Capital structure and payout
Dividends and buybacks
Compare paying out cash as a dividend with buying back shares: what happens to the share price, EPS and shareholder value.
Learning objectives
- Calculate the share price after a dividend and after a buyback
- Show why, in a perfect market, both leave shareholder wealth unchanged
- Explain why a buyback can raise EPS without creating value
A company with more cash than it can invest at a good return should give it back. It can pay a dividend (every shareholder gets cash, the share price drops by the dividend) or buy back shares (sellers get cash, the remaining shareholders own a bigger share of a smaller company).
In a perfect market, with no taxes, no transaction costs and a fair buyback price, the two are equivalent: a shareholder's wealth is the same either way, and the same as if nothing were paid. What changes are the accounting optics, such as EPS, and the real-world frictions: taxes on dividends versus capital gains (which differ by country and investor), the signal management sends, and flexibility, since a buyback can be stopped without the stigma of a dividend cut.
Ex-dividend price = (Equity value − Cash paid) ÷ Shares Price after buyback = (Equity value − Cash paid) ÷ (Shares − Cash ÷ Price)
- Equity value
- share price × shares before the payout (includes the surplus cash)
- Cash ÷ Price
- shares bought back at the market price
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