Dividends vs. Buybacks: What’s Best for Investors?

In the spring of 2023, Apple shareholders found themselves facing an exciting financial paradox after the company, which owns one of the largest cash reserves in the world, exceeding $165 billion, announced a share buyback worth $90 billion.

While the company kept its cash dividends at $0.24 per share only, which sparked widespread controversy among investors, as a team believed that pumping this amount of liquidity into buybacks would boost the share price and raise the share’s profitability in the long term.

On the other hand, investors wondered about the feasibility of ignoring the distribution of larger cash dividends in light of the huge cash flows achieved by the company.

While Apple’s stock achieved an increase of about 45% during 2023, supported by the buyback program, some old shareholders, especially pension funds that prefer fixed income, felt that the direct cash return had become less than it should have been.

This paradox was not limited to Apple shareholders, as shareholders of other major companies such as Meta, Alphabet, and Microsoft found themselves facing the same dilemma, after those companies directed hundreds of billions toward buying back shares in exchange for limited cash dividends.

In recent years, corporate policies for distributing returns to shareholders have become the focus of increasing attention from investors, as the flow of liquidity in global markets and companies achieving record levels of free cash flows have led them to face multiple options.

Companies face a strategic challenge between distributing cash dividends directly to shareholders or directing funds to repurchase shares.

Guaranteed return or risky bet?

In 2024, S&P 500 companies returned approximately $1.6 trillion to shareholders through dividends and stock repurchases, including $942.5 billion in repurchases (a historic high) and $629.6 billion in cash dividends.

Cash dividends remain the most obvious and simple option for shareholders, as they give them a direct and predictable cash flow. This guaranteed return represents a source of reassurance for investors looking for fixed income, such as pension funds and conservative investors.

But this return comes at the expense of flexibility, as companies that depend on distributing fixed dividends often find themselves forced to maintain the same pace even in periods of weak profits or limited liquidity, because any reduction in dividends is interpreted negatively in the market and is seen as a signal of declining performance.

On the other hand, repurchasing shares represents a bet on the future, especially when management believes that the share price in the market is less than its true value, as reducing the number of outstanding shares automatically enhances earnings per share, which supports the share price in the market and improves performance indicators.

Comparison between stock buybacks and dividends

Some countries also give the buyback process an additional advantage to shareholders related to the tax aspect, which is a factor influencing investor preferences.

In the United States, cash dividends are treated as taxable income in the year of distribution, while capital gains resulting from buybacks are taxed only when shares are sold.

According to estimates by the US Joint Committee on Taxation, the tax advantage is still 5 to 8% in favor of buybacks compared to cash dividends.

This means that larger investors, such as hedge funds and institutional investors, are more likely to favor buybacks due to tax efficiency and the possibility of controlling the timing of profits.

As for the individual investor, who relies on regular returns, he still sees cash distributions as a guaranteed means of periodic income.

Which of the two options serves the company’s performance?

Share buybacks provide management with discipline and adaptability. It allows you to determine the timing of purchases, inject funds when surpluses are available, and pause the program if flows weaken or the company faces urgent financial obligations.

On the other hand, dividends often turn into a permanent obligation that is difficult to reduce without this being misinterpreted in the market as a sign of weakness or lax performance, which forces some companies to stick to dividends despite potential liquidity pressures.

For example, AT&T faced difficulties after committing to high dividends despite declining profits, which forced it to reduce dividends in 2022, a decision that investors interpreted as a sign that it was facing financial pressure, and led to a temporary decline in its stock.

Data from the Morgan Stanley Capital International Index of US companies also show that companies that adopt regular and disciplined buyback programs, such as Microsoft and ExxonMobil, have outperformed their counterparts that are content with high cash dividends without buybacks.

In the fourth quarter of 2024, the value of repurchases in the S&P 500 index amounted to about $243 billion, compared to about $168 billion in dividends.

This disparity reflects the tendency of many large companies to favor buybacks as a more flexible means of raising shareholder value, especially in periods of high liquidity and low investment opportunities.

This means that if a company’s cash flows are strong and growth opportunities are limited, a buyback may be the ideal option to raise the value of the stock, reduce dilution, and improve profitability indicators.

In cases where the company requires financing new projects, covering debts, or expanding investments, cash distributions may become a burden on performance flexibility if used without a thoughtful balance.

Does the market prefer dividends or buybacks?

When a company announces an increase in its dividends, this step is interpreted among investors as a clear indication of the health of the financial statements, the strength of cash flows, and management’s confidence in the continuity of profitability.

While repurchase programs reflect management’s confidence in the stock’s market price, in some less positive cases, they are viewed as a way to artificially raise earnings per share to increase returns attributable to executives.

However, market signals are not always positive at all. When a company chooses to direct its resources towards buyback programs rather than investing in research and development or expansion, this may be interpreted as an indication that management prefers quick returns at the expense of long-term sustainable growth.

In contrast, cash dividends force management into financial commitment and discipline; When you promise a certain distribution, it is difficult to reduce it without this being understood as a weakness or decline in performance, which means that dividends suit the investor who is looking for stability and periodic income.

On the other hand, buybacks tend to be more appropriate for those who trust management’s ability to transform opportunities into sustainable growth, but in the end there is no ideal option that fits all cases.

In other words, the question is not: “Who wins? Dividends or buybacks?”, but rather “Who integrates return, liquidity, growth, and governance into a single policy that reflects the company’s strategy and financial context?”

For investors looking for income, especially in low-growth companies, cash dividends remain the most suitable option.

In mature companies with cash surpluses and limited investment opportunities, buybacks often achieve higher value for shareholders, as happened in 2024 when its value reached $942.5 billion.

But boards must consider sustainability, governance and balance; Buybacks may increase profitability temporarily, but they may hide poor investment, while profits oblige the company to make continuous dividends.

The best shareholder return is achieved when capital allocation policies are linked to a solid strategy that delivers real value, rather than just a window dressing for financial performance.

Sources: S&P Dow Jones Indices – S&P Global website – FirstTrust – FT Portfolios website – Janus Henderson – Boston Partners – Morgan Stanley Capital