5 ms·

Could you explain why buybacks lead to higher stocks as opposed to dividends? I though they were (theoretical) equivalents.

by wjnc 4y ago

jmalicki 4y ago
Let's say I have 100 shares outstanding, each priced at $100, and I have $100 I want to give back to investors. If I give a dividend, each shareholder now has 100 shares priced at $99 (assuming the typical price drop for the dividend), and $1 cash. If I buy back 1 share for $100, now one ex-shareholder has $100 in cash, and 99 other shareholders have 1 share valued at $100. In each case, the company has $100 less dollars, and its market cap dropped from $10,000 to $9,900. But the stock price is higher ($100) in the case of buybacks than in the case of dividends ($99).
- wjnc 4y ago
  I think you’ve shown equivalence? 100 shareholders own ($1 cash + $99 in stock) or 99 shareholders ($100 in stock) and one former shareholder ($100 in cash). (Not trying to be snarky here. Appreciate the answer.) Gone out for a reputable source: CFA [1] John Cochrane: “That was the big point. Share buybacks are a good way to get money out of firms with no ideas, into firms with good ideas.” [2] [1] https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/analysis-dividends-share-repurchases https://www.cfainstitute.org/en/membership/professional-deve... [2] https://johnhcochrane.blogspot.com/2018/04/buybacks-redux.html?m=1 https://johnhcochrane.blogspot.com/2018/04/buybacks-redux.ht...
  - jmalicki 4y ago
    Yes - they're equivalent in terms of cash and market cap, but not equivalent in terms of number of outstanding shares or share price. If the management team is compensated with unvested stock or options, they receive the benefits from share buybacks, but not from dividends (since those only go to actual shareholders) - which is part of why management teams prefer buybacks.
    - neilc 4y ago
      Also not equivalent in terms of tax treatment.
- glacials 4y ago
  Can you explain how a $1 dividend on a $100 stock drops the price to $99? Theoretically wouldn’t the stock become more valuable, because its average returns have gone up? (As an extreme example, what if I gave a $1M dividend on that same stock?)
  - neilc 4y ago
    The assets of the company are exactly the same, except that $1*num-shares that was previously on the company's balance sheet is no longer there. The company is less valuable and so the stock goes down. Having an attractive dividend policy can make a stock more valuable to certain investors, but the act of actually paying out a scheduled dividend basically only makes the stock price go down.
deleted 4y ago
[deleted]

Could you explain why buybacks lead to higher stocks as opposed to dividends? I though they were (theoretical) equivalents.

by wjnc 4y ago

Could you explain why buybacks lead to higher stocks as opposed to dividends? I though they were (theoretical) equivalents.

jmalicki 4y ago

Let's say I have 100 shares outstanding, each priced at $100, and I have $100 I want to give back to investors. If I give a dividend, each shareholder now has 100 shares priced at $99 (assuming the typical price drop for the dividend), and $1 cash. If I buy back 1 share for $100, now one ex-shareholder has $100 in cash, and 99 other shareholders have 1 share valued at $100. In each case, the company has $100 less dollars, and its market cap dropped from $10,000 to $9,900. But the stock price is higher ($100) in the case of buybacks than in the case of dividends ($99).

wjnc 4y ago
I think you’ve shown equivalence? 100 shareholders own ($1 cash + $99 in stock) or 99 shareholders ($100 in stock) and one former shareholder ($100 in cash). (Not trying to be snarky here. Appreciate the answer.) Gone out for a reputable source: CFA [1] John Cochrane: “That was the big point. Share buybacks are a good way to get money out of firms with no ideas, into firms with good ideas.” [2] [1] https://www.cfainstitute.org/en/membership/professional-development/refresher-readings/analysis-dividends-share-repurchases https://www.cfainstitute.org/en/membership/professional-deve... [2] https://johnhcochrane.blogspot.com/2018/04/buybacks-redux.html?m=1 https://johnhcochrane.blogspot.com/2018/04/buybacks-redux.ht...
- jmalicki 4y ago
  Yes - they're equivalent in terms of cash and market cap, but not equivalent in terms of number of outstanding shares or share price. If the management team is compensated with unvested stock or options, they receive the benefits from share buybacks, but not from dividends (since those only go to actual shareholders) - which is part of why management teams prefer buybacks.
  - neilc 4y ago
    Also not equivalent in terms of tax treatment.
glacials 4y ago
Can you explain how a $1 dividend on a $100 stock drops the price to $99? Theoretically wouldn’t the stock become more valuable, because its average returns have gone up? (As an extreme example, what if I gave a $1M dividend on that same stock?)
- neilc 4y ago
  The assets of the company are exactly the same, except that $1*num-shares that was previously on the company's balance sheet is no longer there. The company is less valuable and so the stock goes down. Having an attractive dividend policy can make a stock more valuable to certain investors, but the act of actually paying out a scheduled dividend basically only makes the stock price go down.

deleted 4y ago

[deleted]