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Share Buybacks: The Other Dividend

Published Tue, 01 Oct 2019 05:51:57 -0400 on Seeking Alpha

By Jeff Weniger
You have a business, and your cash on hand is growing. What do you do? If you park it in T-bills, the income generated will probably be negligible. You believe it's time to move it off the balance sheet either as a dividend, which is often a taxable event, or by repurchasing shares, where taxes can be more easily managed (some shareholders will opt to sell, while others can sit tight).
Look at this writ large: Share buybacks have become the other dividend. According to Qing Li at S&P Dow Jones Indices, S&P 500 Index companies purchased $806 billion worth of shares last year (Figure 1). For context, the total value of the S&P is $26 trillion.
Figure 1: S&P 500 Buyback Trends

Figure 2 shows the logic using a hypothetical business worth $1,000 with $200 in cash. Say, it only needs half the cash to operate. If management buys back stock, look what happens to earnings per share and return on equity (ROE). This isn't rocket science, but on paper, the management looks like a bunch of geniuses.
Figure 2: Implementing a $100 Buyback

Some firms1 opt to do the opposite, issuing shares to raise money because they are growing or, troublingly, because business is down. At latest count, the S&P 500's net buyback yield is 2.7%, found by netting out issuances from the volume of buybacks. Add the 1.9% dividend yield and the sum is the 4.6% shareholder yield.
Figure 3 breaks out by shareholder yield the 10-year equity returns... Read more