When companies have excess cash, they should distribute this to the shareholders. For this, they can:
- either pay the money in dividends
- or buy back their own company shares and subsequently cancel the shares, increasing the earnings and assets of the remaining shares
My clear preference is dividends, I have yet to meet an investor who complained about having received too high dividends.There is only one catch, some investors don't like it when the dividend is cut, so if companies want to pay dividends and know that part of that is due to a one-off event (for instance an asset sale that brought in a huge profit), they could declare part of it as "special" dividend, indicating that it might not be repeated in the future. A clear dividend policy towards the investors would also help in this matter. Another advantage is that dividends are very easy to track, even years in the future one can look back and check how much has been paid in the past.
Issues surrounding share buybacks:
- Share buybacks only make sense if the share is undervalued, but value is in the eye of the beholder. This issue doesn't play a role for dividends.
- Buybacks must be monitored, the company should make sure that they don't buy more shares than say 20% of the volume done that day. Thus, it can easily distract the management of the company, they should better be focused on their own business instead of monitoring buybacks.
- I have seen companies "defending" their share by massively buying stock at a certain price, after they exhausted their money, the share tanked and the company even lost money on paper.
- I have also seen examples where the company bought large amounts of shares exactly when the CEO sold his private shares.
All in all, I would strongly prefer dividends over share buybacks, it is more easy, more transparent and can not be abused. Only if the share buyback is executed correctly, the positive effects might be similar to the effects of dividends.
The only company that might use buybacks actively is a closed-end fund: when the share is trading below its Net Asset Value, it could buy some shares and keep them in Treasury. When the share is trading above its Net Asset Value, it could slowly sell some of its Treasury shares.That way it could ensure that the gap between the share price and the Net Asset Value per share is not too large.