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Yakk · 01-12-2007, 08:19 AM

Yes, the act of the stock buyback is factored into the price of the stock even before the act occurs.

Compared to capital gains, dividends are taxed at a high rate.

The following situation is simplified math with unrealistic growth rates.

Take two companies -- A and B. Both are companies worth 1 billion$ as a whole and have 10 million outstanding stocks initially. (each stock is worth 100$).

Both generate 50$ million in profit every year, and have nothing better to do with it than pass it on to shareholders.

Company A issues a dividend every year.
Company B buys back 50$ million in stock every year. This is 5% of the outstanding shares.

Both actions result, on average, in 50$ million being passed from the hands of the company to the hands of shareholders.

At the end of 10 years, both companies are still worth 1$ billion dollars. The first company still has 10 million shares. Each share is worth 100$.

The second company has bought back 5% of it's shares over the last 10 years. That means it only has about 6,000,000 shares outstanding. Each share, given that the company is worth 1$ billion, is worth 167.02$.

The investor in company A chooses to use his dividends to buy shares. He has a 20% marginal tax rate on the dividend income. After 10 years, he owns 1.4802 shares for every share he owned initially -- so his 100$ initial investment is now worth 148.02$.

The investor in company B then sells his share. 67.02$ in capital gains, taxed at 20% marginal, is 53.62$.

Notice that 48.02$ in post-tax profit from the owner of Company A is less than the 53.62$ in post-tax profit the owner of Company B has.

Note that after a few years of doing this, Company B would do a stock split to keep the value of a single share from getting out of hand. But issues like stock splits aren't that important -- they don't change the underlying asset being talked about.

Now, as mentioned, the situation is more complex than this. Tax shelters, regulatory paperwork, and other rules that differentiate between the various ways of moving money from corperation to stockholder change the landscape. And the price of stock isn't determined by how useful the stock is to you, but rather how useful the stock is, on the margin, to a new buyer.

But effects like the above is one reason why dividends have been falling out of favour more and more.

The power to defer taxation that most areas grant to capital gains is ridiculously powerful, and there are ways you can pass the value of stock onto stockholders via capital gains rather than traditional methods.

01-12-2007, 08:19 AM	#4 (permalink)
Yakk Wehret Den Anfängen! Location: Ontario, Canada	Yes, the act of the stock buyback is factored into the price of the stock even before the act occurs. Compared to capital gains, dividends are taxed at a high rate. The following situation is simplified math with unrealistic growth rates. Take two companies -- A and B. Both are companies worth 1 billion$ as a whole and have 10 million outstanding stocks initially. (each stock is worth 100$). Both generate 50$ million in profit every year, and have nothing better to do with it than pass it on to shareholders. Company A issues a dividend every year. Company B buys back 50$ million in stock every year. This is 5% of the outstanding shares. Both actions result, on average, in 50$ million being passed from the hands of the company to the hands of shareholders. At the end of 10 years, both companies are still worth 1$ billion dollars. The first company still has 10 million shares. Each share is worth 100$. The second company has bought back 5% of it's shares over the last 10 years. That means it only has about 6,000,000 shares outstanding. Each share, given that the company is worth 1$ billion, is worth 167.02$. The investor in company A chooses to use his dividends to buy shares. He has a 20% marginal tax rate on the dividend income. After 10 years, he owns 1.4802 shares for every share he owned initially -- so his 100$ initial investment is now worth 148.02$. The investor in company B then sells his share. 67.02$ in capital gains, taxed at 20% marginal, is 53.62$. Notice that 48.02$ in post-tax profit from the owner of Company A is less than the 53.62$ in post-tax profit the owner of Company B has. Note that after a few years of doing this, Company B would do a stock split to keep the value of a single share from getting out of hand. But issues like stock splits aren't that important -- they don't change the underlying asset being talked about. Now, as mentioned, the situation is more complex than this. Tax shelters, regulatory paperwork, and other rules that differentiate between the various ways of moving money from corperation to stockholder change the landscape. And the price of stock isn't determined by how useful the stock is to you, but rather how useful the stock is, on the margin, to a new buyer. But effects like the above is one reason why dividends have been falling out of favour more and more. The power to defer taxation that most areas grant to capital gains is ridiculously powerful, and there are ways you can pass the value of stock onto stockholders via capital gains rather than traditional methods. __________________ Last edited by JHVH : 10-29-4004 BC at 09:00 PM. Reason: Time for a rest.