Daily Gains Letter

Three Ways to Have a Company Return Its Wealth to You

By for Daily Gains Letter |

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When it comes to the stock market, there are three ways a profitable, publicly traded company can reward its investors: 1) pay a dividend; 2) initiate a share buyback plan; or 3) invest it back into the company. All three of these are aimed at building shareholder wealth, though some are more popular than others.

1. Dividends

Investors looking for capital gains and an income stream in today’s economic climate can’t go wrong with fundamentally strong companies with a good history of paying out quarterly or monthly dividends.

In light of low interest rates, many dividend-yielding stocks outperform the historical avenues for investment income. Most banks begrudgingly doll out just 0.5% interest, while 30-year Treasuries come in near a mere three percent.

Investors hoping to maintain a comfortable retirement need to find better income streams—and for many, it’s in high-yield dividend stocks. Consumer goods company Altria Group Inc.’s (NYSE/MO) share price is up almost 200% since the beginning of 2009, and it currently provides an annual dividend of 5.1%. And business equipment provider Pitney Bowes Inc. (NYSE/PBI) provides an annual dividend of 10.1% and is up 35.5% since the beginning of 2013.

Getting quarterly checks from a company for simply being an investor is a great way to generate additional income. But are there any downsides? Cutting or eliminating a dividend can significantly impact a company’s share price. Paying out dividends decreases the amount of money a company has, meaning it may not be able to operate as efficiently if an unforeseen situation arises—like one did in 2008, when the markets crashed. Companies that didn’t have enough cash to operate then fell to the wayside, taking unwary investors along for the ride.

2. Share Buyback Plans

Less popular with dividend-obsessed investors are those companies that initiate share buyback plans. While both dividends and share buyback plans are great ways to channel money back to investors—they don’t have quite the same appeal.

Using cash to buy back a set number of shares shrinks the number of outstanding shares. This means that each shareholder now owns a larger piece of the company—which also means that earnings are shared by fewer people.

With share buyback plans, it’s all about timing. Companies that initiate share repurchase programs often do so because they believe the share price is undervalued. A buyback can signal a rising share price.

There can be dangers with a buyback. Troubles arise when management decides to buy back shares when they’re overvalued, in effect, wasting money and shareholder value. Share repurchase programs also have the effect of manipulating earnings. Fewer shares increase the earnings per share even when the earnings are the same.

3. Keeping Cash

With many companies sitting on hoards of cash, many investors are looking for them to put the cash to work, as either increased dividend payments or more aggressive share buybacks.

Sometimes, share buybacks and dividends aren’t the best use of corporate profits. When it comes to making money and rewarding shareholders, reinvesting it may be the best way to go.

In his 2012 annual letter to shareholders, Warren Buffett said, “a company’s management should first examine reinvestment possibilities offered by its current business—projects to become more efficient, expand territorially, extend and improve product lines or to otherwise widen the economic moat separating the company from its competitors.” (Source: “Berkshire Hathaway Inc. 2012 Annual Letter to Shareholders,” Berkshire Hathaway, Inc. web site, March 1, 2013, last accessed April 8, 2013.)

While it might be nice to receive a monthly or quarterly dividend check, it’s still possible to make money by selling a portion of your shares each year. If the share price increases on the heels of acquisitions and improved product lines, you can maintain the principal amount and sell any gains above that mark.

There are many ways a company can financially reward its investors. You just have to decide which one best fits your wealth management strategy.

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