An Alternative To Dividends That Might Improve Your Wealth

I dont think thats a question at all equitybore.

If you have an investment in mind that could generate higher returns then, as the holder of the shares, just sell a few.
The result is exactly the same, probably better from a tax perspective.

Try running through the numbers with other companies - like national grid or gsk, and you'll get a better picture on the effectiveness of share buybacks. I don't invest in a company for them to use their profits to buy back their own shares. Would much prefer enhanced dividends - so then I get the choice on what to do with the proceeds...

As people have observed, a buyback is more-or-less the same as a dividend that the company automatically reinvests in the shares for you, whether you want that reinvestment or not, and the greater effectiveness of the buyback highlighted for the particular case of BATS in this article just reflects the fact that reinvesting the company's dividends in its own shares would have been a very profitable move.

So what's hidden behind that weasel phrase "more-or-less"?

To deal with a fairly trivial issue first, there's the fact that your number of shares doesn't increase: you have the same number of shares out of a smaller total number of shares in issue rather than a larger number of shares out of the same total number of shares in issue. That makes the buyback more closely equivalent to an automatically-reinvested dividend coupled with a share consolidation than just the former on its own - which is a point that needs watching from the 'spin' point of view but is otherwise fairly harmless. (The 'spin' is that the company claims the credit for the buyback twice - once for returning cash to shareholders by buying back say 5% of the shares in issue, and again for increasing the dividend per share by say 10%. In fact, the dividends paid by the company have only increased to 0.95*1.1 = 1.045 times what they were. The remainder of the dividend increase is basically what the investor should expect anyway for the "share consolidation" aspect of the buyback...)

Secondly, there's the issue of trading costs. The very large purchases involved in a company buyback should be doable with lower trading costs (as a percentage of the value of the shares) than most individuals can manage. So if you want to reinvest the "dividends" in the shares that prouced them, a buyback will probably be slightly better for you. But only slightly, because Dividend Reinvestment Plans (DRiPs) can typically be used to reinvest dividends in the shares that produced them at a low percentage cost even for small dividends.

On the other hand, if you don't want to reinvest the "dividends" in the shares that produced them, a buyback gives you the choice of either putting up with the reinvestment anyway or selling shares to effectively reverse the buyback. The latter is unlikely to be very cost-effective for an individual shareholding - to match e.g. a 0.1% buyback with a cost-effective sale, you need something of the order of a million-pound holding, and even if you lump all the buybacks done in a year together to be matched by a single sale (with a resulting risk of adverse price movements) you still need a holding in the tens-of-thousands-of-pounds range for a cost-effective sale... In an ideal world, low-cost Buyback Participation Plans would be available in addition to low-cost DRiPs, but we don't live in that world!

Thirdly, there's the tax angle. For many people, it's irrelevant, due to the shareholdings being in ISAs, SIPPs or other tax shelters, or to being basic-rate taxpayers whose capital gains remain below the CGT allowance and so not paying tax on either dividends or capital gains. But there certainly are people for whom it is relevant due to having investments beyond those they can sensibly shelter from tax and needing to pay Income Tax, CGT or both on them. But even for them, it can work out either way. For example, a higher-rate taxpayer pays tax on unsheltered dividends equal to 25% of the dividends received, so as long as they remain below their CGT allowance, the capital gains produced by buybacks are quite a lot better taxwise. But once they go over their CGT allowance, the CGT rate is 28%, making dividends arguably slightly better taxwise ("arguably" because there is generally much more scope to defer taking capital gains by long-term holding of shares). As a second example, someone who is not yet a higher-rate taxpayer but anticipates becoming one in a few years' time due to promotion at work would probably prefer to take dividends now, while they're effectively untaxed, over letting them the profits build up as capital gains that they're likely to pay 28% CGT on in the future (i.e. the deferring of capital gains can be a disadvantage in the wrong circumstances!).

All in all, while I see some financial differences between a buyback and a dividend reinvested in the share that produced it, I don't see any that very clearly argue for buybacks over dividends or vice versa over the entire population of shareholders. Some individual shareholders will have clear financial reasons for preferring one over the other, but many won't, and among those who do, the preferences won't all run one way. That's the context in which I say that a buyback is more-or-less equivalent to a dividend that is reinvested in the share that produced it.

And that also gives me the criterion by which I judge whether buybacks are good. BATS buybacks now are more-or-less equivalent to investments in a share with a P/E of 15.9, i.e. an earnings yield of a fraction over 6%. I cannot help feeling that as investments in mature industries go, one can do better... And so I don't really regard buybacks by BATS as particularly attractive. It would be considerably more attractive iIf they were to instead say something like "we'll buy back, but only when the share price is low enough to make an earnings yield of over 8% available - and if we build up significantly more cash than we need because the share price doesn't drop that low, we'll declare a special dividend."

Gengulphus

It seems to me that the main problem with this is that you have to wait a number of years to get the data to decide what you think would have been the better course of action. By which time the train has left.

Dividends in my ISA or my SIPP are fine.

For money outside of those wrappers, I would love to utilise the annual capital gains tax allowance. So it would be nice if a few good companies engaged heavily in share buybacks & paid no dividends.