This is false (conditionally). Most valuations look something like: earnings x growth + cash. If you have cash that you cannot reinvest at the same ROI that you have been growing at, you can increase shareholder value by removing the cash element, since it's dead weight. A buy back is a way to invest that cash at the same ROI that your company is growing at. A dividend would require the investors to re-invest that cash and get the same ROI that the company is growing at.
This is why it make sense for large, fast growing companies to buy back their shares and for large, slow-growing companies to issue dividends.
A dividend lets the investors choose if they want to buy more shares (from the same sellers who would sell in a buyback) or mix their current shares with the cash.
The key is the asymmetry of information. The market price should reflect all public information. However the company has non-public information, which puts them in the best position to judge if money is best invested inside the company or out. Share buybacks are a legal form of insider-trading.
Reducing shares increases the price (while keeping market cap the same). Share splits increases the shares outstanding and decreases the price. So... yes, shares outstanding does matter.
You're wrong. When the company issues the dividend, the share price falls for precisely the amount issued. So if everybody used that money to buy the shares again, the share price should return (roughly) to the value before the dividend was paid. The number of shares outstanding wouldn't change.
There is a value in a future dividend. On the ex-dividend date, the share becomes less valuable because the new holder will not receive a dividend in X days. This X is usually very small, so a share that goes from paying you $5 in two weeks to not paying you has clearly lost value close to $5.
If your argument was true, that a stock's price predictably fell the day after the dividend, investors could simply short the stock and get a guaranteed profit, which is not possible in an efficient market.
False. If I receive cash today I can reinvest it and start earning a return. If I receive cash in a month I have forgone one months reinvestment return.
> investors could simply short the stock and get a guaranteed profit, which is not possible in an efficient market.
False. Well if you are short a stock over ex dividend date then you need to pay the owner of the stock (whomever you borrowed from) 1) the dividend which he has forgone 2) a financing spread equal to a benchmark (e.g. FED Funds + 300 bp's) for the duration you are short.
No offense but you really haven't thought this through very hard.
Also markets are not efficient despite what you read in academia.
The ex-dividend rate is an implementation flaw that makes the stock price discontinuous at the dividend date. If dividends were pro-rata it would not be.
I never said markets were perfectly efficient.
You didn't think through your answer very hard did you? ;)
They do. But you don't usually see this, because the prices are "adjusted", to make price history continuous, same as with stock splits.
Take a look at MSFT (Microsoft) stock price on Yahoo! Finance. "Close" is what actually happened, and "Adj Close" is what you see on the graph.
Date close Adj Close*
16 Feb 2016 51.09 51.09
16 Feb 2016 0.36 Dividend
12 Feb 2016 50.50 50.14
* Close price adjusted for dividends and splits.
> investors could simply short the stock and get a guaranteed profit
No, to short a stock you need to borrow it first. If you borrow a stock, you owe the dividends that were due in the meantime.
When shorting, you only pass the dividends through. The company sends you the dividend, you send it to the original owner, you could still profit from the drop in share price.
Edit: e.g. EWM (an ETF, I think)
https://uk.finance.yahoo.com/q/hp?s=EWM&d=3&e=4&f=2016&g=d&a...
No, shorting doesn't work that way, obviously. "Shorting" means you sell he stock, so the new owner gets the dividend, not you. That's one reason shorting equities is very risky long-term.
Say you own 1 share. It's trading for $20. Tomorrow the company pays $2 dividend. Then your share is worth $18 and you have $2 cash as well.
Alternatively, if you're buying the share, you're willing to pay $20 for it today but only $18 tomorrow, because you know that you won't be getting a $2 dividend if you buy it.
If you take future dividend payments into account, you also need to discount them. If you think that (discounted future dividends) > (stock price), that's a signal for you to buy. If enough investors reason this way, the price will rise until (discounted future dividends) ~~ (stock price).
Before dividend:
P = D_0 + δ D_1 + δ^2 D_2 + δ^3 D_3 + ...
P = δ D_1 + δ^2 D_2 + δ^3 D_3 + ...The point I'm making, which I admit is an obvious one, is that without profits a dividend will erode a company's value. Simple flow of money. Unless there's a surplus flow of money in, you can't have an outward flow. Therefore, the effect of a dividend on a company's market cap depends on how much profit they have in comparison.
