Buyback preferred over dividend?

Assuming Company is good for investments on all other parameters.

Buying back of the shares is probably the best effort, to increase net worth, by management if done at right price. If certain conditions are met, buying back of shares can lead to increase in wealth for shareholders.

Here, by buyback we refer to shares bought back from the market (public) and then extinguished. Mode of buying back may be open market purchase, tendering offer, compulsory buy back etc. But important point is that shares need to be extinguished. (Some people consider similar actions by management as buyback like increasing their holding from open market purchase, placement or ESOPs but we are not referring to that right now because emphasis is on increasing net worth and not market price). The management should also participate in buyback. If not, it will increase its stake. Under such situation, the general investor should think over.

Prerequisites of the buyback:

  1. Shares should be available at substantially below the intrinsic value
  2. Availability of sufficient cash to meet its business requirement and should also generate enough cash ongoing basis.

Assuming that both the above conditions are fulfilled, you can see from the table below difference it can create.

This incremental CAGR of 5.24% p.a. will make you richer by 277.73% at the end of year 20. Next time think again before you offer shares for buyback.

“A manager who consistently turns his back on repurchases, when these clearly are in the interests of owners, reveals more than he knows of his motivations” – Berkshire Hathway 1984 Letter to Shareholders


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