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ETF Specialist

Buy in to Buybacks

Dividends aren't the only way that firms return capital to shareholders.

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There are about 30 exchange-traded funds focused on dividend-paying stocks, but only two focused on stocks that buy back their own shares. While academics might claim that investors should be indifferent between stocks that pay a dividend and those that buy back shares, fund providers know that investors like the allure of dividend funds. But there is good reason to pay attention to firms that reduce their shares outstanding.

Firms have three choices to deploy excess cash: invest back into the business, distribute the cash as a dividend, or buy back shares. Expected returns among the three options should be the same, at least according to the of Modigliani-Miller dividend irrelevance theorem. But that theory holds only under some strict assumptions, chiefly that firm managers will be good stewards of shareholder capital and will invest only in projects that earn rates of return at least as high as the firm's cost of capital.

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Michael Rawson does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.