Trump’s tariffs and the impact on global trade and inflation have been weighing on stock market sentiment recently, causing its fair share of ups and downs.
When markets are volatile, shareholders are keen to earn a reward on their investments – it’s why investors tend to prefer income stocks in times of uncertainty.
Dividends aren't the only way companies can return cash to shareholders though, and the popularity of share buybacks has rocketed in recent years.
But what’s the difference? Which one is better for you, and where should you look?
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. Yields are variable and no dividend is ever guaranteed. Ratios also shouldn’t be looked at on their own. Tax rules change and benefits depend on personal circumstances.
Investing in an individual company isn’t right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you’re investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.
Dividends
What are dividends?
Dividends are cash payments to shareholders. Typically, a portion of a company’s profits is paid out to shareholders, usually every three, six or twelve months in the UK, depending on the company.
What does it mean for investors?
The great thing about dividends is they represent a tangible return from holding a share – it’s cash that goes straight into your account.
Investors can then use the cash for other purposes, or reinvest it in the same company to build up their stake in the business.
Companies rarely start making payments without being confident they can continue to pay the dividend over a long period of time.
If you hold shares in a company with a strong 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 require shareholder approval, so they’re not guaranteed and could vary.
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).
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How have dividend payments changed over the years?
In times of volatility, investors often favour income stocks (which typically pay steady dividends) over growth stocks (which typically focus on capital appreciation).
Aesop’s tale rings true here – “A bird in the hand is worth two in the bush”.
Putting that in modern-day investing terms, it means dividend payments now can be more appealing than the uncertain promise of capital gains in the future.
UK investors looking to earn dividend income don’t need to look far, with the FTSE 100 index fitting the bill well.
Over the past 15 years, the FTSE 100 has displayed a strong track record of dividend payments, yielding a respectable 3.9% on average. That’s significantly higher than its US counterpart, the S&P 500.
FTSE 100 annual dividend yield
While there’s no guarantee this level of dividend yield will continue, the make-up of the UK stock market is favourable for income investors.
The UK is home to multinational companies. This means they earn a decent chunk of their revenue from overseas, which helps to diversify away some individual currency and tariff risk.
Many of the sectors that dominate the UK market, like energy, financials and healthcare, are vital to everyday life. Consumers need these types of businesses no matter what the current economic mood music is, which translates to relatively reliable revenue streams.
These are also mature industries, dominated by a handful of large companies with strong balance sheets. This further adds weight to their ability to maintain dividend payments, even during volatile periods.
Share buybacks
What are share buybacks?
A share buyback is when a company uses its excess cash to buy its own shares back from shareholders.
What does it mean for investors?
When a company buys back its own shares, the total number of shares available in the market goes down. So even though you still own the same number of shares, there are fewer shares overall, which can make each share more valuable. It's like having a bigger piece of the same-sized pie, so the value of your investment could increase.
Share buybacks tend to 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.
What’s the current trend?
Since the pandemic, the volume of share buybacks among the largest UK companies has stepped up massively – way above historical levels.
One reason for this is that the pandemic gave many companies an excuse to rebase their dividend payments to a more sensible level. That’s left them with more cash on hand and the financial flexibility to carry out things like share buybacks when they see fit.
On a relative basis, the FTSE 100 even holds its own in terms of buybacks compared to US markets.
FTSE 100 share buybacks ($bn)
Another reason for the uptick in share buyback activity is that the UK market has been seen as undervalued in the years following the pandemic.
While still at elevated levels, investors should keep in mind that the volume of UK share buybacks has been slowing steadily since 2022.
This could be a sign that companies are becoming more cautious about the future, amid high interest rates and geopolitical uncertainty. 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 more fairly valued now.
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 it’s always best to get professional advice on tax, it’s worth noting that the tax treatment on dividends and buybacks can also differ.
Dividends tend to be 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. That’s because future dividend payments will need to be split over a smaller number of shares.
Opportunity on offer – where should income-focused investors look?
Typically, it’s more mature stable businesses with strong cash generation that can keep shareholder payouts near the top of the priority list.
We’re positive on the outlook for UK markets and see a lot of value still on offer.
The FTSE 100 currently trades at around 16.4 times its earnings, while the US market trades at around 25.4 times its earnings.
Income investors could look at the FTSE 100’s highest yielders, which are dominated by property companies, financial services providers, natural resources businesses, utilities and consumer staples.
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. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by LSEG. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss. Yields are variable and not guaranteed.
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.