Dividends vs. Buybacks & The Great Tax Deferral Debate

0:00Stephen:I think Warren Buffett has done that math. And he's always used that as an argument for why Berkshire Hathaway has never paid the dividend. Because he's like, look, on a tax basis, you're getting a better deal if we buy back the stock. My biggest issue with that whole argument is that what you were saying at the beginning is like when you get a dividend, that's your cash. When you do a buyback, you may or may not ever see that. because if a company does it like 10 years of buybacks and then their stock drops 90 percent well what help did that do this show is sponsored by liquid iv with the days getting longer and warmer i'm spending way more time outside but lately i was hitting a massive afternoon slump i quickly realized that plain water just wasn't cutting it i needed a better hydration i could actually trust to keep me going that's why i rely on liquid iv as an investor i'm a data guy so i love that they have scientific advisory board of world-renowned researchers knowing it's backed by real science gives me peace of mind.

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3:40Stephen:Freedom start now. And welcome back to the Investing for Beginners podcast. My name is Stephen Morris. Across from me is Andrew Sather, formerly known as, is that right? Artist? Yeah, part of the investor formerly known as the Drip King. Today we are going to be talking about the difference between buybacks and dividends. And so I just want to jump straight into it. And Andrew, if a company has a billion dollars in excess cash that they got to hand out to investors, what is the difference between them doing it through a dividend and a buyback? Yeah, great question. Good for a beginner to learn.

4:31Stephen:And then also something we could talk about probably for a long time because there's plenty of debates around all this. but if if we do a dividend basically they're going to take that money and they're just going to divvy it out to shareholders and so you own the stock you're going to get that dividend you'll see it in your brokerage account it'll either reinvest in a drip program or it'll just accumulate in your account what the company does when they buy back stock is they take that money they buy shares of the stock and they retire them and so what that does is it reduces the number of shares outstanding it makes the percentage of the company that everybody else owns higher and what that does is not only reduces the shares outstanding but what that does in effect is it increases the earnings per share it increases the stock price per share because we're all buying stocks and they're all per share right so if they can reduce the number of shares that increases the metrics for everything so you can get stocks like i used dominoes in a previous episode i used to shout out wd-40 a lot because i think that's such a cool example that company is like less than a billion dollars and has earned shareholders something like 15 20 a year for a long time and how how did it earn so much even though the company is still so small from buybacks so buybacks can be a great way to grow your wealth and so can dividends because the dividends can compound so um hey either way a company wants to give me money i am for it i love it and so that kind of bring why i brought up the the the drip king joke um because you used to you formerly were all about the dividend and now you're more on the buyback side um and i think that's that's like a classic philosophical argument of what's better the compounding or the tax deferral but that's besides the point um we'll get to that later i guess um when you started investing if you remember do you remember what it was like like the psychology of it did you feel like a dividend was better because it you saw that money hit your brokerage account versus a buyback where you really don't see anything happen it that's so yeah that is a that is one of the many factors back when i first started um companies actually used to pay dividends which is a weird thing like i don't know where it started become not cool to pay a dividend but it's almost like back in the day you would start paying a dividend the stock market would like it now if you now if you pay a dividend it's like um throwing up your boomer card and saying hey i'm a boomer now i've got not much time left and wall street does not like to see companies that start paying the dividend so it's It's a very different environment.

7:45Stephen:I feel like there's almost a stigma now around dividends because people assume, which is silly because if they're buying back stock, it's the same thing. A company that buys back a lost stock is not considered matured and has no growth left, but a dividend company suddenly is. I don't know. It's just one of those weird things. but there are many benefits to dividends, which I still see as true today. Dividends is more secure. You will very rarely see a company cut their dividend because people are relying on those dividends for income. They buy for the income. When you stop a dividend, it does not do good for the share price.

8:39Stephen:Buybacks can be more discretionary. And so a company might do a bunch of buybacks one year and then no buybacks the next year. So you can't count on that money going back to shareholders like you can when there's a dividend. There's a lot of advantages for dividends, but for whatever reason, Wall Street has not looked kindly on them. And I had a whole, I had a whole, it was like a confession. I was trying to one-up Usher or something. It was this long piece I did, almost like a journal, and I was talking about all my angry feelings. But basically this idea that maybe the ultra-low interest rates have been the big factor into why companies have not been paying the dividend.

