Dividends are generally preferred by those shareholders who require a steady cash flow. However, they are generally subject to tax in the year in which they are paid by the company. With share repurchases, on the other hand, shareholders can generally defer paying tax on their capital gain until the sale of the shares has been concluded.

The need for a company to have sufficient cash to distribute dividends at regular intervals tends to encourage a fairly conservative approach to capitalisation. Companies that are already paying a high regular dividend are likely to distribute excess cash to shareholders via a ‘special dividend’, which does not have a prescribed pay-out date and might be infrequent. Dividends are a mechanism whereby profits are returned to all shareholders, whether they need the money or not. With share repurchasing, however, shareholders decide whether or not they wish to participate in the arrangement by accepting or rejecting the company’s share repurchase offer. In other words, they are self-selected.

‘Not only is share repurchasing generally a more tax-efficient method of rewarding shareholders, it can also positively impact earnings per share and the share price.’

One of the advantages of share repurchases is that by reducing the number of shares in the market, the earnings per share (EPS) improve, thus sending a positive message about the company’s profitability. This may boost the share price in the long run. On the flip side, share repurchasing could signal a dearth of profitable investment opportunities or suggest that the company lacks confidence in its short-term financial prospects.

The concept of a dividend is fairly straightforward, with two main types: the regular dividend and the less frequent ‘special dividend’. Share repurchasing has more variations. The most common and most cost-effective share repurchase approach is for the company to purchase shares in the ‘open market’ at the prevailing market price. This affords the company much flexibility because it can go into the market at a convenient time. Another option is to make an offer to shareholders to purchase a fixed number of shares at a fixed price (which is usually above the current market price). There is also the self-tender approach, which is similar to the fixed-price offer, except the company specifies an acceptable price range within which shareholders can indicate their willingness to sell. Finally, a company can approach specific shareholders directly and extend an offer to them exclusively to purchase their shares.

In South Africa, the two types of share repurchase are general or ‘open market’ purchases and ‘specific’ purchases, the latter comprising pro-rata fixed-price offers and specific offers directed at targeted entities.

‘Concerns have been expressed that companies seem to be focusing on the short-term benefits of share price manipulation at the expense of the longer-term benefits to be derived from a carefully conceived investment strategy.’