If you are new to the stock market and looking for the best investment options to generate yields on total corpus amount, you should know about the multiple methods by which you can earn the same. Purchasing equity stocks can increase a shareholder’s wealth in two primary ways – dividends and stock buybacks.
Investors can choose dividend payouts to get access to steady cash flow through periodic profit distribution. At the same time, stock buybacks involve capital gains for shareholders opting to surrender their share to a respective company.
In the case of stock buybacks, the number of shares in circulation falls significantly. As a result, total earnings per share rises, thereby increasing their underlying value.
Such measures undertaken by the management of a company are often perceived well in the stock market, owing to an appreciated value of remnant shares, thereby increasing their demand, and increasing the market value of such securities.
Suppose you decide upon buying 100 shares of company XYZ, each valued at Rs. 10. After a year, the company publishes an annual profit of Rs. 5 lakh, which has to be distributed among shareholders.
Assuming around 1,00,000 shares are available in the market, each share is eligible for a dividend yield of Rs. 5. Thus, you should receive Rs. 500, at the end of a year. This is the dividend payout method.
Alternatively, you can benefit from stock buybacks as well, provided company XYZ facilitates such transactions. Suppose the market value of a share is Rs. 15 when the company rolls out a buyback option. If you choose to sell your entire portfolio, you can realize revenue of Rs. 1500. Given your cost of purchase is Rs. 1,000, capital gains amounting to Rs. 500 was realized through this venture.
Even though the profits realized through both dividend vs buyback are similar in the given example, such returns are subject to fluctuations in the stock market, as well as internal management of a company.
This brings forward the question of which should you choose. As per your investment regime, and future predictions regarding the stock market performance, you can decide upon retaining shares to enjoy periodic dividend yields, or correspondingly opt for share buybacks. In this regard, analyzing each method of return generation should be scrutinized to select one offering the highest earnings.
Both methods are offered by listed companies to ensure substantial financial gains for investors, which, in turn, increases the market reputation and long-term profits of a business. While dividend buybacks require proper documentation ensuring complete transparency concerning profit disbursal, share buybacks often lead to increased valuation of all remaining shares in the market.
The points of difference between dividends and stock buybacks can be elaborated as follows –
As stated above, dividend payouts ensure a periodic disbursal of funds in the name of shareholders calculated as per total revenue generated by the company in one financial year. This is pegged as a regular source of income for shareholders, primarily used to meet personal expenses.
In the case of share buybacks, on the other hand, profits are realised by selling the shares to the company at a higher price. An increased cost can be attributed to tender offers made by the business, or at a higher price reached through market fluctuations. Such buybacks are funded through retained earnings of the company. This increases the valuation of the share prices in the market. Investors choosing to forego a stake in a company in this method realise capital gains on the total investment, which, in turn, can be utilised for reinvestment in the stock market or meet personal funding requirements.
All earnings through the share market are subject to taxation, provided it is above a specified amount. Dividend distribution tax is levied on periodic yields, while capital gains tax (can be long term or short term) have to be paid in case of stock buybacks.
While companies have to deposit the dividend distribution tax with the government before disbursing stipulated profits, an additional tax has to be paid by individual shareholders, provided the total dividend income is above Rs. 10 lakh. Tax at the rate of 10% has to be paid on the excess dividend income (above Rs. 10 lakh) by resident Indians and Hindu undivided families.
In the case of stock buybacks, the tax rate depends upon the holding period of security. Shareholders giving up shares for buyback after a one-year holding period and realising capital gains on the same have to pay tax at the rate of 10% on total earnings. In case the sale is made before the completion of a year, a short-term capital gains tax at 15% on total profits is levied.
Dividend payouts fluctuate every year, deepening the profits realized in one financial year. Additionally, small and mid-cap companies sometimes choose to retain dividend yields for a stipulated year, for reinvestment and business development. Thus, such sources of income are not stable or guaranteed.
In the case of stock buybacks, on the other hand, investors have an idea about the total gains realized during the time of resale. Nonetheless, often such share buybacks increase the total value of remaining shares available in the market, implying substantial capital gains if you choose to sell the shares at a later date. Thus, such buyback decisions require a thorough analysis of the market for accurate predictions of market fluctuations to ensure high capital gains through such sale of securities.
Usually, stock buybacks are undertaken by experienced investors, as they have an in-depth understanding of market operations, wherein the released funds are used for reinvesting in the stock market.
Keeping in mind these pointers of dividend and stock buybacks, you can choose between any of the two methods to maximize your returns on stock market investments. After a thorough examination of all underlying factors, the objectives behind the investment, and market coefficients such as the buyback ratio, you can opt to retain a share for period dividend earnings, or to sell the same through share buybacks for capital gains.
Disclaimer: The views expressed in this post are that of the author and not those of Groww.