9:28And if we see high interest rates in the future that are sustained,

9:33Stephen:that calculus might start changing and you might start to see more dividends. because the reason why one versus the other might be better have several factors to them, interest rates being one of them, but also just what's the overall impact to an investor. And what you said earlier when you asked me that question, when they do a buyback, you don't always see it. And that's so, so true. like if if a company is buying back stock and their stock is so expensive and so they're getting just pebbles of of shares that they're buying back because the stock's so expensive that really is lighting money on fire and investors are not seeing that benefit and so there there is some of that going on for sure but um i don't know he opened up uh he opened up something maybe you shouldn't have because i'll just keep rambling on but i'll stop there for now no i mean why why why would a company opt to pay a dividend versus a buyback like what what do you have any insight into what a company's psyche might be of why they will go one way and versus another?

10:57Stephen:I don't know. I felt like I used to have a decent handle on that, but it really doesn't make sense to me anymore. There's so many great companies out there that might as well pay a dividend because they're buying back so much stock, but they're just not. So I don't know if executive compensation has something to do about it. Like if you and I are comped on earnings per share, then yeah we're going to go buy back or we're going to choose to do a buy back over dividend every single day because the doing a dividend doesn't help our earnings per share but a buyback would so maybe it's maybe some of its incentives maybe some of it's how managers are compensated um i would love to see a return of the dividend because i think it's it's such a cool it creates such a snowball compounding effect that an investor sees in their account that you won't necessarily see it you do see a compounding effect in the stock market but it's not always as um visualized as it is when you see it in your brokerage account so um i don't know does that answer your question i mean yeah i guess but no i was just curious and then um i guess a personal question and you don't have to answer it if you don't want to what what kind of caused you to switch sides i guess if you will is it just because kind of fewer companies started paying dividends or stopped paying dividends um or was there math to it as Well, there's some math to it.

12:42Stephen:I wouldn't say like I hate dividends. I wouldn't say I've like swung to the anti-jerking or anything like that. But I've seen the positive benefits that the dividends can have to all the per share metrics, like we mentioned, the earnings per share, which means the free cash flow per share. so all those things i like to put in my dcf and i put a dividend as well in the dcf but um because i'm buying cheaper stocks you do get a little bit more of a bang for the buck when a company does a buyback versus not like going when costco pays us a dividend and they give us like a special dividend i actually i would prefer that than them buy back shares at like 45 pe so it's all context um context related context specific no that makes total sense um i know like i've mentioned it a couple of times and i don't know if this is part of your math but when you get a dividend you have to pay taxes on it that year um when you get or when when the company issues a buyback you you don't pay it's you don't pay taxes on it until you you sell your stock so i mean have you ever done the math to see which one of those compounds more um or is that just kind of like something so far-fetched i guess i don't even know how to even begin starting to do that that compounding math uh it's a great question i think warren buffett has done that math and he's always used that as an argument for why berkshire hathaway has never paid the dividend because he's like look on a tax basis you're getting a better deal if we buy back the stock.

14:41My biggest issue with that whole argument is that what you were saying at the beginning is

14:48Stephen:like when you get a dividend, that's your cash. When you do a buyback, you may or may not ever see that because if a company does like 10 years of buybacks and then their stock drops 90%, well, what help did that do to me? It all depends on when you sold the stock, but that dividend can never be taken away once it's given to you so it's an it's an interesting thing and i i'm sure buffett probably is he's done the math and he he knows better than i do on this but i guess i'm just trying to be a little more practical in that um the math isn't what plays out in reality these stock prices move so much that we can't just use tax deferral math to justify and not paying the dividend.

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18:46But I guess the same applies with the stock. But I think, tell me if I'm like totally missing the mark here. for me with with with with a buyback the compounding that's happening is is on the basis that costco stays in business for the next 30 years yeah but a dividend is mine today right yeah does that make sense yeah it does yeah and and sometimes companies will go back on

19:24Stephen:like uh dick sporting goods i don't want to beat up on them because i like that stock i have liked it um when the pandemic hit they had to do a convertible debt and so years of buybacks erased because they had to to convertible debt and then they had to restart their buybacks to get back to even so not not to say companies can't make mistakes in general but yeah you can't like to your point it's your money and it's like you earned it right here shareholder you earned it so there's something psychologically there that you don't get with the with the buyback so i agree with you yeah what are some red flags you look for when when it comes to a company's buybacks and or dividends are there any like key red flags um our listeners need to pay attention to to like Like, oh, that's a bad buyback.

20:21Yeah, that's a good question.

