5 ms·
Prior to the Bush era tax cuts, all dividends were taxed at the income rate, which I think explains the biggest motivation in the shift from dividends to buybac
by fiprofessor 2y ago
Prior to the Bush era tax cuts, all dividends were taxed at the income rate, which I think explains the biggest motivation in the shift from dividends to buybacks in that era.
Nowadays, as you say, there is no difference in tax rates for qualified dividends. However, one big remaining benefit of buybacks is that a dividend forces one to incur a taxable event when the dividend is issued, even if one chooses to immediately re-invest the dividend in the company (as many people still in the accumulation phase of investing do). On the other hand, a buyback does not force those people to sell.
On the other hand, a buyback should lower the market cap of a stock, so cap-weighted index funds ought to sell and re-balance when a buyback is issued, so most index investors would seemingly end up selling. However, they end up being able to avoid most of the capital gains taxes by re-balancing through redemptions and heartbeat trades.
- gizmondo 2y ago> On the other hand, a buyback should lower the market cap of a stock You got it backwards. If a stock is priced fairly, a buyback is value-neutral. Reduction of the cash on hand is offset by the increase of future cash flow per share. It's dividends that reduce the market cap.
- fiprofessor 2y agoNo, because the future cash flow per share is not reflected in the current market cap. Perhaps you are thinking of share price instead: there it is true that dividends reduce share price, while buybacks are share-price neutral at least theoretically, though it is commonly believed by many people that they do affect price. (Hence, under that same theoretical model, market cap must decrease if share price remains the same because market cap is total number of outstanding shares * share price. So if the former decreases while the latter stays the same, market cap must have decreased.)
- gizmondo 2y agoYou're right, I need a coffee.
- otteromkram 2y ago> On the other hand, a buyback should lower the market cap of a stock [...] Uhh...what? Buybacks are a return of value. Share prices adjust accordingly to the updated proportion of outstanding stock. Might want to select a new username, friend.
- pliny 2y agoThe price of the share stays the same but there are fewer shares, so the market cap would go down.
- mrkstu 2y agoBut EPS rises so equilibrium would suggest the price of the share would almost certainly rise to match the old EPS.
- fiprofessor 2y agoThe earnings per share certainly increases. But this is (at least theoretically) offset by the fact that the firm's assets have decreased. For example, if the buyback was paid for with cash, then prior to the buyback, the shares represented a claim of ownership not just on future earnings, but also on that cash reserve. That said, this is all under a theoretical model (as in Miller-Modigliani theorem). In practice/empirically, there is reason to plausibly believe that e.g. the decision to announce a buyback has a signalling effect and so can increase share prices.
- User23 2y agoWell it certainly makes a market for the lucky duckies who are the counterparties for the buyback. They benefit.
- mrkstu 2y agoIs there a heuristic for how much of the value of a share is assigned to asset value vs forward looking earnings? Many of the ‘hot’ stocks like Nvidia seem almost all forward looking.