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I read an article about share buybacks.

Tax Benefit In many ways, a buyback is similar to a dividend because the company is distributing money to shareholders. Traditionally, a major advantage that buybacks had over dividends was that they were taxed at the lower capital-gains tax rate, whereas dividends are taxed at ordinary income tax rates.

What does this mean?

It that means when company buyback their stock, the stock price will definitely go up?

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    stock price is a function of supply and demand, if you reduce supply without changing demand then clearly the price will go up. – MD-Tech Nov 22 '17 at 9:23
  • I'm always a bit suspicious of a company that believes that the best use of $50 million is to buy its own stock when it could use the money to develop a new product, build a new factory, automate an existing factory, etc. It seems to me that the stock buyback is a short-term tactic and that the best companies invest in the long-term. – chili555 Nov 22 '17 at 14:58
  • the answer of course is "it all depends" and is completely situation specific. Sometimes, stock buy backs attract more capital, directly from the stock market and indirectly from outside investors. That is up to the company's board to decide the best course of action for that particular company. – rocketman Nov 22 '17 at 18:08
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They are similar in the sense that they are transferring money from the company to shareholders, but that's about it. There is different tax treatment, yes, but that's because they are fundamentally different.

Dividends transfer money equally to all shareholders, but that also reduces the value of each share by the same amount, since it's cash out the door, which drops the value of the company. Shareholders are taxed on dividends at the capital gains tax rate.

A buyback returns the cash to shareholders who decide to sell. Other shareholders get a secondary benefit of now owning a slightly larger portion of the company since there are fewer shares outstanding. Shareholders only pay tax if they sell shares for a gain.

It that means when company buyback their stock, the stock price will definitely go up?

Not necessarily. It depends on the price that the company buys back the shares for and what the "opportunity cost" of that cash is - meaning what else could the company have done with the cash that would have been better?

Buybacks often happen in mature companies with undervalued stock prices and fewer opportunities for further investment. If a company has an intrinsic value of $10 a share but its stock is trading at $8 a share, then it can instantly get a 25% "return" by buying back stock. I use the term "return" loosely since the company does not actually profit from the buyback, but from the shareholder's perspective the company is worth more per share.

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  • The other obvious difference is that after a dividend, you still have the stock, and can get more dividends later, or sell it later. If you sell your stock in a buyback, you no longer own it and can't receive any future benefits from it. – BrenBarn Nov 23 '17 at 0:27

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