Dueling Fools: Dividends Rule, Buybacks Drool

When you buy a share of stock, you become a part owner of a business. You put your money at risk by buying those shares, and if the business you own is successful, you deserve to be rewarded. After all, it's your company, your money, and your risk.

Companies that pay dividends are the only ones that truly acknowledge that reality. Sure, CEOs and executives in other companies may talk a good game. In fact, that's likely how they got that high in your company in the first place. In the end, though, if you're not seeing a tangible reward for the financial risks you're taking, ask yourself why not. Unless every project that company is running has a legitimate chance of returning more than your investing hurdle rate, executives who won't pay dividends are simply wasting your money.

If a company's shares are dramatically undervalued, it may make sense for the owners if the company buys back shares. In other circumstances, buybacks are useless at best and active destroyers of owners' wealth at worst. If a company is fairly valued, for instance, a buyback only truly rewards former owners who sell into the support created by the buyback. And if a company is overvalued, a buyback is an active waste of your cash as an owner. After all, if a company is truly worth $50 a share but pays $60 for each stub, that's $10 of the owners' money lost in the transaction -- for each share bought back.

Cash never goes out of style
From an owner's perspective, that's the beautiful thing about dividends. They're a reward based on the success of the business behind the stock, not the market's daily price movements. Better yet, unlike a buyback that can actually destroy your wealth as an owner, every dollar you get from a dividend spends the same regardless of the underlying stock's valuation.

If you still like the prospects and valuation of the company that paid the dividend, you can reinvest it. And if you don't, you can always take your cash elsewhere. In the end, as an owner, whether it's value theoretically returned through a buyback or truly returned via a dividend, the money the company used to return that value to you was already yours. So insist on it coming back to you in the truest form possible: cold hard cash.

The reward that keeps on growing
Perhaps the best part of dividends, however, is what comes next. Any given payment is nice to have today. For the most part, though, dividends aren't static. Successful companies with management that respects the owners will raise their dividend payouts as their businesses grow. As a result, if you buy a strong company that treats its owners well and simply hold on to it, your rewards will increase over time.

Given enough time, the annual reward based on your original, one-time purchase price can be absolutely phenomenal. The companies in this table, for instance, have each raised their dividends every year for at least the past decade:

Their long-term owners have been -- and continue to be -- directly and increasingly rewarded for the risks they've taken by investing. A growing, even if once lowly dividend (especially if it's reinvested in great companies over time), eventually adds up to an unbeatable fountain of wealth. It's how some of the world's largest fortunes were made and are maintained. And if it's good enough for them, I figure it's good enough for me.

You're not done yet! Read the other arguments and then vote for a winner.