When investors consider the benefits of investing in a stock, they usually only consider the basic level of capital appreciation and dividend payouts. After all, this is what is largely covered in the mainstream financial media and what is talked about at the proverbial cocktail parties, with people bragging about their dividend yield or how much their stock just went up.
However, there’s a less common third option that allows investors to compound their capital more effectively while benefiting from a more efficient tax structure. This way isn’t often discussed in the media or social settings, as most investors don’t truly understand its benefits. Stock buybacks are the hidden gem of wealth compounding that Warren Buffett is very fond of in his very own company.
This is why investors will see through stocks like Berkshire Hathaway (NYSE:BRKb), AutoZone (NYSE:AZO), and even Domino’s Pizza (NYSE:DPZ) the real-time benefits of owning stock in a company that actively buys back its shares rather than paying a dividend to its shareholders. But before getting into it, here’s why buybacks are better than dividends.
Stock Buybacks vs. Dividends: Which Is Best?
Well, it depends. If an investor has already accumulated enough wealth so that earning dividends makes more sense, then, of course, dividends win. However, most investors are in the market to see their wealth grow, and that’s where stock buybacks take the cake.
First, they’re tax-friendly. When companies pay dividends, they do so through capital that has already been taxed, and then investors need to pay double tax on that income. The implication is that this capital is leaving the company, indirectly eroding enterprise value and potential returns where that capital is to be invested.
Buybacks are only taxed once. They retain capital within the company and, therefore, its enterprise value. They also generate returns by tapping into the company’s underlying return on invested capital (ROIC) rates. For wealth compounding, choose buybacks over dividends.
Warren Buffett’s Berkshire Hathaway: The Prime Example
As large as Berkshire Hathaway became in the financial sector, with a nearly $1 trillion market capitalization, it pays no dividends. Warren Buffett has stated that if he ever were to return excess cash to shareholders, he’d do it by buying back Berkshire stock at valuations he believes to be under intrinsic value; otherwise, that cash would go to treasury bonds.
The effects can be noticed right away in the stock’s performance. The S&P 500 has delivered a 367% performance since 2000, while Berkshire Hathaway stock has more than doubled this rate at 766%, all through owning mostly low-beta stocks that should—in theory—perform at or just below the S&P 500.
So why the outperformance? Stock buybacks have allowed capital to stay within the company and compound at an ROIC rate of up to 15.2%, according to the company financials. That’s nearly double the 8% average annual return for the S&P 500, which makes sense to see Berkshire double the index’s performance.
AutoZone Stock’s Chart Builds a Case for Buybacks
Now, here’s an interesting way to look at stock buybacks and their benefits: While the S&P 500 has run 367% since 2000, AutoZone stock delivered a massive 12,270% return to shareholders. Here’s how the stock did it and how investors can use this information to find their next wealth compounder.
By consistently buying back stock, AutoZone tapped millions of dollars in capital into its ROIC rates of up to 39.7% as of the past 12 months. This means the stock compounds on itself like no other in the peer group or the market, which explains the massive outperformance seen in the chart.
More than that, analysts still think it can push for higher prices despite its massive runs; those at Citigroup (NYSE:C) reiterated AutoZone stock as a Buy as of December 2024, placing a $3,900 price target on it to call for up to 16% upside from today’s prices.
Domino’s Pizza: A Buffett Buy and Buybacks Compounder
Recent 13-F filings show that Warren Buffett initiated a position in Domino’s Pizza stock, another example for investors to reiterate the fact that companies that buy back stock tend to attract the best of capital. Again, since its IPO in 2005, Domino’s Pizza stock delivered a massive run of 3,470% to tenfold the S&P 500’s returns.
This can be attributed to consistent buyback programs, which tap into the company’s ROIC pace of over 61% as of the past 12 months. This is probably also why Buffett felt so keen on buying some for his company. This compound effect has also spread to Wall Street, judging by what some analysts see.
Those at Loop Capital now have a Buy rating in Domino’s Pizza stock, where they previously held a Hold view, this time also placing a $559 price target on the company to call for as much as 23.3% upside from where it trades today.