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By Matthew Coffina, CFA | 02-11-2015 04:00 PM

Why Dividends Trump Buybacks

Though both are preferable to accumulating cash, paying dividends is a better method for preserving shareholder value, says Morningstar's Matt Coffina.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Many management teams have been focusing on share repurchases versus dividends in recent years. I'm here with Matt Coffina--he's the editor of Morningstar StockInvestor newsletter--to hear how he thinks about the differences between the two. Matt, thanks for joining me.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: So, how should investors think about dividends versus share buybacks? Are they really equivalent? Are they both creating value, or do you prefer one over the other?

Coffina: In theory, there shouldn't be a difference between share repurchases and dividends; but in practice, I don't think the theory really holds up. What we see is that companies tend to be much more aggressive with share repurchases at exactly the wrong time. It's when the business environment is favorable and the companies are feeling flush with cash. They have a lot of excess cash on hand, and they're repurchasing their stocks at relatively high stock prices. And then they tend to cut back on share repurchases at exactly the wrong time--when the market takes a turn for the worse or the economy takes a turn for the worse--and their shares could be acquired at better terms. That's when they tend to be not repurchasing shares.

So, we're seeing a great example of this in the energy sector right now. A lot of energy companies, particularly the larger oil majors, have been aggressively repurchasing stock over the past five years. Now, energy prices have taken a tumble, everyone's trying to preserve cash, and share buybacks are really the first thing to go. You'd really rather see those companies accelerating their share repurchases now, when their share prices are lower; but exactly the opposite is taking place.

For that reason, I tend to prefer dividends. As my colleague Josh Peters over at Morningstar DividendInvestor likes to say, dividends are always worth 100 cents on the dollar. It's not possible for a company to destroy value by returning cash directly to shareholders. And so, that's usually the preferred method in my view.

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