Question

What are the advantages and disadvantages of stock repurchases relative to traditional dividend payments?

Answer 1

Share buyback or share repurchase is an action to buy back shares from the shareholders. There are two parties involved in this transaction.

1) Company. 2) Shareholder

Advantage- The share buyback is flexible in nature. The share repurchase program is conducted for an extended period of time; unlike cash dividend whiy need to be immediately.

Tax benefits- Some countries have lower Capital gain tax rate compared to Dividend tax rate. The share buyback will be taxed under capital gain tax category.

Share buyback is generally a positive signal because company perceives shares to be undervalued and it has confido in its growth prospects.

Disadvantage

Share buyback boosta some ratios like; EPS, ROA,ROE etc. This increase in ratios is not because of the increase in profitability but due to a decrease in outstanding shares. It is not an organic growth in profit.Hence the buyback will show an optimistic picture which is away from the economic reality of the company.

Though management had better access to information of the company there are chances that they also can make mistakes about valuing the company.