20:25Stephen:Something to look at. So for dividends, you can just look at the payout ratio. You can take a simple ratio, like look at dividends per share divided by earnings per share. You can average that out over several years. And if that gets really high, well, that's not much money left for the company to do anything else. the other thing you want to look at is um the debt is um is the debt going higher and you should be looking at that every time you analyze a stock for the first time but are they how are they paying for the buyback or dividend are they getting all this debt added and that's something to look out for um another thing would be just doing a bunch of buybacks to offset stock-based compensation tech companies are especially guilty of this but if they have all these stock options for executives and you know they're just handing out stock options like candy and it's not really helping shareholders they can hide how much they're doing by handing out a bunch of stock options and then doing buybacks but the actual share is outstanding doesn't change much so when you're looking at the cash flow statement seeing, okay, a company's spending 20 billion in buybacks, check that shares outstanding is actually decreasing.

21:49Stephen:And then the last way that that can still get kind of messed up is again, if a company's buying back stock, when the stock's super, super expensive, you'll see it in that metric. Again, the shares outstanding won't move much. That's because they're just, they're overpaying for the stock. So they're setting money on fire. You don't want to see a stock that's super overvalued also buying back stock because if you wouldn't buy the stock at a certain price, why would you want the managers of that company doing it? So those are all different red flags to look for. Yeah, definitely. And the one that came to my mind is what is the value of the stock?

22:31Are they over over buying can you think of an example of when a company's done that i can't think when they're buying their their stock at a premium price versus

22:45Stephen:yeah i think you can just pick any um growth company i just got a snowflake to pop up well because a lot of these growth companies they'll be doing a lot of buybacks because they're they're in the growth mode and they're diluting a lot so they're handing out so many stock options for compensation. But that might not be. So here, I got Snowflake pulled up. I pull up their cash flow statement. They did in 2020. It's okay. 2025, they repurchased 1.9 billion in shares. So they did a buyback of 1.9 billion and their shares outstanding actually went up. So where'd that 1.9 billion go? So from 25 to 26 shares outstanding increased 1.4 % over the year.

23:38Stephen:So again, I asked where did that 1.9 billion go? To me, it's a combination of an expensive stock and they're just handing out too much in stock-based compensation. So it really is a tragedy if investors are not looking at the entire picture and not realizing that's what's happening. Hopefully they're all aware and they trust the long term. but it is a lot of capital destruction and about you know they're making bets on the long term but sometimes those don't work out and it's just money being set on fire yeah yeah we love companies that set money on fire so this might be a dumb question did you know if the sec has any control or regulation over buybacks and dividends?

24:31Stephen:That's a good question. I don't as to say that there's too much you can do or something, I don't think there's limits or there's definitely not minimums or requirements. I think all they care about is are you reporting everything transparently and they're not trying to get too much more hands-on than that. Their big role is just to make sure that investors are being communicated the most pertinent information. And if they're not, then the company should be fined and the shareholders should be compensated. Which I just got a letter in the mail yesterday over a stock I used to own. And I was kind of doing that.

25:12Stephen:I was saying the company was not disclosing everything that they should have. So there's a$1.6 million settlement for shareholders. if you bought and sold at a certain price which i did not so unfortunately i made money on the stock like this sucks because i can't get a claim on the class action yeah but that class action you're gonna get like 20 bucks maybe right yeah you probably came out ahead so i guess i guess my my my last question well actually no not my last question my last or second to last question have you ever seen a company do both a dividend and a buyback yeah a bunch of them in my portfolio our portfolio alphabet apple apple's a nice one microsoft tick sporting goods um yeah lots of lots of them and that's some sweet like I don't want to do the math because it's like the story's not over yet but one day you know 15 years from now we'll do the math and be like man that was sweet we were getting snowball on snowball right that's awesome I love it so my second to last question is um or no that was my continuing on my last question for you around this i guess is uh if you could only pick one for the rest of your life gun to your head like you can either have a dividend or a buyback yeah yeah which one you going i'd have to say a dividend because like yeah like all the things we were saying the the dream for me the dream is to have a stock portfolio where you can live off the dividends that's kind of like, I know there's a blog, he called it living off dividends, but that's kind of like the big dream a lot of dividend investors have.

27:12Stephen:And I think it sounds awesome. Being in retirement, having a portfolio where your money's still going up because those stocks are still growing, but you're able to live off the income just from the dividends. And yes, Warren Buffett would argue you can sell stock in an equal amount to the buybacks that are being done, but that's just not practical and it's not because we've all seen how the stock market's so volatile so do you really want to be selling at the worst time when i could have just had like this stable dividend income instead so i don't know that's where i stand hopefully some of that dividend versus buyback conversation was helpful obviously we could talk on and on and on about it and people do and uh more power to them but we're gonna pull up some companies that have some interesting dividend growth rate and also buyback growth rate.

