Dividends vs share buybacks – is one better than the other?

There are two main ways companies can return spare cash to shareholders, dividends and share buybacks.

Dividends have been a regular part of investing for decades. Meanwhile, global share buybacks are headed towards their lowest level since 2020.

But what's the difference? And more importantly, what do they mean for you as an investor?

This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Investments and any income from them will rise and fall in value, so you could get back less than you invest. Remember not to look at ratios just on their own. Yields are also variable and past performance isn’t a guide to the future.

Dividends

What are they?

Dividends are cash payments to shareholders. Usually paid annually, semi-annually or quarterly, depending on the company.

How does it affect investors?

If you hold shares in a company with a track record of paying dividends, you could get a steady source of income.

But keep in mind that dividends are at the boards’ discretion, and final dividends typically rely on shareholder approval, so they’re not guaranteed and can vary.

If you’re looking to use dividend payments as an income, you’ll want to look at a company’s forward dividend yield. That’s the expected annual dividend payment as a percentage of its current share price.

Dividend income is usually taxed too, so investors should consider holding dividend stocks in tax-efficient accounts like a Stocks and Shares ISA or a Self-Invested Personal Pension (SIPP).

ISA, pension and tax rules can change and depend on your individual circumstances.

What does it mean?

Dividends tell us a few things about a company.

If a company announces it’s about to start paying dividends, it’s usually a good sign. The message is that it’s making enough cash to give some back directly to shareholders.

Companies rarely start making payments without being confident they can continue to pay the dividend over a long period of time.

The message when companies cut the dividend is usually clearer – it’s a bad sign.

Cutting a dividend that’s been steadily increasing usually causes the share price to fall. It also tends to have a bad impact on how investors now view the company.

Take Coca-Cola for example.

It’s paid a quarterly dividend since 1920, and has increased its dividends for 62 consecutive years. If it were to suddenly cut the dividend, it’s unlikely to give investors a positive message.

Share buybacks

What are they?

A share buyback is when a company uses its excess cash to buy its own shares, which typically reduces the number of shares outstanding.

How does it affect investors?

When companies buy back their own shares, you’ll own the same number of shares as before. But because there are now fewer shares in existence, it can push up the value of your shares. You’ll basically have a bigger slice of the same pie.

What does it mean?

Ideally, share buybacks will take place when the company’s management thinks its shares are undervalued. This is one half of the basic ‘buy low, sell high’ mantra.

These executives are arguably best placed to know the value of their company’s own shares. Buying back shares when they’re selling for less than their true value is like buying a pound for 90 pence.

Of course, identifying the true value is never easy, but in theory it’s a great way to add value to the company. And when that happens, it’s shareholders that reap the benefits.

Well-executed share buybacks can also save shareholders having to pick the right time to reinvest dividend payments. But there’s always a danger management could buy back shares at the wrong time.

Apple is an example of a company that has added value by executing share buybacks. Since 2016, the tech giant has returned more than $623bn to shareholders through share buybacks alone.

What’s the current trend?

Global share buybacks are headed towards their lowest value since 2020.

Between the start of 2024 and 9 September, the total value of share buybacks by public companies on major exchanges was $163.5bn. That’s a 35% decline from the $178.5bn seen in 2023.

This could be a sign that companies are becoming more cautious about the future, amid high interest rates and fears of a global economic slowdown. By slowing the pace of share buybacks, it means there’s more cash on hand to cushion any bumps further down the road.

Alternatively, it could also just be a sign that these companies’ management teams think their stock is fairly valued now.

For example, the forward price-to-earnings ratio of the S&P 500 index has risen steadily over this period, sitting well above its long-term average in early September.

Remember, the price is important with share buybacks and should only be carried out if they add value. No one wants to buy a pound for £1.10.

Are dividends or share buybacks better?

There’s no clear winner in the buybacks versus dividends debate, both are usually good news for investors.

That means the answer probably depends on what you’re looking for.

While its always best to get professional advice on taxation, it’s worth noting that the tax treatment on dividends and buybacks can also differ.

Dividends are better for investors looking for a regular income stream and are, therefore, perhaps suited to investors in their later life.

Buybacks are more geared towards capital growth. This could therefore be more suited to investors with a longer time horizon, looking to benefit from the power of compounding.

But ultimately, it’s a company’s financial and strategic prospects that should form the basis of any investment decision.

It’s not always a straight comparison either. Some companies opt to return cash through a blend of both methods.

All things being equal, a buyback should also boost the yield as in future periods dividend payments will need to be split over a smaller number of shares.

Where to look for income?

Typically, it’s more mature stable businesses with strong cash generation that tend to favour returning cash to shareholders over reinvesting in the business.

The FTSE 100’s highest yielders are dominated by property companies, financial services providers, natural resources businesses, utilities and consumer staples.

Across the pond in the US, the mega cap tech sector is another sector noted for its impressive cash generation. However, these stocks tend to be more priced for growth meaning the yields aren’t always as attractive.

There’s also arguably more scope for internal investment which means share buybacks, that are generally less regular in nature, are the preferred route to take.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.