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Why some companies prefer dividends and some prefer buybacks - two-minute explainer

Companies often buy back shares even whether the price is high or low, which most investors would view as not the most effective use of cash

Microsoft Corporation -

Three of the largest and most dominant tech companies in the world have never paid a dividend, but Microsoft Corporation (NASDAQ:MSFT) last night increased dividends for the 12th year in a row as well as unveiling a gigantic share buyback.

So if this trillion-dollar tech titan can do it, why do others like Amazon, Alphabet and Facebook not?

READ: Microsoft unveils giant share buyback on top of annual dividend hike

One reason companies and their executives like buybacks is that they increase earnings per share, by the simple method of reducing the number of shares.

Some well-known companies on both sides of the Atlantic have employed them while their profits were falling.

They are easy for companies to start and stop as their levels of cash wax and wane, rather than having to announce an embarrassing dividend cut or pressing pause, often rebranded a ‘rebasing’ of the payout.

But for investors, the record of buybacks supporting share prices is not the best.

Part of the reason is that companies often buy back shares even whether the price is high or low, which most investors would see as not the most effective use of cash.

Some investors in growing companies, however, might not want to see companies employ cash on shareholders but rather plough it all back into the company for more capital growth.

Although, as JPMorgan Chase boss Jamie Dimon put it earlier this year, and might also be said for Amazon and co, they do it “because our cup runneth over”.

But as legendary investor Warren Buffett and his sidekick Charlie Munger, have argued many times, a bulging balance sheet should not be the only reason: “Charlie and I favour repurchases when two conditions are met: first, a company has ample funds to take care of the operational liquidity and needs of its business; second, its stock is selling at a material discount to the company's intrinsic business value, conservatively calculated.

“The second of those is often wilfully ignored.”

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