Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific advice on making successful stock market investments. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Tip of the week: “In the long run, share buybacks can complement your dividend profits.”

Stock market investments have two main ways to distribute their profits to shareholders. They can pay dividends, or they can buy back their own shares. Both dividends and buybacks pay off for investors. Here are 3 reasons why:

1. Dividends give you cash-in-hand. You’ll pay tax on dividends in the year you get them, if you hold the shares outside your RRSP. However, dividends on Canadian companies receive favourable tax treatment in Canada, thanks to the dividend tax credit.
2. By buying its shares back, a company boosts per-share profit, because profits get divided among fewer shares.
3. Boosting per-share profits can also push up share prices. Plus, buybacks let you defer taxes on those capital gains. That’s because you only pay capital-gains taxes when you sell. What’s more, you’ll pay tax at half the rate on capital gains than you would on ordinary income. And you can offset capital gains with capital losses.

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Here’s a great example of these 3 benefits in action

Some stock market investments regularly buy back shares and raise their dividends. That’s a double win for investors. A good example is Tim Hortons Inc. (symbol THI on Toronto), which we analyze in our Successful Investor and Stock Pickers Digest newsletters. The company recently raised its quarterly dividend by 30%, from $0.10 to $0.13. The new annual rate of $0.52 yields 1.3%. This is the third consecutive year that Tim Hortons has raised its dividend.

Recently, Tim Hortons received $430 million (after taxes) from the sale of half of its Maidstone Bakeries business. It now plans to use this cash to buy back up to $400 million of its shares. That will push up Tim Hortons’ earnings per share.

The company sold its half of the bakery to Aryzta AG of Switzerland. (Tim Hortons and Aryzta owned the bakery through a joint venture.) Based in Brantford, Ontario, Maidstone supplies donuts and other baked goods to Tim Horton’s 3,082 stores in Canada and its 621 stores in the U.S.

Our investment advice: If you stick with our long-standing advice of investing mainly in well-established, dividend-paying stock market investments with strong business prospects (like those we recommend in The Successful Investor), you will automatically earn regular dividend income. Plus, the fact that these companies have strong positions in healthy industries makes it more likely that they will buy back shares on a regular basis, and raise their dividends.

Next Wednesday, December 1, 2010, Investor Toolkit will show you some calculations you can use to determine whether you will have enough money in retirement.

You can get our advice on investment issues, plus buy/sell/hold advice on stocks you may be considering buying in our Successful Investor newsletter. Click here to learn how you can get one month free when you subscribe today.