By Jonnelle Marte
Now that companies are recording profits again, the question becomes: What should they do with this newfound free cash?
Yes, they could reinvest in the company, but shareholders often push for stock buybacks, which raise the value of the outstanding shares, or higher dividend payments. Companies have increased their offerings of both as the economy’s started to recover: Among members of the S&P 500, repurchases jumped 128% over the past year, and dividend payments rose 9%.
From a tax standpoint, repurchases might appear to be the better news because they’re not taxable to investors. But dividends might actually be the better bet. For one thing, they’re more reliable. Share buybacks fell 61% between the third quarter of 2008 and the third quarter of 2009, while dividends underlying the S&P 500 index fell 23% in the same period.
And even though dividends are taxed, the recent tax law has made them more appealing. For the next two years, taxes on dividends will be capped at 15%. Without an extension, the dividend tax would have reverted to rates as high as 39.6% beginning in 2011.
Another bonus: Now that the tax break on dividends has been extended, shareholders are more likely to get them, as companies with hoards of cash might feel more comfortable boosting payments. (Pfizer, General Electric and Weyerhaeuser are among companies that have announced large dividend increases since the tax deal was unveiled.)
And companies don’t always buy back stock in a smart way. Companies that bought shares frequently before the recession but stopped buying during it were essentially buying high and panicking low–an investment no-no.
It raises the question of what investors find more rewarding — unpredictable but untaxed stock buybacks, or steady but taxed dividend payouts? Readers, what do do you prefer?