As a beginner in the stock market, it is important to know market fundamentals to identify the best investment opportunities. However, it is also important to go beyond the basics, like what is trading and what is Demat account, and understand the various ways you can earn returns in the equity market. Equity stocks typically provide returns in two major ways: stock buybacks and dividends.

Comparing buyback vs. dividend, while dividend payouts are a reliable source of income, stock buybacks include significant capital gains for the stockholders who choose to give up their shares. A key impact of buybacks is that the cumulative stocks of the company decrease significantly in the market and the EPS (earnings per share) increases. Thus, as the amount of shares falls, their intrinsic value increases. Usually, the market also perceives buybacks favourably.

In this article, we will primarily focus on the buyback vs. dividend debate, understand what dividends and buybacks are with examples, learn the key areas of distinction, and explain how smart investors should pick an option that works best for them.

Now that the basics of buyback vs. dividend are clear, let us illustrate their differences through an example.

Imagine you are engaged in share trading and have bought 500 shares of company ABC. One share is priced at Rs. 5. In a year, the company declares a profit of Rs. 10 lakh. This amount has to be paid to shareholders as dividend payouts. If there are a total of 10,000 shares of the company in the financial market, every share will be entitled to a return of Rs. 10. This entitles you to a dividend payout of Rs. 5,000. This illustrates returns through dividends.

In contrast, returns can also be earned through buybacks. Suppose the company ABC’s shares are trading at Rs. 10 when a stock buyback is initiated. At this point, if you have 500 shares, you can choose to either hold or sell. Selling would earn you a return of Rs. 5,000 and a profit of Rs. 2,500 (as you entered the position at Rs. 5 per share).

As the returns from both methods could be similar, it warrants the next point of enquiry, which is better buyback vs. dividend. The returns through both methods also depend on the market; thus, it is important to make informed decisions that align with your investment preferences and strategy. Let us see how you can pick the best option.

Options for buybacks and dividends are provided to make sure that investors experience robust returns. This improves market perception of the business and prospects for profits in the long term. Let us understand how buyback vs dividend is distinct:

• Earnings
  The major selling point of dividends is the stability they provide. For most investors, dividends are a regular secondary income source, which can be employed for personal expenses or further reinvestment towards wealth creation.
  On the other hand, profits from share buybacks are pocketed when the shares are sold at a higher cost. The price could go higher for any reason. On the company’s end, buybacks are financed through credit or retained earnings. Eventually, this enhances the value of each share in the market, and investors can secure capital gains on their investments.
• Tax
  All share market earnings fall under the ambit of taxation when they are more than a given amount. Dividends are taxed with the dividend distribution tax, and stock buybacks attract capital gains taxes.
  
  In the case of dividends, while companies pay a dividend distribution tax, investors also have to pay taxes according to their income tax slab, as dividends are accounted as income under the taxation laws.
  
  When it comes to buybacks, the rate of taxation varies according to the security holding period. If the shares are surrendered to profit from capital gains after holding for over one year, a 12.5% tax is levied as long-term capital gains tax, and if they are sold before a year, a 20 % short-term capital gains tax applies to the earnings.
• Assured returns
  Dividends are naturally volatile. Their exact amount depends on the company’s annual profits. Moreover, a company can always choose not to pay dividends and favour reinvestment.
  
  With buybacks, you have information about your returns before making the sale. Even if you hold, the intrinsic value of the shares in your portfolio will increase once the buyback is complete. This means you have a good chance of making a higher profit at times by holding and not selling. This is why buybacks need to be thoroughly analysed. Stock buybacks as an option are more commonly opted for by seasoned market investors as they have the necessary expertise to make informed decisions.
  
  With these pointers comparing buyback vs. dividend, you can make a better decision and align with one method of return that suits you better. Keep in mind that in-depth research is required to understand market sentiment and movement and maximise profits.

Also read: Forward contract

Conclusion

Understanding the dynamics of buyback vs. dividend is crucial for making informed investment decisions. Dividends offer stable income, while buybacks can provide significant capital gains and enhance share value. Each method has distinct tax implications and benefits, so you should choose which kind of return you want based on your financial goals and market conditions.