It is basically the opposite of issuing shares and diluting existing shareholders.
Say the only thing my company owns is a bank account with $100 in it. There are 5 shares outstanding worth $20 each. The company buys back one share for $20, so now there are 4 shares outstanding in a company that owns $80.
The ownership percentage is hidden inside the equity.
The obvious way to demonstrate this is you sell 10 shares for a higher price than 10 billion shares.
So the interesting question is why are they doing this now given the medium/long term ROI a company with cash looks generate. It could mean they stopped seeing obvious medium/long term investments. Maybe a small bubble is 5-10 years away.
1) https://ycharts.com/indicators/sp_500_eps (note: slowly rising, if you ignore seasonality)
2) https://ycharts.com/indicators/reports/sp_500_earnings (note: dropping fast)
TLDR earnings are going down, but earnings/shares are going up. So what is going on ? Earnings for the US economy as a whole are dropping (pretty fast even). But the metric investors use to value shares, earnings per share is going up.
That means U.S. companies are buying back shares at a faster rate than their earnings are dropping. Why ? Exactly to generate this outcome : normal valuation metrics for shares (net-present-value of future earnings per share) go up as a result of this operation. When cutting a million corners the share price of any (large cap) stock should be roughly NPV(8%, future_cashflow).
The next question to ask is ... given that this uses a LOT of debt that is currently at very low interest rates, what happens if interest payments inevitably go up (either as a result of inflation, or of the FED raising rates) ? The problem with low interest rates is that, at the moment, 1% rate rise would quadruple interest payments for the government, and double interest payments for AA corporations.
I'm pretty sure they don't do this as a loan from the untaxed or under-taxed overseas entity back to the taxed parent would create a tax event.
AAPL has more cash than it knows what to do with, but it's a huge borrower in the corporate market so that it can fund its dividend payments.
I don't see this equivalence. I guess It's rather like settling debt since after a buy-back there will be fewer future dividends to pay. But nothing changes for continuing shareholders, does it?
Example:
Assume 10M shares at $1 each. With a 10 cent dividend ($1M total), an investor with 100k shares (1% of the company) receives $10k. The market cap drops to $9M (since cash holdings decreased) and the stock price drops to $0.90. They then buy ~11k (10k/.9) shares and have 111k shares, or 1.1%.
Now instead assume the company does a buyback of 1M shares. Now there are 9M shares, each still priced at $1 (cash holdings decreased). The investor has 1.11% of the company.
Lots of assumptions here (no fluctuation in price due to market reaction, cash is not discounted in market cap, etc) but the numbers check out in a perfect world.
The point is that with a Dividend investors can choose whether to reinvest, whereas with a buyback everyone essentially reinvests.
The whole point of giving out dividends as a company is saying to an investor "here, you can invest this cash better than we can". If you're not giving out dividends you think you have better investment foresight than your investors, which may often be true.
What you as a company then do then with the cash, whether you're investing it in R&D, personnel, etc.. or buy stock doesn't change the mathematics of things for the investor, even if the stock you buy happens to be your own stock.
In my example with the buyback, if the investor sold 0.11% of the company after the buyback, the result would look just like what would happen if they did not reinvest the dividend. 1% of the company and $10k cash.
Dividends and buybacks are simply a way to get money from the company to the shareholder. The total number of outstanding shares is of no import---as you can see in stock splits.
(I give you credit for knowing the difference, but not every reader will know the difference, so I'm trying to help them, not nitpick you.)
On the other hand, when the rate of taxation on capital gains is lower than the rate of taxation on corporate dividends, it's advantageous to pay out surplus cash in the form of capital gains by executing a share buyback. This also provides a tax-planning benefit to shareholders: Everybody is forced to realize a dividend (and pay tax on it) but some shareholders will prefer to realize more or less capital gains in a given year.
In Canada we have rules which sometimes reclassify capital gains as "deemed dividends" to prevent this sort of maneuver. A far better solution would be to simply fix the tax system so that economically equivalent actions get taxed identically in the first place.