A Rough guide to Dividends, Buybacks and the Net Payout Yield

Thursday, May 31 2012 by
A Rough guide to Dividends Buybacks and the Net Payout Yield

There are few topics more divisive among income investors than the question of whether dividends or share buybacks are the superior wealth generator. 

Where once the humble dividend was the favoured means of returning cash to shareholders, these days companies are turning in increasing numbers to buying back their own stock in the market or direct from investors, often as a (theoretical) means of boosting earnings per share (EPS). Regardless of how you view the issue, the fact that many companies now pay dividends AND routinely buyback shares means that traditional metrics for comparing income stocks have become deficient in some circumstances. What’s needed is a new solution. 

Dividends vs. Buybacks 

The debate over dividends vs. buybacks is an in depth affair (and one for another day) but the rough guide goes something like this… 

While dividend payouts are at the top of the priority list for income investors – who use metrics like dividend yield, growth and cover to screen the market for potential stock candidates – share buybacks meanwhile, present a few uncertainties. 

On the plus side, a company with excess cash can act to increase its EPS simply by buying up its own stock at less than intrinsic value and reducing the number of shares in issue. On paper, that looks like a great idea because a buyback has the effect of spreading a company’s profits between fewer shares, meaning that the share price should respond accordingly. 

However, critics point to the fact that management incentive schemes are frequently linked to EPS performance, which, they argue, can unduly influence the decision to launch a buyback scheme. In turn, detractors have stressed that even management teams can be poor at determining the price at which a buyback represents good value. In 2011, for instance, Home Retail (LON:HOME), the group behind the Argos and Homebase retail chains, spent 12 months and £150 million buying back shares at well over 230p (and occasionally as high as 270p) but its shares have since fallen to around 77p. 

A further criticism of buybacks is that companies can (and do) continue to issue shares even when they are buying back stock in the market – for example, when they need to cover stock options. If the net effect is that more shares are issued than bought back, then…

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NEXT plc is a United Kingdom-based retailer offering clothing, footwear, accessories and home products. The Company's segments include NEXT Retail, a chain of over 500 stores in the United Kingdom and Eire; NEXT Directory, an online and catalogue shopping business with over four million active customers and international Websites serving approximately 70 countries; NEXT International Retail, with approximately 200 mainly franchised stores; NEXT Sourcing, which designs and sources NEXT branded products; Lipsy, which designs and sells Lipsy branded younger women's fashion products, and Property Management, which holds properties and property leases which are sub-let to other segments and external parties. Lipsy also sells directly through its own stores and Website, to wholesale customers and to franchise partners. The Company's franchise partners operate approximately 180 stores in over 30 countries. more »

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Vodafone Group Plc is a telecommunications company. The Company's business is organized into two geographic regions: Europe, and Africa, Middle East and Asia Pacific (AMAP). Its segments include Europe and AMAP. Its Europe segment includes geographic regions, such as Germany, Italy, the United Kingdom, Spain and Other Europe. The Other Europe includes the Netherlands, Portugal, Greece, Hungary and Romania, among others. Its AMAP segment includes India, South Africa, Tanzania, Mozambique, Lesotho, Africa, Turkey, Australia, Egypt, Ghana, Kenya, and among others. The Company provides a range of services, including voice, messaging and data across mobile and fixed networks. more »

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  Is LON:HOME fundamentally strong or weak? Find out More »

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