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Three Reasons to Prefer Dividends Over Buybacks
06/15/07 - 11:53 AM EDT
The rate of share repurchases is growing at a torrid pace. S&P 500 Index companies bought back a stunning $432 billion in shares in 2006 -- almost 59% of reported earnings and up from 45% in 2005. This is huge. Furthermore, these repurchases increased earnings about 4%, going a long way to explain the S&P's double-digit growth rates. So is this a good thing for The Millionaire Zone investors? Or if big companies have so much cash to throw around, would you be better off if they paid you a dividend instead? Let's take a closer look.
- A bird in the hand. As the adage goes, it's better than two elsewhere. Cash is cash, and when you receive a dividend, you don't rely on the so-called market mechanism to deliver value. Better yet, a dividend is like an ongoing commitment to continue paying cash to investors. A stated payout isn't a contractual commitment, but especially for investment-grade corporations, it isn't likely to be retracted anytime soon. And tax implications follow the "bird in hand" theory. Dividends are taxed at a rate not exceeding 15% even for AMT, while a capital gain -- from a share price increase tied to a buyback -- may be taxed at ordinary rates if the stock is sold within a year. And if you wait more than a year, who knows what the tax law will be? So the dividend, at least for now, locks in the lower rate.
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