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Why is a buyback worse than a dividend? Both are a form of delivering ROI, it just happens that one is better for shareholders due to the tax system. In fact i

Why is a buyback worse than a dividend? Both are a form of delivering ROI, it just happens that one is better for shareholders due to the tax system. In fact if airlines had actually reinvested that money, they would be even more fucked up than they are now. At least now they have free cash flow to make a temporary drop in revenue hurt less. Reinvesting money in the corporate world often involves converting cash flow into debt, which they’re probably going to have to do now to meet their existing financial obligations. Much better than if they were midway through financing some large fleet expansion and had less FCF on hand to weather the travel slowdown

majormajor 7y ago
I don't understand who buybacks are better for. A dividend would've returned money to all the people who held onto shares and wasn't paying attention to how much they should be selling off to capture the buyback and just had all the gains wiped out...
- opportune 7y ago
  Absent a market selloff, they're better for shareholders for two reasons: one, it manifests earnings as capital gains/stock appreciation rather than dividends, and two, it has positive future ROI. Point 1 is not super important because of the existence of qualified dividends. Point 2 is like this: let's say I'm a company with 1000 outstanding shares valued at $100 each and want to pay a yearly dividend (for simplicity) of $5/share. All market movements notwithstanding and absent any changes, that means I'm basically giving investors a 5% yearly ROI. But, let's say I instead bought back my shares with all my earnings. The first year, I buy back 5% of the outstanding shares. Now there are 950 outstanding shares and total earnings are still $5000/year. Next year each remaining shareholder gets an extra 5% of earnings per share (this compounds). And rather than pay tax each year on dividends, shareholders defer all their taxes until they exit their position. One argument is that dividends aren't really worse in this case because investors could still choose to spend the cash on purchasing more shares, accomplishing the same thing. But the deferred taxes change the math.
- toast0 7y ago
  In the absence of taxes, a buyback is equivilent to a dividend with automatic reinvestment. It's better as a shareholder in many cases to be able to control when you recognize the gain from the return to investors.
  - mrscottson 7y ago
    Hilarious but probably time to leave this site...I got down voted into oblivion for pointing out the US economy would probably collapse due to repo operations 44 days ago... Too bad, I guess anyone thinking outside the box and pointing out that our herd is going off a cliff is problematic...
    - toast0 7y ago
      The economy may be very well on its way to collapse, but I don't think it's because of the repo operations.
      - mrscottson 7y ago
        Not because of repo ops, but repo ops are the indicators of underlying liquidity issues that signal collapse.
boomboomsubban 7y ago
>it just happens that one is better for shareholders due to the tax system. This would make buybacks worse than dividends for everyone who isn't a shareholder.
- opportune 7y ago
  Sure. Just like it's worse for everybody that I try to max my investments in my 401k before contributing to after tax accounts.
  - lmm 7y ago
    That tax incentive was set up deliberately. It's socially valuable for people to have retirement savings, so the rest of us are happy to subsidise you in that saving. Buybacks are an accident of tax law and ought to be taxed the same way as dividends.
    - AnthonyMouse 7y ago
      > Buybacks are an accident of tax law and ought to be taxed the same way as dividends. The problem is it's really the other way around -- reinvested dividends should be taxed like buybacks, i.e. taxed when the purchased shares are sold. By contrast, taxing buybacks like current dividends would create a really grisly incentive for corporations to hoard a giant pile of money, since that would be the remaining way to defer the tax. This is already what international corporations do with offshore profits because of a similar incentive to defer corporate income tax, and it's a huge problem. We have a policy of allowing people to avoid tax on investment gains until the investments are cashed out -- this is what a 401k is all about. We might as well make it consistent across the board so it stops creating all of these perverse incentives. (That would reduce the amount of tax collected, but it would also remove most of the justification for taxing capital gains at a lower rate than earned income, so changing both at once would about balance out.)
      - lmm 7y ago
        I'd actually go the other route: tax investment gains like any other income, at the time when they happen, and then the incentive to do buybacks or cash hoarding goes away.

majormajor 7y ago

I don't understand who buybacks are better for. A dividend would've returned money to all the people who held onto shares and wasn't paying attention to how much they should be selling off to capture the buyback and just had all the gains wiped out...

opportune 7y ago
Absent a market selloff, they're better for shareholders for two reasons: one, it manifests earnings as capital gains/stock appreciation rather than dividends, and two, it has positive future ROI. Point 1 is not super important because of the existence of qualified dividends. Point 2 is like this: let's say I'm a company with 1000 outstanding shares valued at $100 each and want to pay a yearly dividend (for simplicity) of $5/share. All market movements notwithstanding and absent any changes, that means I'm basically giving investors a 5% yearly ROI. But, let's say I instead bought back my shares with all my earnings. The first year, I buy back 5% of the outstanding shares. Now there are 950 outstanding shares and total earnings are still $5000/year. Next year each remaining shareholder gets an extra 5% of earnings per share (this compounds). And rather than pay tax each year on dividends, shareholders defer all their taxes until they exit their position. One argument is that dividends aren't really worse in this case because investors could still choose to spend the cash on purchasing more shares, accomplishing the same thing. But the deferred taxes change the math.
toast0 7y ago
In the absence of taxes, a buyback is equivilent to a dividend with automatic reinvestment. It's better as a shareholder in many cases to be able to control when you recognize the gain from the return to investors.
- mrscottson 7y ago
  Hilarious but probably time to leave this site...I got down voted into oblivion for pointing out the US economy would probably collapse due to repo operations 44 days ago... Too bad, I guess anyone thinking outside the box and pointing out that our herd is going off a cliff is problematic...
  - toast0 7y ago
    The economy may be very well on its way to collapse, but I don't think it's because of the repo operations.
    - mrscottson 7y ago
      Not because of repo ops, but repo ops are the indicators of underlying liquidity issues that signal collapse.

boomboomsubban 7y ago

>it just happens that one is better for shareholders due to the tax system. This would make buybacks worse than dividends for everyone who isn't a shareholder.

opportune 7y ago
Sure. Just like it's worse for everybody that I try to max my investments in my 401k before contributing to after tax accounts.
- lmm 7y ago
  That tax incentive was set up deliberately. It's socially valuable for people to have retirement savings, so the rest of us are happy to subsidise you in that saving. Buybacks are an accident of tax law and ought to be taxed the same way as dividends.
  - AnthonyMouse 7y ago
    > Buybacks are an accident of tax law and ought to be taxed the same way as dividends. The problem is it's really the other way around -- reinvested dividends should be taxed like buybacks, i.e. taxed when the purchased shares are sold. By contrast, taxing buybacks like current dividends would create a really grisly incentive for corporations to hoard a giant pile of money, since that would be the remaining way to defer the tax. This is already what international corporations do with offshore profits because of a similar incentive to defer corporate income tax, and it's a huge problem. We have a policy of allowing people to avoid tax on investment gains until the investments are cashed out -- this is what a 401k is all about. We might as well make it consistent across the board so it stops creating all of these perverse incentives. (That would reduce the amount of tax collected, but it would also remove most of the justification for taxing capital gains at a lower rate than earned income, so changing both at once would about balance out.)
    - lmm 7y ago
      I'd actually go the other route: tax investment gains like any other income, at the time when they happen, and then the incentive to do buybacks or cash hoarding goes away.