1. Dividends vs Share Buybacks
So let's take a moment here to discuss the difference between dividends
and share buybacks. First of all, with dividends, keep in mind that they
could be a one time dividend or an ongoing dividend. They would also
then contribute to the yield on a stock. If they were ongoing regular
dividends, they would have no impact on shares outstanding or EPS.
We need to keep in mind that often share buybacks on the other
hand, are often preferable to dividends. Why? Well, it's partly because
dividends are considered more permanent for the company, and also dividends
cannot be turned down by the investor. Also dividends can create an additional
tax burden for the investor. So let's switch over now to look at
shared buybacks, which would reduce the number of shares outstanding, obviously,
this would increase the earnings per share from the reduction of shares
outstanding. And share buybacks are generally seen as a positive market
signal. And this is really due to the implication that the company considers
the shares under valued. Share buyback can also be used to alter the
capital structure. So a buyback would obviously decrease the proportion
of equity and increase the proportion of debt.
Share buyback and also offset dilution, which may have been caused by the
issuance of stock options.
2. Let's practice!