There are potential benefits offered by companies that both pay dividends and buy back their own stock, even though, theoretically, neither action may make sense.
Even at the fairly low current dividend tax rates, the argument could be made that dividends are a waste of capital. Here's why: Companies pay taxes on income, then distribute a portion to shareholders, who in turn pay taxes to federal and state governments. Had the funds instead stayed with the company, less capital would have flowed to the government in the form of taxes paid by shareholders.
In the case of buybacks, the argument can be made that the company repurchasing shares must be out of productive ways to deploy its cash, thus indicating that future growth opportunities must be limited. You could make a similar argument about dividends.
Of course, theory and practice quickly part ways, especially when it comes to investors, their behavior and their attitudes toward a return of cash to them in the form of dividends. It's not just about the yield itself and the "bird in the hand" that cash dividends represent, but also the growth in dividends. Unlike earnings, dividends can't lie; what you see is what you get, and growing dividends can be an indicator of a company's health. There is a level of confidence shown by management teams that continue to increase dividend payouts. To do so when they really can't afford to would be unwise and ultimately would cause a great deal of pain, which creates its own check and balance. That's not to say mistakes are made, and certainly not all company management teams are created equal.
In terms of share repurchases, when buyback programs initially are announced, stocks often receive a boost. While dividend reductions or eliminations are typically headline news and can affect a stock's price greatly, companies that don't follow through on their buyback programs may need to withstand some analyst questions on quarterly calls, but it is unlikely their inaction will make the headlines.
Nonetheless, a company's follow through on buybacks can be measured and monitored. Reductions in shares outstanding from year to year as measured by the buyback yield are a great indicator that companies actively are buying back stock.
A word of caution: The combination of growing dividends and stock buybacks is not always a recipe for investment success. Take video game retailer GameStop (GME) , for instance. The company has reduced shares outstanding by 26% the past five years; its average buyback yield during that time is 5.8%. Quarterly dividends have grown from 15 cents a share in 2012 to 38 cents in 2017, a staggering 17% compound annual growth rate. Yet shares are trading at the same level they were back in 2012. After hitting the $55 level in 2013, they've fallen to about $22. Currently yielding 7%, the market seems to think GameStop's best days are behind it. While the numbers are important, you also need to look at the industry a company operates within -- in this case, retail.
Next week I will be adding yet another tracking portfolio to my growing list. This one will focus on companies that have increased dividends while simultaneously repurchasing stock.
