporations and their wealthy shareholders rankles in this environment, regardless how easily explained. Perhaps the capital gains rate should be raised to make buybacks equally attractive, tax-wise, to dividends. Perhaps it would spur investment over paydays.
- OscarCunningham 8y ago
  If you want to increase taxes on the rich, why is it better to do it with capital gains tax rather than income tax? I'd prefer to target whichever factor correlates best with how much the person can afford to pay. A capital gains tax is bad by this analysis, because it also hits the retirement accounts of poorer folk. An income tax increase for high incomes would only affect the rich.
  - telchar 8y ago
    I think your point is easily solved with a capital gains deduction or marginal rate, where the first X of annual (or averaged annual) gains are exempted. So a person selling $50,000 (or whatever) or more would see a higher rate, thus people withdrawing from their retirement account wouldn't be hit by an increase. The main reason I would increase the capital gains rate is the very richest, like Warren Buffet (as he himself pointed out), pay a lower rate than much less wealthy/lower income people due to the favorable capital gains rate. This sort of inversion shouldn't exist in a progressive tax system. Personally I view one of the several valid goals of a tax system to be keeping income/wealth inequality within reasonable limits and I think this would help with that.
    - OscarCunningham 8y ago
      What about dropping corporation tax to 0% and then treating capital gains as income?

mantasm 8y ago

It's a little more complicated than that. Say a company is worth $1000, and has 100 shares outstanding, for a share price of $10. They can pay a dividend of $100, reducing their value to $900 (share price of $9) and paying out $1 per share to shareholders. In the end, the shareholders still have $10 of value per share, but some was forcibly liquidated! Alternatively, the company can do a stock buyback of 10% of their shares. They spend $100 destroying 10 shares. The company is now worth $900 and there are 90 shares outstanding - investors still have $10 worth of value, whether they sold their shares or not. In the end, no value is created in either scenario - capital is just returned to shareholders. This is still a simplification because: 1. Stock prices often rise on the announcement of new dividends/share repurchases for similar reasons. It's a positive signal to investors that either of these things will happen, and affects their valuation of the firm. 2. Investors like capital-efficient businesses, and either of these methods of returning capital can actually create value for investors.

telchar 8y ago

Is it so crazy to want more tax to be collected, especially from the wealthiest who have recently benefited from a $1.5T tax cut? The federal deficit is in the vicinity of a trillion dollars per year currently. Any tax avoidance by gigantic corporations and their wealthy shareholders rankles in this environment, regardless how easily explained. Perhaps the capital gains rate should be raised to make buybacks equally attractive, tax-wise, to dividends. Perhaps it would spur investment over paydays.

OscarCunningham 8y ago
If you want to increase taxes on the rich, why is it better to do it with capital gains tax rather than income tax? I'd prefer to target whichever factor correlates best with how much the person can afford to pay. A capital gains tax is bad by this analysis, because it also hits the retirement accounts of poorer folk. An income tax increase for high incomes would only affect the rich.
- telchar 8y ago
  I think your point is easily solved with a capital gains deduction or marginal rate, where the first X of annual (or averaged annual) gains are exempted. So a person selling $50,000 (or whatever) or more would see a higher rate, thus people withdrawing from their retirement account wouldn't be hit by an increase. The main reason I would increase the capital gains rate is the very richest, like Warren Buffet (as he himself pointed out), pay a lower rate than much less wealthy/lower income people due to the favorable capital gains rate. This sort of inversion shouldn't exist in a progressive tax system. Personally I view one of the several valid goals of a tax system to be keeping income/wealth inequality within reasonable limits and I think this would help with that.
  - OscarCunningham 8y ago
    What about dropping corporation tax to 0% and then treating capital gains as income?