Dividend income is what most of income investors focus on. There is no doubt that dividends are the most powerful tool to grow your income and that they perform better than many asset classes.
But one other variable that determines your overall yield on an investment is share-buyback plans. Just like dividends, share buybacks return cash to you. Let’s find out what share buybacks are and how they help investors to earn more cash.
Share buybacks
Share buybacks are a simple way many companies reduce the number of outstanding shares. The issuing company pays shareholders a pre-determined value of the shares and removes that portion of the public ownership.
There can be many reasons for a company to repurchase its shares, such as reducing the overall cost of capital, or signaling to investors that its shares are undervalued.
Many companies take advantage of a situation when they feel their shares are trading below their realistic value due to some short-term negative factors.
How do share buybacks increase your yield?
As I discussed earlier, companies can return cash in many ways. Paying regular dividends is the most common one. But returning cash through share buybacks is another powerful tool to pay back cash to investors.
With a share buyback, the value of your holdings improves, as there will be a fewer number of shares outstanding and a higher proportion of earnings being distributed among a fewer number of shareholders. The company concentrates on its shareholder value rather than diluting it.
Company ABC, for example, has a market value of $100 million, and it pays $5 million per year in dividends, giving it a 5% yield. It the ABC decides to buy back $5 million worth of shares, technically its total yield rises to 10%.
In Canada, Magna International Inc. (TSX:MG)(NYSE:MGA) and Canadian Imperial Bank of Commerce (TSX:CM)(NYSE:CM) are among the top names that have bought back shares during recent years.
Magna, a global car parts maker with the market capitalization of $23.6 billion, announced plans this year to re-purchase up to 1,500,000 common shares. The timing of the move was probably right for the company, as its stock price was depressed in March; it’s started to recover since then.
Onex Corporation (TSX:ONEX) is another company which undertakes an aggressive buyback plan. The company had 111.5 million shares outstanding by the end of 2013. By the end of last year, shares fell to 102.9 million.
The bottom line
Considering the companies with active buyback plans should also be the part of your dividend income strategy. When you see an announcement of a share re-purchase, you should analyze why is this happening and how will you benefit from this move.
