A firm with cash beyond its positive-NPV projects should return it to shareholders.
Four dates matter: the declaration date (board announces), the ex-dividend date (buyers on or after this date do not receive the dividend), the record date (the list of shareholders is fixed) and the payment date. With one-day settlement in Canada and the US, the ex-dividend date is normally the same day as the record date. On the ex-date the share price falls by roughly the dividend. Dividends can be regular, special (one-time) or reinvested through a dividend reinvestment plan (DRIP).
The firm buys its own shares, on the open market over time, through a fixed-price or Dutch-auction tender offer, or by private agreement. Fewer shares remain, so each owns a larger slice.
In a perfect market, payout policy does not change value. A shareholder who wants cash can sell shares; one who does not can reinvest dividends. What matters is the firm's investment policy.
A firm earns 100 with 50 shares: EPS is $2.00. At a price of $40 it spends 200 of idle cash to buy back 5 shares. EPS becomes 100 / 45 = $2.22. EPS rose 11% but the firm is worth 200 less, so in theory the price per share is unchanged. A buyback creates value for remaining shareholders only when shares are bought below intrinsic value. EPS growth from buybacks is not business growth.
Dividend yield = dividend per share / price. Payout ratio = dividends / net income. Total shareholder yield = (dividends + net buybacks) / market capitalization. Sustainable growth rate = ROE x retention ratio: a firm with 15% ROE paying out 40% can grow equity at 15% x 60% = 9% without new financing.
These create more shares without changing total value. A 2-for-1 split halves the price and doubles the count.
John Lintner's interviews in the 1950s, confirmed by later surveys, found that managers have a target payout ratio and move toward it slowly:
With a target payout of 50%, a speed of 0.3, EPS rising to $2.40 and a last dividend of $1.00: the target dividend is $1.20, and the increase is 0.3 x 0.20 = $0.06, giving $1.06. This smoothing is why dividends move far less than earnings.
A company's shares are worth $30 each on a careful valuation, and it has 100 shares, so intrinsic equity is 3,000. The market price is $40. Management spends 400 buying back 10 shares.
The buyback transferred value from the shareholders who stayed to those who sold. Had the price been $20, the same logic would raise intrinsic value per share for those who stayed. Buybacks are a good use of cash only when shares are cheap.
Suppose an investor pays 30% tax on dividends and 20% on capital gains (both illustrative). A dividend of 100 leaves 70 after tax. If instead the company buys back 100 of shares and the investor sells shares with a cost base of 60, only the gain of 40 is taxed: tax 8, keeping 92. Investors who do not sell pay nothing now. This advantage is why buybacks have grown, and why both Canada and the US now levy a small tax on them at the company level.
Compare total payouts (dividends plus buybacks) with free cash flow, not just with net income. A company paying 150 of dividends and 100 of buybacks from 200 of free cash flow is returning 125% of what it generates and must be borrowing or running down cash to do it.
A DRIP reinvests dividends in new shares, sometimes at a small discount (often 2% to 3% for Canadian issuers that offer one). For the company, a DRIP that issues new shares is a quiet equity raise. Taxable investors still owe tax on the dividend even though no cash reaches them.
A one-time special dividend returns surplus cash without committing to a higher regular payout. A return of capital is not taxed as a dividend when received but reduces the investor's cost base.
In Canada, open-market buybacks on the TSX run under a normal course issuer bid (NCIB) with annual limits, and larger tenders are substantial issuer bids. Eligible dividends from Canadian corporations receive the gross-up and dividend tax credit in taxable accounts. Both countries now levy a tax on corporate share repurchases (2% of net repurchases in Canada, 1% in the US, as of 2026). US qualified dividends are taxed at preferential long-term capital gains rates.
For a company you follow, compute five years of dividend yield, payout ratio, buybacks as a percentage of market capitalization and the change in diluted share count. Did buybacks actually reduce the share count, or only offset stock-based compensation?
Educational content only; not investment, tax or legal advice. Companies, tickers and figures are illustrative examples, not recommendations. Rules, rates and limits change, so check current details with the regulator, exchange or tax authority before relying on them. Worked examples are not forecasts. Written by Elizabeta Dimoska. RiskStock is not a registered dealer or adviser.