28:04Stephen:So I pulled up on Fiscal, a stock screener, and there are some names on the stock screener that kind of surprised me. Maybe some names that don't surprise us. So did you know Ford has 32 % a year dividend increase over the last five years? No. I don't know. Where does that money come from? maybe that's one of those red flags let's look real quick i'll pull them up and see if they have like crazy debt story going on you know it's funny my dad listened to the podcast he's like you know i love you guys podcast but you don't have to bang on ford all the time

28:51Stephen:sorry pops right um okay so from 2022 to 2025 they've had net debt to EBITDA go from 6.8 to 9.4 so that's debt related to EBITDA our favorite metric um 50 higher so that's that's quite a bit that's a lot um i think maybe that's part of the answer is they're they're borrowing a lot um they borrowed 57 billion in 2024 now they're paying off some of it too at the same time but yeah it's a lot of a lot of debt happening maybe they did buy i don't know maybe they did buybacks i don't know so there let's move on from bashing ford uh progressive corporations on there uh 23 a year over the last five years that's been a nice investment uh if you've been following us nvidia is on here did you know nvidia pays a dividend yeah they just okay they do buybacks and they just started a dividend did they not one way or they've had they've had yeah i think maybe they just started buybacks and they've had like a tiny dividend for a while um are you feeling fomo on nvidia yet no we've talked about that man i missed the ship oh well i'll catch the next one oracle's on here interestingly they've done 16 a year so i'd be curious how that slows down for them with all the havoc that's been going on at oracle yeah oracle is in in hot water um yes to put it politically correctly i guess um okay now looking at buybacks companies who've reduced the most amount of shares over the last five years the biggest company i'm running this for companies 10 billion or higher is marathon petroleum corporation uh they've reduced shares by almost 15 a year over five years are you familiar with them by the way i am not but that seems like it's really high it's crazy what they've done um over the last five years their stock's gone from about 55 to 200 almost 250 dollars a share and they do like refining so um yeah they're just a refi i guess that's their big thing is refining the oil and stuff um just crazy i saw them the other day and i was like man i remembered in the middle of covid them being one of the dogs you know uh 2020, everybody thought nobody would drive ever again.

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34:18Stephen:Join the hundreds of thousands who've already streamlined their finances with Found. AutoZone, obviously a big buybacks. There's so many companies actually that buy back a lot of stock um it's all names that you would you would understand too like lowe's obviously um booking holdings paypal o'reilly marriott lockheed martin hilton bank of america morgan stanley adobe northrop grumman caterpillar like these are all american names you know and they're all over the last five years have been reducing their their share count by 3 % or more a year every year. So it's a great time to be a U.S. investor, I would say.

35:01Stephen:There's lots of companies raising their dividends, lots of companies buying back stock. And don't underestimate how much that can compound over the long term. We didn't do the math on this episode, but that could be a fun exercise, just how much wealth it generates for people over the long term. i hadn't heard um warren buffett's take on it but i mean it makes sense but at the same time like you said it how practical is it actually going to be in the long run um but i mean he's the billionaire so i mean yeah that is true you can never argue that i think i think caterpillar is a really interesting company we should do like a bird's eye view one day of caterpillar because they got some really cool ev stuff happening um yeah it's uh you know you're talking about a 30 000 pound machine that's fully electric like we yeah they got some really cool stuff um i'm not sure how like in the market it is right now but uh my dad dad that's the work my dad did for he was in the mining trade and so i know all about like the what you know caterpillar and mining and front end loaders and all that stuff anyway um yeah we might we might have to look into that because i'm really interested into how they're doing and what's going on with them their stock is has tripled over the last five years so there you're doing something right so all right awesome so what what's the key takeaway you think for for our listeners today andrew what what what one thing do you hope uh you drove home I hope this is somehow it came across that dividends and buybacks are important and they're a big part of compounding and they're not as flashy as a company growing you know a hundred X because they just created the greatest thing since Nvidia's GPUs but it's just a more reliable a more common way to build wealth and there's so many companies that can make really great returns for you and it doesn't you don't have to find the next invidia and so buybacks and dividends are a great tool for making those returns for you well so like we're looking at ford and we're not saying ford is a bad company to invest in um necessarily what but you're looking at ford and you see they're doing all these things what would your strategy be to figure out whether or not their buybacks and or dividends are justified sustainable for the long term because that's important too right because if they can't sustain these buybacks for the long term like so we got some great buybacks for two years but we didn't get a buyback for the next eight that was pretty much useless right so So what's your strategy for figuring out how sustainable it is?