Share Buybacks: Why the “Invisible Dividend” Beats Cash
Share Buybacks: Why the “Invisible Dividend” Beats Cash
EXECUTIVE SUMMARY
- The Mechanism: A company can return cash to shareholders in two ways: Pay a dividend (cash in hand) or buy back its own shares (stock price up). Buybacks reduce the number of shares outstanding, making your remaining shares represent a larger slice of the pizza.
- The Tax Edge: Dividends are taxed immediately (15-20%). Buybacks are taxed never (until you sell). This tax deferral allows your wealth to compound faster inside the stock.
- The Signal: Massive buybacks (like Apple or AutoZone) signal that management believes the stock is undervalued. It acts as a floor on the stock price.
Warren Buffett doesn’t pay a dividend. He prefers buybacks. Why? Because receiving a dividend forces you to pay taxes and reinvest the cash yourself (friction). Share Buybacks are “frictionless.” The company reinvests for you by retiring shares. According to Team BMT Analysis, the “Shareholder Yield” (Dividends + Buybacks) is a far superior metric than Dividend Yield alone. Source: Berkshire Hathaway Annual Reports
Scenario: Company has $1B Market Cap (10M shares at $100). Earns $100M/year ($10 EPS).
- Option A (Dividend): Pays $100M dividend ($10/share).
You get: $10 cash. (After tax: $8). Stock price drops to $90.
Net Worth: $98. - Option B (Buyback): Buys $100M of stock (1M shares).
Shares Left: 9M.
New EPS: $100M / 9M = $11.11.
New Price: Stock rises to $111 (assuming constant P/E).
Net Worth: $111. (Tax deferred). - Verdict: Buybacks created $13 more wealth by avoiding the tax leak and boosting EPS.
Performance: Buyback Achievers vs. S&P 500
| Index | Annualized Return (2000-2020) |
|---|---|
| S&P 500 | 6.5 |
| S&P 500 Buyback Index | 11.0 |
*Chart Note: Companies that aggressively reduce their share count (High Buyback Yield) consistently outperform the broader market due to the “supply shock” of disappearing shares.
CRITICAL SCENARIO: The “Bad Buyback” Trap
When management destroys value.
| Condition | Result |
|---|---|
| Buying stock when P/E is Low (Undervalued) | Value Accretive (Buffett Style). Boosts EPS massively. |
| Buying stock when P/E is High (Overvalued) | Value Destructive. Burning cash to buy expensive paper. (Often done to offset executive options). |
Execution Protocol
Some companies buy back stock just to offset the shares they give to employees (Stock Based Compensation). This is fake. Look for a decreasing share count year-over-year. If share count is flat, the buyback is a lie.
Funds like PKW (Invesco Buyback Achievers) or TTAC focus on companies with high shareholder yield. They automatically filter for firms shrinking their float.
The sweet spot is often companies that do both: Pay a modest dividend (2%) and do massive buybacks (3-4%). This gives you some cash now and lots of growth later.
Fail Condition: Ignoring debt. If a company borrows money to buy back stock (leveraged buyback), run away. That is a ticking time bomb.
WEALTH STRATEGY DIRECTIVE
- Do This: Prioritize “Total Shareholder Yield” (Dividend % + Buyback %) over simple Dividend Yield. A stock with 0% dividend and 5% buyback is often better than a 5% dividend stock.
- Avoid This: The “Income Fallacy.” Thinking that selling a few shares of a buyback monster (like Apple) to create cash flow is “eating principal.” It is not. It is mathematically identical to receiving a dividend.
Frequently Asked Questions
Are buybacks manipulated?
Critics say buybacks artificially boost EPS. While true, this “manipulation” benefits shareholders. If EPS goes up, the stock price usually follows. As long as the business is healthy, it works.
Will they be taxed?
The US government introduced a 1% excise tax on buybacks in 2023. While this adds a small friction, it is still far cheaper than the tax rate on dividends.
Apple vs. Coca-Cola?
Apple focuses on buybacks; Coke focuses on dividends. Apple’s approach is more tax-efficient for wealthy investors. Coke’s approach is better for retirees who need passive income without selling shares.