The general idea of any business is to provide goods or services to customers in exchange for money.
But when companies generate more cash than they need to run the business, they face an important decision – what to do with the surplus. They can reinvest it to expand operations, pay down debt, build up a buffer for when times are tougher – or they can return it to shareholders.
And for many investors, how a company chooses to hand back that cash matters.
Businesses have two main options – dividends and share buybacks. Both aim to reward investors, but they work in different ways and can send different signals about a company’s confidence, financial strength and growth prospects.
Understanding why companies choose one or the other, or even a mix of both can help investors judge the outlook for a business. But how can it help you understand which is most suitable for your goals?
This article isn’t personal advice. If you’re not sure an investment is right for you, seek advice. Investments and any income from them will rise and fall in value, so you could get back less than you invest. Ratios also shouldn’t be looked at on their own.
Investing in an individual company isn’t right for everyone because if that company fails, you could lose your whole investment. If you cannot afford this, investing in a single company might not be right for you. You should make sure you understand the companies you’re investing in and their specific risks. You should also make sure any shares you own are part of a diversified portfolio.
What do dividends mean to investors?
Dividends are cash payments to shareholders and are usually paid annually, semi-annually, or quarterly, depending on the company.
If you hold shares in a company with a track record of paying dividends, it could be a steady source of income. But keep in mind that dividends are at the board’s discretion, and typically rely on shareholder approval, so there are no guarantees and the amounts will vary.
If income is what you’re looking for, you’ll want to look at a company’s forward dividend yield. That’s the expected annual dividend payment as a percentage of its current share price.
There are also a few things dividends can tell you about a company.
Companies rarely start making payments without being confident they can continue to pay the dividend for the long term. So, they’re typically paid by mature, cash-generative businesses. A consistent or growing dividend can signal confidence in future cash flows.
Boards are typically reluctant to cut dividend payouts unless they’re under pressure, as many companies were during the pandemic. This is because a reduction in dividend payments can weigh on investor sentiment and the share price.
An investment idea for dividends
Legal & General (L&G) is an insurance and investment juggernaut, with operations in pretty much every service within those buckets.
Dividend income is a key draw for investment, with L&G sporting an attractive forward dividend yield of 8.2%. Of the roughly £10.1bn of excess cash returned to shareholders over the last decade, more than 98% of that total has come via dividend payments.
The balance sheet is in great shape, giving the group the financial flexibility to complete £0.2bn of share buybacks in 2024, and that looks set to rise to around half a billion for 2025. And we’re expecting that figure to climb closer to £1.2bn in 2026, supported by the £1.8bn sale of its US protection business. But as always, shareholder returns are variable and never guaranteed.
Business performance has largely been positive lately. Growth in its retail and institutional divisions helped offset some slight weakness in asset management. Alongside major streamlining efforts, that’s been enough to keep operating profits moving in the right direction, up 6% to £859mn at the half-year mark.
Pension risk transfers are key to operations. This is where L&G takes on responsibility for paying some or all of the pensions from a company’s final salary pension scheme (often called bulk annuities).
In return, the group gets a lump sum which it invests today. The goal is to earn a higher return on investments than the cost of future pension payouts and operating costs.
L&G’s different operating divisions complement each other well, giving it a solid chance of winning new business, benefiting from scale, and ultimately meeting this goal.
With the mature UK market as its biggest region, L&G is setting sights on growth further afield. Its new US partnership could unlock major value down the line, but there's a lot of work to be done before we really start seeing those benefits.
The valuation is in line with peers, which looks attractive to us given the number of strings to L&G’s bow, and shareholder return plans. Increasing overseas exposure looks like the obvious route to growth, but there are execution risks that come with it.
What do share buybacks mean to investors?
A share buyback is when a company uses excess cash to repurchase its own shares, typically reducing the number available on the open market.
When companies do this, you’ll still own the same number of shares as before. But because there are now fewer overall, your shares make up a bigger stake in the company.
This means that you have a larger claim on future profits (provided there are any), which can push up the value of your shares. As a result, companies undertaking relatively large buyback programmes are arguably better suited to investors looking for capital appreciation.
They are also a more flexible way of returning cash to shareholders. Pausing or not announcing a new share buyback programme isn’t viewed as negatively by the market as pausing or cutting dividend payments.
Ideally, share buybacks will occur when management believes its shares are undervalued. These executives are arguably best placed to know the value of their company’s own shares. Buying back shares when they’re trading below their true value is like buying a pound for 90 pence. And when this happens, it’s the shareholders that benefit.
Of course, identifying the true value is never easy.
There’s always a danger that management could buy back shares at the wrong time, at a price above their true value (like buying a pound for £1.10), which would negatively impact shareholders.
Some people also argue that high levels of share buybacks signal a shortage of investment opportunities. As a result, investors should assess each company to determine whether share buybacks reflect confidence and smart capital discipline, or subdued growth expectations.
An investment idea for share buybacks
With one in five people globally owning an iPhone in 2025, Apple is a name that needs little introduction. A large part of this success is down to the group’s ecosystem of products and services, which are purpose-built to complement each other, providing a seamless experience for users.
While its reputation for great products is well-known, it’s also developed a lesser-known reputation for share buybacks. Over the last 10 years, the group’s returned around $850bn to shareholders through dividends and share buybacks, with the latter accounting for nearly 85%.
Some critics argue that these mammoth amounts of cash could have been put to better use, perhaps improving its own artificial intelligence (AI) offering, given Apple Intelligence was a country mile from the experience users were promised.
And there’s no getting around it – Apple dropped the ball on AI, and it’s unlikely to ever be a frontier model builder. But we don’t think Apple needs to own the AI layer to offer a strong product. Given that it has the hardware in consumers’ hands, partnering with Google to integrate Gemini alongside its own AI models is a best-of-both approach.
We’re cautiously optimistic that this strategy will be enough to convince users to keep upgrading to the latest model, and recent demand for the iPhone 17 has been strong. That should also support continued growth in its higher-margin services segment, areas like the App Store and Apple Music.
Skyrocketing memory prices look like the biggest near-term headwind, which could add around 15% to the cost of the upcoming iPhone 18. Apple will likely have to pass most of this cost onto consumers, which could weigh on volumes later this year.
Apple’s brand is so strong that it’s well placed to navigate the uncertainty ahead. The group remains a consumer-staple cash machine and offers some diversification from other big tech names if AI model building becomes commoditised. Rising memory prices are likely to put pressure on margins towards the end of the year, and the impact on profitability will be a key risk to monitor.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by LSEG. These estimates are not a reliable indicator of future performance. Past performance is not a guide to the future. Investments rise and fall in value so investors could make a loss. Yields are variable and not guaranteed.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment.