Stock Dividend Yields & Share Buybacks — A Surprise

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
Topic Author
SimpleGift
Posts: 4477
Joined: Tue Feb 08, 2011 2:45 pm

Stock Dividend Yields & Share Buybacks — A Surprise

Post by SimpleGift »

Most investors are aware that companies have been spending a large portion of their net income on share buybacks, as opposed to dividend distributions. In fact, over the last decade, share repurchases have dwarfed dividend payouts, in aggregate, for S&P 500 companies (chart below). Dividend payouts tend to be quite consistent, as companies are often reluctant to cut them — but share repurchases are often volatile, following the business cycle and the stock market.

Image
Source: Yardeni Research

Clearly, companies have changed how they distribute their cash to investors. As a result, the question has arisen about how to quantify the overall yield return that investors are actually receiving. According to Mebane Faber in his recent e-book, investors now need to consider two separate stock yields:
  • • Dividend Yield = Trailing 12 months cash dividends / market capitalization

    • Net Buyback Yield = (Trailing 12 month stock repurchases - stock issuances) / market capitalization
When the dividend yield and the net buyback yield are combined, the overall yield return to investors looks much different than many might expect (chart below). Dividend yields have been sliding lower for decades — but when considered along with net share buybacks, the overall yield returns to shareholders have been much higher and, surprisingly, have shown no downward trend at all:

Image
Source: Mebane Faber

Conclusion: As we've seen, net share buybacks can be quite volatile — but, in a post two years ago, Rick Ferri opined that an average net buyback yield of 0.5% might be a good long-term estimate for planning purposes.
Last edited by SimpleGift on Wed Oct 01, 2014 7:07 am, edited 2 times in total.
User avatar
Topic Author
SimpleGift
Posts: 4477
Joined: Tue Feb 08, 2011 2:45 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by SimpleGift »

For more background on stock buybacks and their resulting yields for investors, an excellent white paper from Credit Suisse:
Disbursing Cash to Shareholders: Questions about Buybacks and Dividends.

It contains some interesting observations like this one (bold in original):
Q: Why are comparisons to historical dividend payouts and yields flawed?

A: Despite the rise in share buybacks in the past 30 years or so, many market analysts continue to use dividend yield as a measure of policy and a means to anticipate future market returns. In fact, you should be very cautious in comparing data before and after 1982. Here’s the reason: buybacks were very scarce prior to that date because the Securities and Exchange Act of 1934 prohibited the manipulation of securities prices. Since the rules weren’t clear about what constituted manipulation, most companies avoided buybacks altogether.

In 1982, Congress enacted Rule 10b-18, which grants companies a safe harbor provided they follow certain rules. Those rules form a legal shield from the threat of being sued by specifying how a company can execute a buyback in terms of manner, timing, price, and volume. The Securities and Exchange Commission has subsequently updated the rules to reflect current market conditions.

Given that the propensity to pay out cash to shareholders has been stable but that the mix has shifted from dividends to buybacks, comparisons must take into consideration share buybacks. The year 1982 really did mark a new regime in how companies could return cash to shareholders.
In other words, stock yield data after 1982 (such as reported by the Ibottson database) are not comparable to stock yield data prior to 1982, unless the net buyback yield is added to them.
Last edited by SimpleGift on Wed Oct 01, 2014 7:04 am, edited 1 time in total.
User avatar
nisiprius
Advisory Board
Posts: 52211
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by nisiprius »

Some tangential points.

1) Another example of why I am seriously beginning to wonder whether "the long-term view" is valid. You have pointed out a crystal clear example of a turning point, with "the stock market" and all of long-term financial data compiled about it, and used to think, plan, and predict, are a different thing before and after that turning point.

I don't think it's the only such turning point.

If 1982 truly separates two different "stock markets," and if there are other watershed moments like that, then does it even make sense to say we have "long-term data?"

2) I don't happen to be a member of the cult of dividend stocks, but it's curious to me that there seems to be a) a cult of dividend stocks, b) a cheering section for buybacks, yet I haven't run across people advocating tilts toward "high-buyback stocks," adding them as a portfolio slice, or anything of the sort.

It turns out that there is at least one "NASDAQ Buyback Achievers Index," presumably hoping to remind us of the "NASDAQ Dividend Achievers Index[es]." There are funds and ETFs tracking the dividend achievers indexes, including one from Vanguard (Vanguard Dividend Appreciation Index Fund and ETF).

And, by golly, there is an ETF that tracks the NASDAQ Buyback Achievers Index: PowerShares Buyback Achievers ETF (PKW), respectable $2.76 billion in assets. It was launched in late 2006, so we can see almost eight years of data and, more significantly, 2008-2009. And since inception it has done slightly better than either the Vanguard Total Market Index (VTSMX, blue) or Vanguard Dividend Appreciation Index (VDIGX)... and although VDIGX dropped noticeably less than VTSMX in 2008-2009, it still can be said that PKW did not do any worse than Total Stock.

Let me be perfectly clear: I'm just poking around looking at things, this is just a case of a green line rising faster than a blue line (reference to satirical piece in The Onion). I think my first point--if there are many watershed moments that separate fundamentally different epochs of stock-market behavior, then do we really have "long-term" data--is valid. I'm not really making any second point.

Image
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
jaab
Posts: 112
Joined: Thu Aug 07, 2014 12:52 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by jaab »

nisiprius wrote:2) I don't happen to be a member of the cult of dividend stocks, but it's curious to me that there seems to be a) a cult of dividend stocks, b) a cheering section for buybacks, yet I haven't run across people advocating tilts toward "high-buyback stocks," adding them as a portfolio slice, or anything of the sort.
We are talking about a carry strategy here, but in stocks this usually ends in value. Unless everyone is stretching for yield and driving up the prices, which is what we have seen for the past years. So there is not much news for peope already using a valuation metric and a secondary profitability/quality one (be it factor based or because of Graham & Doddsville), aside from buybacks fixing the dividend yield value metric for U.S. stocks. Mebane Faber has been making noise for it for years though. And given that his timing PDFs are among the SSRN papers with the highest downloads, I think the concept of "Shareholder Yield" (div + net buyback + net debt paydown) is not a secret in any way.
Last edited by jaab on Wed Oct 01, 2014 9:45 am, edited 1 time in total.
User avatar
Topic Author
SimpleGift
Posts: 4477
Joined: Tue Feb 08, 2011 2:45 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by SimpleGift »

I'm still trying to wrap my mind around how net share buybacks are a "cash payout to shareholders" (as defined by Faber and others) — since the cash doesn't show up in my mutual fund account like dividends do. I can see that net buybacks reduce the number of shares outstanding, increasing the earnings attributable to each share, making each share more valuable. So the actual cash payout must come to shareholders when they sell their (more valuable) shares?

What's most interesting about all this is that, despite the much lamented drop in dividend yields over the past decades, companies as a whole are actually returning just as much cash as ever to shareholders. It's just being returned in a form (net buybacks) that's not ordinarily detectable to most investors — unless they are calculating their net buyback yield and adding it to their dividend yield.
Last edited by SimpleGift on Wed Oct 01, 2014 9:19 am, edited 1 time in total.
User avatar
backpacker
Posts: 1620
Joined: Mon Sep 22, 2014 2:17 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by backpacker »

^Yes. Share buybacks aren't really cash payments to shareholders who continue owning the stock.

Suppose you, nisiprius, and I each own equal shares in a company worth $200. The company then makes $100 in cash and is worth $300. We each now own shares worth $100. Next, the company buys all of nisiprius' shares. Now the company is worth $200 and has two investors. So our shares are each still worth $100. The buyback didn't result in either of us having more cash or even in having shares that were more valuable that we could sell for cash.

Hmmm... Maybe buybacks are like dividends in the following sense? They help companies get rid of cash that they don't know how to use in a way that preserves shareholder value. Like dividends, this may suggest that a company is "shareholder friendly."
bobbun
Posts: 159
Joined: Thu Jun 27, 2013 2:38 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by bobbun »

Simplegift wrote:Dividend payouts tend to be quite consistent, as companies are often reluctant to cut them — but share repurchases are often volatile, following the business cycle and the stock market.
I like to imagine myself as mostly indifferent on dividends, but this statement strikes me as a case for dividends rather than buybacks. This statement suggests that reinvested dividends tend to buy shares when they're cheap more so than stock buybacks.

I'm also interested in knowing if your analysis specifically considers net buybacks (year over year reductions in outstanding shares would be one metric). Many companies that are buying back shares are also issuing new shares at the same time--through employee incentive plans, for example. Only the net should be relevant when considering the impact on shareholder value of a buyback plan.
Pizzasteve510
Posts: 635
Joined: Sun Jul 27, 2014 3:32 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Pizzasteve510 »

I attended a forum for tech company CFOs and buybacks was a topic of lively conversation. In my opinion, a few factors that emerged are interesting to share.

In this group, it was mostly 'winning' software and computer technology companies. In their markets, many were facing a maturation of their industry. These winning high growth companies were now generating huge piles of earned cash. They also faced diminishing returns on growth investments (only so many opportunities that made sense in the queue remaining to fund). The balance sheet figures were astounding. The opportunities to get return on extra cash historically low.

Interestingly, another factor was that much of the cash pile was overseas. Tax efficient repatriation of the cash was an issue due to international tax laws (a distorting influence). Can some of the trend in buybacks be engineered with overseas 'restricted cash' in mind? Perhaps it is a more tax efficient way to gainfully use shareholder cash?

Discussed was whether a small buyback (less than that 5% of equity) were prudent. Some cited studies that suggested that a buy back that was too small might get lost in the volatility of the market (captured by arbitragers?) and yield less benefit to shareholders. A few CFOs discouraged a buy back not sufficient to 'move the stock'. I am not sure if I agreed, as perhaps this motive was to ensure their executive compensation was 'plump' by the action. Certainly a factor to consider is the impact of the structure of executive and employee incentive compensation, which are generally tied to stock price growth. A CFO may be popular with peers if perceived as pushing up the stock above a target strike price. Some in this forum will say that creating a pile of cash deserves a big employee reward ( and is as good as creating a market value that projects earnings growth). I am a but of a skeptic, as this group is already very well paid. Cash spent does not have a multiplier. This was also stressed by the CFOs, if uninvested. So among these CFOs they would prefer an acquisition of a company with high prospects to a buyback, if available.

Just something to think about. I prefer a company with a conscientious CFO struggling with the issues of whether they should authorize a new chip fab facility, invest in new systems, buy a competitor or new hot company, initiate a buyback or start paying a dividend; all while considering international tax laws, earnings growth and the world economy. I remind everyone that the pretty charts only represent data meant to predict the impact of real people making decisions, whether to buy technology, invest in new products, hire engineers or cash in their executive stock options. It was good to see a debate about the struggle in action, by those who really face the decision, for an afternoon. Imagine having cash approaching $B on your balance sheet as a 40something high tech CFO who picked the winning player to support. I was surprised at how many companies I had never heard of were in that exact situation.

Stay the course.
User avatar
Topic Author
SimpleGift
Posts: 4477
Joined: Tue Feb 08, 2011 2:45 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by SimpleGift »

bobbun wrote:
Simplegift wrote:Dividend payouts tend to be quite consistent, as companies are often reluctant to cut them — but share repurchases are often volatile, following the business cycle and the stock market.
I like to imagine myself as mostly indifferent on dividends, but this statement strikes me as a case for dividends rather than buybacks. This statement suggests that reinvested dividends tend to buy shares when they're cheap more so than stock buybacks.
I tend to agree. But also keep in mind that dividends are taxed at the shareholder's current rates each year, while the increased value of shares from net buybacks is only taxed when the shares are sold, and at the capital gains rates.
bobbun wrote:I'm also interested in knowing if your analysis specifically considers net buybacks (year over year reductions in outstanding shares would be one metric). Many companies that are buying back shares are also issuing new shares at the same time--through employee incentive plans, for example.
Right. Faber and others make a point of only calculating NET buyback yields, and this is what is reflected in the yield charts in the original post. As you point out, there's no benefit to shareholders if companies are issuing as much new stock as they are repurchasing.
Last edited by SimpleGift on Wed Oct 01, 2014 11:01 am, edited 2 times in total.
Valuethinker
Posts: 49023
Joined: Fri May 11, 2007 11:07 am

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Valuethinker »

Pizzasteve510 wrote:I attended a forum for tech company CFOs and buybacks was a topic of lively conversation. In my opinion, a few factors that emerged are interesting to share.

In this group, it was mostly 'winning' software and computer technology companies. In their markets, many were facing a maturation of their industry. These winning high growth companies were now generating huge piles of earned cash. They also faced diminishing returns on growth investments (only so many opportunities that made sense in the queue remaining to fund). The balance sheet figures were astounding. The opportunities to get return on extra cash historically low.

Interestingly, another factor was that much of the cash pile was overseas. Tax efficient repatriation of the cash was an issue due to international tax laws (a distorting influence). Can some of the trend in buybacks be engineered with overseas 'restricted cash' in mind? Perhaps it is a more tax efficient way to gainfully use shareholder cash?
Apple issued bonds in the USA (at Yields of around 1%) to buy back shares, whilst having overseas cash. The tech sector is hoping for an amnesty, that is unlikely in the current circumstances. Tax inversions are a whole 'nother controversial issue.
Discussed was whether a small buyback (less than that 5% of equity) were prudent. Some cited studies that suggested that a buy back that was too small might get lost in the volatility of the market (captured by arbitragers?) and yield less benefit to shareholders. A few CFOs discouraged a buy back not sufficient to 'move the stock'. I am not sure if I agreed, as perhaps this motive was to ensure their executive compensation was 'plump' by the action. Certainly a factor to consider is the impact of the structure of executive and employee incentive compensation, which are generally tied to stock price growth. A CFO may be popular with peers if perceived as pushing up the stock above a target strike price. Some in this forum will say that creating a pile of cash deserves a big employee reward ( and is as good as creating a market value that projects earnings growth). I am a but of a skeptic, as this group is already very well paid. Cash spent does not have a multiplier. This was also stressed by the CFOs, if uninvested. So among these CFOs they would prefer an acquisition of a company with high prospects to a buyback, if available.
The record of tech acquisitions is not pleasant (IBM and Rolm, anyone? HP and Autonomy? Marconi?). Even for Cisco, which built its strategy around acquiring interest small companies, has stalled on digesting some of the bigger ones. You could say Oracle appears to have pulled it off?

My impression is that tech companies buy back stock to offset the dilution from executive options. Whether they do more than that, and in preference to just paying dividends, depends.

A tech CFO might figure a buyback is less of a commitment than a dividend, so it's a preferable way of returning cash to shareholders. If next year things aren't so great, no buyback. Conversely shareholders seem to like the signalling effect of a steadily rising dividend.
Just something to think about. I prefer a company with a conscientious CFO struggling with the issues of whether they should authorize a new chip fab facility, invest in new systems, buy a competitor or new hot company, initiate a buyback or start paying a dividend; all while considering international tax laws, earnings growth and the world economy. I remind everyone that the pretty charts only represent data meant to predict the impact of real people making decisions, whether to buy technology, invest in new products, hire engineers or cash in their executive stock options. It was good to see a debate about the struggle in action, by those who really face the decision, for an afternoon. Imagine having cash approaching $B on your balance sheet as a 40something high tech CFO who picked the winning player to support. I was surprised at how many companies I had never heard of were in that exact situation.

Stay the course.
What you don't want is the sort of suicidal capacity and then price wars you see in semiconductors: massive overinvestment followed by bust, rinse and repeat. I think that has been the experience of Japanese and Korean electronics company shareholders?

As a shareholder you might prefer a relatively high distribution policy, because the tech industry's record of correctly anticipating the next cycle (correct by the incumbents) and investing profitably in it is so poor.

Not sure how good the industry record is on venture capital investing, but, logically, if you think you are going to be disrupted at some point, it's worth trying to have a stake in the 'new new thing'. Again, the industry record of so successfully matching disruptive innovations is poor. DEC anyone? Maybe Microsoft now (having missed online markets like Ebay, social software like facebook, search like Google, Paypal, etc.).
TJSI
Posts: 401
Joined: Thu Jan 27, 2011 3:03 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by TJSI »

If you add dividend yield to the percent net buyback your result is a nonsense number. Stockholder yield (return) results from capital gains or dividends. A 5% buyback does not result in an automatic 5% increase in share price.

A buyback is an investment by a corporation. It can be a good, bad, or indifferent investment.

The only thing that results from the adding of dividend yield to net buyback percent is debasement of the word yield.
User avatar
Topic Author
SimpleGift
Posts: 4477
Joined: Tue Feb 08, 2011 2:45 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by SimpleGift »

TJSI wrote:A 5% buyback does not result in an automatic 5% increase in share price.
True. But one can't argue that share buybacks do not add value to shareholders, based on the historical record (see chart). The problem is how to quantify this added value, which "net buyback yield" attempts to do.

Image
Source: ValueWalk
Last edited by SimpleGift on Wed Oct 01, 2014 11:57 am, edited 1 time in total.
User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by ogd »

TJSI wrote:If you add dividend yield to the percent net buyback your result is a nonsense number. Stockholder yield (return) results from capital gains or dividends. A 5% buyback does not result in an automatic 5% increase in share price.
Compared to issuing the same 5% as a dividend, it absolutely does.

Suppose you own 1% of a company worth $1 billion, say 10K shares at $1000 each. The company has $50 million cash.
1) if it buys back 50k shares, what you now have is 10K shares of a total of 950K shares. Your shares are worth 1000 each, total $10M. If you'd rather stay at 1% ownership of the now smaller company or otherwise need 500K, you can sell 50 shares.
2) if it issues a 5% dividend, your original 10K shares are still 1% of the market cap of a company now worth $950M. Each is worth $950. If you'd rather stay at $10M invested you can use the $500K to buy 526 more shares, bringing your total back to $10M.
The shares in the first scenario are worth 5% more than in the second scenario. In both cases the company has disposed of the 5% cash while giving shareholders the option to keep their $ invested constant or reduce it accordingly.

You are right of course that the buyback does not create something out of nothing. Neither does the dividend. These are both means to return to the shareholders their own cash. But the first is more efficient for a taxable shareholder, who is not forced to pay dividend taxes on the 5% if they'd rather keep their money invested. In the second scenario the shareholder has no such option.

The term "buyback yield" is very much appropriate.
TJSI wrote:A buyback is an investment by a corporation. It can be a good, bad, or indifferent investment.
Not at all. An investment is when they use the 5% to buy something that stays within the company, whether acquisition or expansion. Both buybacks and dividends reduce the market cap by that 5%. So it's a divestment of sorts.
User avatar
nisiprius
Advisory Board
Posts: 52211
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by nisiprius »

Every time something like this, we get hung up on the unresolvable question "are buybacks just the same a dividends" (only better because of taxes or something)? It's unresolvable, the issue is clear enough, and it would help if people would just agree to disagree.

In my opinion, part of the a problem is that people who are financially sophisticated start taking mental shortcuts. X can have a tight, reliable, numerically fairly predictable causal connection to Y, but "tantamount to" is not "the same as."

If a company buys back half of its shares, then everyone in the world can see perfectly clearly that each share now represents twice as big a piece of the company as it did before.

Unfortunately, we usually make two lazy assumptions.

Assumption #1 is that the act of making the buybacks, or the business decisions leading to the buybacks, did not change the total value of the company. But maybe it did. "Robert X. Cringley" is writing a series of virulently caustic columns attacking IBM ("the IBM that many of us knew in the past is gone and the IBM of today has management that is, frankly, insane"). Let's not debate whether Cringely's right about IBM. Let's just take what he's saying about IBM and consider it as a hypothetical.

Suppose a company were to concentrate its effort on reaching a high earnings per share by doing "whatever it takes," including buybacks. Suppose the primary goal is the personal enrichment of upper managers compensated in stock. Suppose that goal conflicts with serving customers and maintaining the long-term health of the business. In that case, buybacks themselves would not directly cause a drop in company value. However, there would be a common cause, behind both the buybacks and long-term erosion of the company's value.

Assumption #2 is that if everyone can see the same facts clearly, can can do the same math, and the math shows that every share is worth double what it was before, then in the real world, whenever you want to, you can find an actual buyer with money who is ready, willing, and able to pay that number of dollars for your shares.

In contrast, a dividend payout is irrevocable, and it's not hypothetical in any way. If the company pays you $X, you have $X. Down the road someone can say "in my opinion they couldn't afford to do that," but it doesn't matter, you have the money.

In short, a "price elevation of $X, rationally based on a simple math division problem and information everybody has" is not the same as "paying you $X." It's closely related, but it's not the same.

Whether that's important in terms of long-term returns and the Gordon equation and the dividend discount theory of stock value is a different question.
Last edited by nisiprius on Wed Oct 01, 2014 12:22 pm, edited 3 times in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
Pizzasteve510
Posts: 635
Joined: Sun Jul 27, 2014 3:32 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Pizzasteve510 »

Thanks for the comments valuethinker. Good points. I attended largely for fun, as a non-CFO myself. I do not have much direct experience with the international tax law issues.

I agree that the acquisition success rates in high tech are very hard to determine. There seem to be many questionable deals, for ego sake, driven by execs who confuse success with prescience. But who am I to judge billionaires for wanting to stay on top. At least some of the names you mentioned are run by active shareholders for which their personalities should be well documented. Caveat emptor, shareholders should expect that their 'ownership ride' will continue to have big bets/risks to try to win in the volatile technology marketplace (or maybe spend their energy sponsoring sailing events and buying islands in the Pacific Ocean).

There is also a lot of small scale activity that goes unwritten about. When I helped do some due diligence work i seem to recall that most projects by smaller firms made sense, and that they were mostly buying what they knew well. These seemed to do very well. The mega mergers that make the press i am skeptical, like you seem to be. "Que es la vida, un frenesi..."
User avatar
Topic Author
SimpleGift
Posts: 4477
Joined: Tue Feb 08, 2011 2:45 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by SimpleGift »

nisiprius wrote:Whether that's important in terms of long-term returns and the Gordon equation and the dividend discount theory of stock value is a different question.
Actually there's a good case, I believe, that the dividend discount model for estimating future stock returns (used by Bogle, Bernstein and others) should be revised to include the net buyback yield. Wikipedia indicates that this model (aka the Gordon growth model) was originally published in 1956, based on theories developed in the 1930s. Since share buybacks were rare in those days, and only became very common after 1982, this added cash payout to shareholders wasn't anticipated in the model. Perhaps it should now read:
  • Expected Stock Return = Current Dividend Yield + Net Buyback Yield + Dividend Growth Rate
As mentioned upthread, Rick Ferri estimates a long-term average for the net buyback yield of about 0.5% — but eye-balling Mebane Faber's chart in the OP, the average appears to be more than 1% since 1982.
Last edited by SimpleGift on Wed Oct 01, 2014 12:40 pm, edited 1 time in total.
dkturner
Posts: 1939
Joined: Sun Feb 25, 2007 6:58 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by dkturner »

TJSI wrote: A 5% buyback does not result in an automatic 5% increase in share price.
True, and a 5% cash dividend does not result in an automatic 5% decrease in share price, but you can see where this is going.
User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by ogd »

nisiprius wrote:Assumption #2 is that if everyone can see the same facts clearly, can can do the same math, and the math shows that every share is worth double what it was before, then in the real world, whenever you want to, you can find an actual buyer with money who is ready, willing, and able to pay that number of dollars for your shares.

In contrast, a dividend payout is irrevocable, and it's not hypothetical in any way. If the company pays you $X, you have $X. Down the road someone can say "in my opinion they couldn't afford to do that," but it doesn't matter, you have the money.

In short, a "price elevation of $X, rationally based on a simple math division problem and information everybody has" is not the same as "paying you $X." It's closely related, but it's not the same.
nisiprius: if you are a shareholder who has resolved to reinvest all dividends or not sell the equivalent buybacks, then you don't in fact depend on this assumption. Whatever the market's mispricing of cash on the books might be, it affects the post-dividend reinvestment price just as well.

Now if you actually want to remove from your investment in the company whatever cash it pays out (which sounds arbitrary, but let's say it's the case), then sure, a dividend has more certainty. But like all presumptions of mispricing upon X event, it can't possibly hold in the aggregate as it would have been long ago arbitraged out of existance. If share prices post buyback are consistently low, the Buyback Timing Opportunities Fund XYZYX would have a) existed and b) been a perpetual winner. I think this is an untenable position. It's a case of coin flips (price fluctuations) aggregating to something very predictable.

Meanwhile, what I do know is that the company choosing to pay the dividend has immediately cost me, the long term investor, 5-7% of the dividend which is the value of tax deferral, from my pockets to the IRS. Probably more if I imagine donating or taking capital gains during a sabbatical year. To me, that's the bird in the hand.

As for assumption #1 and in general the feel-good stories about dividends, they make the supposition that a dividend is a signal or even a driving force for the long-term health of the company; but in pratice this just isn't supported by evidence. And if you imagine that there are no politics harmful to the company's interests around the consistency and amount of the dividend, think again; the more significance investors put upon dividends, the more it has a chance of interfering with company function, e.g. good investment opportunities bypassed. And finally, I've never understood the logic in "I want this 3% of my investment out of the hands of those crooks as soon as possible! They shall only manage the other 97%".
garlandwhizzer
Posts: 3565
Joined: Fri Aug 06, 2010 3:42 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by garlandwhizzer »

Where net buybacks put money in the investors pocket is through appreciation in of stock prices. Same corporate income, same book value, fewer shares. Hence the each share is worth more. The payoff for shareholders doesn't come until the market responds to these improved fundamentals and bids up the price of shares, an action has occurred rather quickly in recent years. Many believe that one of the major driving forces of the current 5 year bull market is in fact share buybacks. This is one way that the economy can still be in the doldrums for 5 years while the stock market skyrockets. If you keep reducing share count, stable overall corporate profits translate to ever increasing profits per share (PE) and the market responds to that by bidding up share prices until PE returns to market equilibrium level.

The point has already been made that tax preference is also a plus for buybacks over dividends.

The only problem with using excess cash for buybacks/dividends is that it reflects a fundamental pessimism by management about their future growth prospects. If they believed that using that same money for new plant, equipment, or innovation would result in much greater profit growth they would put the money there rather than dividends or buybacks. Giving money back to shareholders one way or another is a default option when management has a guarded view of profit growth prospects going forward which has been the case for the full 5 year bull.

Garland Whizzer
User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by ogd »

garlandwhizzer wrote:Many believe that one of the major driving forces of the current 5 year bull market is in fact share buybacks. This is one way that the economy can still be in the doldrums for 5 years while the stock market skyrockets. If you keep reducing share count, stable overall corporate profits translate to ever increasing profits per share (PE) and the market responds to that by bidding up share prices until PE returns to market equilibrium level.
Two points:

1) share buybacks do not affect total return. It has been a bull market in total return as well, easily comparable to others which included more dividends. The big reason is the increase in corporate profitability, which can and has come even as unemployment and salary levels are mediocre, what you probably mean by "economy is in the doldrums" (other measures are way up).
2) share buybacks do not affect PE ratios, since the # shares appears in both numerator and denominator.
garlandwhizzer wrote:The only problem with using excess cash for buybacks/dividends is that it reflects a fundamental pessimism by management about their future growth prospects. If they believed that using that same money for new plant, equipment, or innovation would result in much greater profit growth they would put the money there rather than dividends or buybacks. Giving money back to shareholders one way or another is a default option when management has a guarded view of profit growth prospects going forward which has been the case for the full 5 year bull.
Well, yes. Everyone is careful after the last crisis showed how capital investments might simply not pay off. It's the same problem you can see in bond yields.
garlandwhizzer
Posts: 3565
Joined: Fri Aug 06, 2010 3:42 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by garlandwhizzer »

ogd wrote:
2) share buybacks do not affect PE ratios, since the # shares appears in both numerator and denominator.
Companies who buy back shares can either hold them as investments (which doesn't affect share volume) or retire the shares, taking them off the market, which lowers share counts and increases earnings per share, book value per share and therefore initiates a market rise in share price. What I and Faber are talking about is retiring shares, reducing share count, not the company itself holding the shares as investment. Management typically has large holdings of stock options and retiring shares is more in line with management's ultimate goal of increasing share price which lines their pockets with big bucks. Hence, in my opinion, management prefers to retire shares, making themselves and other shareholders more wealthy. This is why Faber concentrates on net changes in share volume.

Garland Whizzer
Snowjob
Posts: 1651
Joined: Sun Jun 28, 2009 10:53 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Snowjob »

Shareholder yield is certainly not a new concept, I've been acutely focused on this over the past 5 years and it has been great.
garlandwhizzer
Posts: 3565
Joined: Fri Aug 06, 2010 3:42 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by garlandwhizzer »

ogd wrote:
1) share buybacks do not affect total return. It has been a bull market in total return as well, easily comparable to others which included more dividends. The big reason is the increase in corporate profitability, which can and has come even as unemployment and salary levels are mediocre, what you probably mean by "economy is in the doldrums" (other measures are way up).
As for this point I suggest that you read the following article from Financial Sense Insider.Below is an interview with Gary Dorsch of Global Money Trends done by Financial Sense. Source: <www.financialsense.com/contributors/gar ... ces-stocks> If you don't want to read the whole interview and article the following direct quote delivers the message.
Close to 80% of all the profits of the S&P 500 companies are being recycled into the hands of shareholders through buybacks and dividends, and this is the most powerful force pushing the market higher.
I don't know that it's the most powerful force driving the market higher, but I do believe that buybacks and dividends have been one major factor pushing this much unloved bull market upward for 5 years.

Garland Whizzer



The Two Most Powerful Forces Pushing the Stock Market Higher
FS STAFF06/09/2014
Print
More Sharing Services
Following last week’s announcement by the European Central Bank (ECB), the stock market has now broken out above its mostly sideways movement since the beginning of the year to new all-time highs. Over the course of this bull market, each time the market has begun to show weakness, many have expected a selloff to occur only to then find the opposite take place: stocks roar back to life and continue to soar higher.

In a recent interview with Financial Sense Newshour, Gary Dorsch of Global Money Trends says that over the last several years, investors have underestimated the power of two major forces driving stocks higher—quantitative easing by central banks and companies buying back their stock—and that these two forces may propel the market even higher.

Here are some excerpts from his recent interview (click here for audio) that aired to the public on Saturday:

FSN: Gary, the market has now broken out again to all-time highs and continues to push upwards despite all the bearish projections we’ve heard over the last several years. What’s driving the market higher in your opinion?

Dorsch: I think the two major factors that are supporting this market in a nut shell are the Federal Reserve's quantitative easing money injection scheme [and]…the shrinking stock market, which is the enormous amount of stock buybacks being conducted by the S&P 500 companies. Last year the S&P 500 companies bought $475 billion of their own stock and in the first quarter purchased another $160 billion. Close to 80% of all the profits of the S&P 500 companies are being recycled into the hands of shareholders through buybacks and dividends, and this is the most powerful force pushing the market higher. You wonder why the market doesn't have any pullbacks—it’s because the major corporations are buying on all dips and they've got plenty of firepower left. So, between the buybacks that are still projected between now and the end of the year, which could be about $350 billion plus injections by the Fed of $180 billion, you've got about half a trillion dollars yet to come into this market between now and the end of the year.

FSN: So, with the Fed’s QE and stock buybacks driving the market higher, what targets are you looking for on the major averages?

Dorsch: I would project that it’s very possible we could see the Dow hit 18,000, which would be about another 1100 points from here, and for the S&P 500 to hit 2200, in what could be the final euphoria stage of the market where people really just don't even have any fear of risk any more.

FSN: Are there any worrying signs you see technically with this current move higher?

Dorsch: A very interesting technical aspect of this rally is that it is occurring on shrinking volume…and so some technicians would argue that this is not a good sign. It doesn't lend to a lot of participation. The rally is on very narrow breadth. That of the top 500 stocks, only about 25 are having new 52-week highs. This is a very narrowly based rally. I understand all that, but all these bearish arguments that we've been hearing for the last few years have just fallen flat and I think it's because we have underestimated the power of buybacks and QE, even as the Fed winds down its QE, low and behold it has one of its colleagues, the ECB, coming to the rescue just at the right time to do some money injections in to the European banking system. Although, it’s an intelligent type of QE that the ECB is going to do by funneling it directly into the hands of small business and medium sized businesses as opposed to just randomly giving it out to hedge fund managers as the Federal Reserve does, or investment bankers to inflate stock prices. But this could actually help the European economy, but still, the net result is Europe is going to be keeping its interest rates down.

FSN: Is this what you think has also helped to drive interest rates lower here in the U.S.?

Dorsch: One of the reasons US bond yields have dropped so far this year to the amazement of most economists is that we've seen a drop in interest rates in Europe, in Switzerland, in Germany, and Italy and Spain. And so because of the drop in international bond yields, US bond yields looked relatively good. So some money managers bought US bonds in reaction to the drop in foreign bond yields, and that's also been a supporting factor in a way for the stock market as US corporations can borrow very cheaply. And, in fact, many of the buybacks are leveraged buybacks where the companies are borrowing very cheaply and using it to buy back their own stock. There's not much care about the long-term organic growth of the company. It's all very short-term focus on today and tomorrow and CEOs have a lot riding with their stock options based on the price of their stock. So they're acting in their own personal interest. So, I believe we're sort of that euphoric stage now where psychology kind of gets out of hand. The Fed realizes that they're blowing the bubble, but they have no inclination what so ever to stop it through monetary policy and so it could very well be that we see this parabolic final euphoric liquidity surge.

FSN: Gary, with central banks and plentiful liquidity helping to push the stock market higher, many would have thought that gold would’ve sprung to life by now. What's your take on the yellow metal?

Dorsch: Well, if you take a look at the gold market, I always think first of all the biggest buyers of gold are China and India. They buy a little over more than half of all the gold that is produced in the world and there was a recent report by the World Gold Council indicating that there was a sharp drop-off in demand for gold out of India and China in the first quarter. About an 18% drop in China and a 26% decline in India. Of course, India has had restrictions on imports as a government policy to help India…get its current account deficit under control and it has succeeded in stabilizing its currency. […] This new government in India is lending optimism that those restrictions on purchases of gold overseas will be relaxed in the months’ ahead. That could be a supporting factor, but overall in the gold market I think after last year’s sharp decline in 2013, watching the amount of gold that is being held in the global ETF such as GLD here in the US, the amount of gold now being held in ETFs is down about a third from its peak level in 2011 and it has not recovered. Those numbers are still showing that we are slightly below last year’s low and it indicates that investment demand in the western world via ETFs has not yet revived. So, to me, it looks like it’s sort of consolidating and has lost its luster and, if anything, I would say traders have made a psychological shift saying the way to profit from massive central bank intervention is you're better off with equities where the company is buying back their own stock. You have that added benefit. You don't have that with the gold. So they know that money is being devalued and it’s how do you stay ahead of the devaluation, and equities have now become the favored asset class. I think that's been a big shift where the typical retail investor now has abandoned the gold market and you're basically mostly depending on traditional cash buyers…So, I don't look for gold to do all that much. $1200 is a very important number because that is the average breakeven cost for miners around the world. Half the miners have an all-inclusive cost above $1200, the other half slightly below $1200. Should it go below $1200 I think you'd really start to see some reductions in production and supply and then some mining companies may ultimately be forced out of business. That would be a tough situation, but that's kind of how it’s going to have to heal itself. The mining companies are going to have to think about ways of reducing supply in order to get a recovery in the market so, to me, I don't see the gold market going much above the $1350 level on any possible rally and I see a bottom should be around $1200 because of the breakeven point there. And a lot of traders are aware of that. So I'm not really projecting much for the gold market in the next few months.
User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by ogd »

garlandwhizzer wrote:
Close to 80% of all the profits of the S&P 500 companies are being recycled into the hands of shareholders through buybacks and dividends, and this is the most powerful force pushing the market higher.
I don't know that it's the most powerful force driving the market higher, but I do believe that buybacks and dividends have been one major factor pushing this much unloved bull market upward for 5 years.
Well yes, but those profits have to exist in the first place and that's the primary factor. You can't compare the returns with dividends/buybacks to prospective returns when profits would have disappeared into a black hole (same problem as the old "dividends account for 50%+ of total return, therefore you must love dividends").

As for the rest of the article, I completely disagree with just about everything else and I think it's a recipe for one of those heart breaking "sat on the sidelines for most of the bull market" threads. Pay heed at your own risk. That's about all I can discuss within the guidelines of the forum.
User avatar
JoMoney
Posts: 16260
Joined: Tue Jul 23, 2013 5:31 am

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by JoMoney »

ogd wrote:...2) share buybacks do not affect PE ratios, since the # shares appears in both numerator and denominator...
This was something John Neff suggested in his stock screening (essentially PEG Ratio with dividends added to earnings growth). It should make no difference if "Company A" grows earnings 3% faster than "Company B" which pays a 3% dividend yield, because the investor can just use the extra yield and simulate the same amount of growth buying more stock. If everything else is equivalent between the companies "Earnings Growth" and "Dividend Yield" should be interchangeable. The problem though, is that the market doesn't always price them equivalently, maybe because the market is expecting faster/slower growth or maybe because dividends are in/out of favor. But if an investor isn't trying to pick stocks and make those kinds of calls about what future expected growth will be they should be indifferent to it.
Simplegift wrote:...I believe, that the dividend discount model for estimating future stock returns (used by Bogle, Bernstein and others) ...
I've seen other people trying to say Bogle uses the Gordon or dividend discount model, but I've never actually heard or seen him use it. He uses a model looking at EARNINGS GROWTH + DIVIDENDS, do you have a reference of him using the dividend discount model?

...
a couple of previous posts where I tried to discuss similar topic:
http://www.bogleheads.org/forum/viewtop ... 3#p2137400
http://www.bogleheads.org/forum/viewtop ... 0#p2106868
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
IlliniDave
Posts: 2388
Joined: Fri May 17, 2013 7:09 am

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by IlliniDave »

Simplegift wrote:I'm still trying to wrap my mind around how net share buybacks are a "cash payout to shareholders" (as defined by Faber and others) — since the cash doesn't show up in my mutual fund account like dividends do. I can see that net buybacks reduce the number of shares outstanding, increasing the earnings attributable to each share, making each share more valuable. So the actual cash payout must come to shareholders when they sell their (more valuable) shares?

What's most interesting about all this is that, despite the much lamented drop in dividend yields over the past decades, companies as a whole are actually returning just as much cash as ever to shareholders. It's just being returned in a form (net buybacks) that's not ordinarily detectable to most investors — unless they are calculating their net buyback yield and adding it to their dividend yield.
I'm like you in that it difficult to get my mind around. To some degree I guess it depends on what the company does with them. If the shares are permanently retired, then it seems like it is a case of the company unilaterally deciding some part of my dividend is to be reinvested. That has a tax advantage if the shares are held outside a tax advantaged account, but exposes the dividend to price fluctuation risks. Probably something that arguably works out over the long haul.

Where I get concerned is the situation where share buyback may not be the most prudent business move or not be in the public shareholders best interest. I think there is a temptation for executives largely compensated in stock grants/options to manipulate short term share prices, as it affects both the value of the shares they have and the size of future awards. If the repurchased shares are doled out to management and/or resold (or new shares issued, however that works) a few years down the road, it seems like it's just a big circuit of money movement that allows for easy skimming. Hopefully that doesn't happen too often.
Don't do something. Just stand there!
User avatar
Topic Author
SimpleGift
Posts: 4477
Joined: Tue Feb 08, 2011 2:45 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by SimpleGift »

JoMoney wrote:I've seen other people trying to say Bogle uses the Gordon or dividend discount model, but I've never actually heard or seen him use it. He uses a model looking at EARNINGS GROWTH + DIVIDENDS, do you have a reference of him using the dividend discount model?
I believe you're right that Bogle uses earnings growth (plus dividends) and Bernstein uses dividend growth (plus dividends) in estimating fundamental stock returns. But for the kind of "back of the envelope" estimates made by the simplified Gordon Model, it really doesn't matter. Both earnings and dividends have grown at similar long-term rates historically (chart below) — and getting more precise than, say, a 5% growth rate for each is futile, in my view, when estimating future returns.

Image
Source: Bernstein, The Four Pillar of Investing
Valuethinker
Posts: 49023
Joined: Fri May 11, 2007 11:07 am

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Valuethinker »

I am reading a lot of stuff here that doesn't make sense against the theory of corporate finance taught in every textbook on the subject for the last 30 years.

We need to first understand that share buybacks increase EPS. They do so until 1/PE < Int rate (1- tax rate) for companies borrowing to buy back shares. Or 1/PE < int rate on cash bal (1- tax rate) for companies that are net cash.

1/PE is your earnings yield ie E/P rather than P/E. Int rate (1 - tax rate) is your after tax cost of borrowing as a corporation.

I feel a need to restate what Modigliani and Miller told us over 45 years ago, and which won them the Nobel Prize.

1. Money in the company is the shareholder's money. In the absence of taxes (and later coda: agency problems and information costs) there is no difference to a shareholder between money in the company and money in their own bank account

2. the shareholder is indifferent between share buybacks and dividends. To receive a cash dividend from a buyback, the shareholder merely tenders some of her holding to the buyback. Again in the absence of taxes

3. In the absence of taxes there is no difference to the shareholder of a highly indebted company and a company with lots of cash. However because tax is calculated after interest but before dividends, taking on leverage creates value for shareholders by creating a tax shield for the corporation.

Therefore

- if a company buys back shares with its own cash (in the absence of taxes) that's the same thing as paying a dividend

- if a company borrows to buy back shares, then if there is corporate tax, then it can create value for shareholders. It should not do so if it believes it can earn a higher rate of return on investing equity than can shareholders in a diversified portfolio with the same beta ie if management believes they can add 'alpha'

Subsequent additions to M&M theory

- if you have strong agency costs (eg management is greedy or not maximizing shareholder value) then it may be better for the company to pay a dividend or do a buyback than hold onto cash. Hostile takeovers and LBOs perform the same function (see Michael Jensen and Karen Wruck The Free Cash Flow of the Firm)

- dividends appear to function as a 'signal' from insiders to outsiders about the stability of the company's earnings and its future prospects. As per game theory, a credible signal is one that costs the signaller to make and 'binds' them to a course of action. A steady or rising dividend is an example. Whereas share buybacks appear, empirically, not to give that signal-- companies announce them, don't fulfill them, change them

- if management is incentivized by EPS or Return on Capital measures, they will tend to use share buybacks to earn higher returns


http://aswathdamodaran.blogspot.co.uk/2 ... rices.html

http://people.stern.nyu.edu/adamodar/pd ... s/ch10.pdf

http://open.salon.com/blog/simoleonsens ... s_going_on

A few places to get started.

http://www.sml.hw.ac.uk/ms75/GP%20Papers/G32.pdf

We should understand that since all CFOs know this theory, learned it in business school in the last 30 years (as they did Beta), that corporate actions will be governed by it, to a certain extent.
Valuethinker
Posts: 49023
Joined: Fri May 11, 2007 11:07 am

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Valuethinker »

Pizzasteve510 wrote:Thanks for the comments valuethinker. Good points. I attended largely for fun, as a non-CFO myself. I do not have much direct experience with the international tax law issues.

I agree that the acquisition success rates in high tech are very hard to determine. There seem to be many questionable deals, for ego sake, driven by execs who confuse success with prescience. But who am I to judge billionaires for wanting to stay on top. At least some of the names you mentioned are run by active shareholders for which their personalities should be well documented. Caveat emptor, shareholders should expect that their 'ownership ride' will continue to have big bets/risks to try to win in the volatile technology marketplace (or maybe spend their energy sponsoring sailing events and buying islands in the Pacific Ocean).

There is also a lot of small scale activity that goes unwritten about. When I helped do some due diligence work i seem to recall that most projects by smaller firms made sense, and that they were mostly buying what they knew well. These seemed to do very well. The mega mergers that make the press i am skeptical, like you seem to be. "Que es la vida, un frenesi..."
The data on M&A suggests that small acquisitions of related businesses, especially if privately sold, especially if there is no auction process, can create value fof acquirers. M&A creates value but in big public deals or competitive auctions, selling shareholders tend to extract that value.

Therefore companies that make sequences of small deals are in effect treating deals as a form of capex: to enter new product or market areas, to jumpstart R&D etc.

And as you say, it seems possible to get that right. Due diligence and rapid post merger integration are key. Also buying relatively early in the target's growth cycle.

Another thing that can work well is buying a direct competitor, because it's easy then to cut costs: take their plant load and put it in your plants, you have 2 of every management level and you cut it down to 1. However competition law places a significant constraint.

There's really only one CEO that I am convinced ONLY does deals to make money for his shareholders, he being the largest shareholder. That being Warren Buffett. The alignment of interests is perfect, unlike every other asset manager Buffett does not pull out a management fee for running BH. And BH deliberately avoids competitive auctions for businesses-- his pitch to ISCOR (largest Israeli company ever sold to a foreigner) was expressly 'if you want debt, pressure to do a quick turn, out in 3 years, then go with LBO/ PE. With me, you diversify your family wealthy, but you keep running the business. If BH acquires you, what you have is a ruthless capital allocation mechanism-- you will have to justify every significant expenditure to me and Charlie Munger'.

Note Buffett blew it with Tesco (UK food retailer) where he is the 3rd largest shareholder. Even Buffett gets it wrong.

With tech CEOs 'only the paranoid survive' as Andy Grove put it. The next product cycle could destroy your firm: DEC, Compaq, Sun.. the list of firms that died or where sold well past their peak is very long.

The problem with CEOs now is they last 4 years. So like hockey stars, their job is to maximize their earnings and glory at their peak earning years. Does not reinforce long term thinking. Friends of mine who work for US tech companies say it all about making your quarterly numbers.

When you get a Steve Jobs, or a leader of a small company that is still not public, then you can get the view of the future of the company and its long term legacy. As long as you don't ride your more junior managers on quarterly profit targets.
beardsworth
Posts: 2135
Joined: Fri Jun 15, 2007 4:02 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by beardsworth »

nisiprius wrote:
[Emphasis added]

And, by golly, there is an ETF that tracks the NASDAQ Buyback Achievers Index: PowerShares Buyback Achievers ETF (PKW), respectable $2.76 billion in assets. It was launched in late 2006, so we can see almost eight years of data and, more significantly, 2008-2009. And since inception it has done slightly better than either the Vanguard Total Market Index (VTSMX, blue) or Vanguard Dividend Appreciation Index (VDIGX)... and although VDIGX dropped noticeably less than VTSMX in 2008-2009 . . .

Image
A small correction: VDIGX, shown in the graph, is actually Vanguard Dividend Growth Fund. Vanguard Dividend Appreciation Index Fund is VDAIX/VDADX (Investor/Admiral shares). I don't know whether that would have changed the graphing relative to the other funds shown.
User avatar
Riprap
Posts: 798
Joined: Thu Jan 29, 2009 1:08 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Riprap »

Valuethinker wrote:I am reading a lot of stuff here that doesn't make sense against the theory of corporate finance taught in every textbook on the subject for the last 30 years.
Valuethinker,

Nice post. Can you recommend a basic corporate finance textbook, preferably one that can be purchased on Amazon? I am ok with lots of math.
User avatar
backpacker
Posts: 1620
Joined: Mon Sep 22, 2014 2:17 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by backpacker »

Valuethinker wrote:I am reading a lot of stuff here that doesn't make sense against the theory of corporate finance taught in every textbook on the subject for the last 30 years. [...]
This was an incredibly helpful post. Thanks Valuethinker! :beer
Valuethinker
Posts: 49023
Joined: Fri May 11, 2007 11:07 am

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Valuethinker »

Riprap wrote:
Valuethinker wrote:I am reading a lot of stuff here that doesn't make sense against the theory of corporate finance taught in every textbook on the subject for the last 30 years.
Valuethinker,

Nice post. Can you recommend a basic corporate finance textbook, preferably one that can be purchased on Amazon? I am ok with lots of math.
The one I really like is Robert Merton & Zvi Bodi 'Financial Economics'. It integrates economics and finance in a way that North American universities (with very separate Business and Economics programs) don't do.

The sort of granddaddy all the formulas are there is Copeland, Shastri, Weston 'Financial Theory and Corporate Policy'. To be honest that's a better second text, not first. I am not sure when it was last updated.

Everyone uses Brealey and Myers, Principles of Corporate Finance. I find it quite confusing-- it spends too long getting to the basic theories.

I should add, crawl all over Damodaran's website . Read his blog posts. Read his ppt presentations.
Valuethinker
Posts: 49023
Joined: Fri May 11, 2007 11:07 am

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Valuethinker »

backpacker wrote:
Valuethinker wrote:I am reading a lot of stuff here that doesn't make sense against the theory of corporate finance taught in every textbook on the subject for the last 30 years. [...]
This was an incredibly helpful post. Thanks Valuethinker! :beer
You are welcome.

I should add M&M make some other simplifying assumptions:

- there are no taxes (either on the company or investors)

- costs of bankruptcy are zero (the shareholders just hand the keys to the debt holders, and walk away)

- shareholders can fully diversify and borrow. So if they think a company has too little debt, they can buy shares in that company by borrowing themselves

There is therefore a huge literature about what happens if any of these are not true.
avalpert
Posts: 6313
Joined: Sat Mar 22, 2008 4:58 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by avalpert »

Riprap wrote:
Valuethinker wrote:I am reading a lot of stuff here that doesn't make sense against the theory of corporate finance taught in every textbook on the subject for the last 30 years.
Valuethinker,

Nice post. Can you recommend a basic corporate finance textbook, preferably one that can be purchased on Amazon? I am ok with lots of math.
These are the ones I've seen used most:

http://www.amazon.com/Financial-Managem ... 1439078092
http://www.amazon.com/Corporate-Finance ... 0077121155
http://www.amazon.com/Fundamentals-Corp ... 0078034647
User avatar
Riprap
Posts: 798
Joined: Thu Jan 29, 2009 1:08 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Riprap »

Thanks Valuethinker and avalpert.
User avatar
nisiprius
Advisory Board
Posts: 52211
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by nisiprius »

beardsworth wrote:A small correction: VDIGX, shown in the graph, is actually Vanguard Dividend Growth Fund.
:oops:
Thank you.
Vanguard Dividend Appreciation Index Fund is VDAIX/VDADX (Investor/Admiral shares). I don't know whether that would have changed the graphing relative to the other funds shown.
Not much, as it turns out:

Image
Last edited by nisiprius on Fri Oct 03, 2014 3:54 pm, edited 1 time in total.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
Chan_va
Posts: 869
Joined: Wed Dec 05, 2012 6:15 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Chan_va »

For every mathematical model of some phenomena, we can ask

1) Does the model accurately predict the behavior of a subset of the entire system?
2) Can the model predict the behavior of a collection of subsystems?

#1 does not necessarily imply #2. Take the classic 3 body problem in physics. Even if you assume that the world works according to Newtonian laws, it turns out that the theory can't be used to predict the simple case of 3 bodies revolving around one another. Only 2 bodies is solvable. That is chaos in action.

Let's assume that the standard theory of corporate finance is a completely accurate model. Then, I think we all agree that mathematically, a stock buyback is completely equivalent to a dividend. You can easily verify this with a simple thought experiment.

However, does that mean that in a market with million buyers and sellers, the two are equal? A dividend is a irreversible transfer of $x of company value into cash for each shareholder. A stock buyback is in theory the same.
FinancialDave
Posts: 1819
Joined: Thu May 26, 2011 9:36 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by FinancialDave »

backpacker wrote:^Yes. Share buybacks aren't really cash payments to shareholders who continue owning the stock.

Suppose you, nisiprius, and I each own equal shares in a company worth $200. The company then makes $100 in cash and is worth $300. We each now own shares worth $100. Next, the company buys all of nisiprius' shares. Now the company is worth $200 and has two investors. So our shares are each still worth $100. The buyback didn't result in either of us having more cash or even in having shares that were more valuable that we could sell for cash.

Hmmm... Maybe buybacks are like dividends in the following sense? They help companies get rid of cash that they don't know how to use in a way that preserves shareholder value. Like dividends, this may suggest that a company is "shareholder friendly."
Let's be clear about one thing - buybacks and dividends are not at all equal.

Dividends are cash in your pocket which can NOT be affect by "Mr. Market, or spent by anyone but you."

Buybacks are really NOTHING in your pocket and are 100% dependent on "Mr. Market," and other investors perceived value of the stock.

Let's not get hung up on what you might think is the intrinsic worth of a company!

fd
I love simulated data. It turns the impossible into the possible!
FinancialDave
Posts: 1819
Joined: Thu May 26, 2011 9:36 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by FinancialDave »

Chan_va wrote:For every mathematical model of some phenomena, we can ask

1) Does the model accurately predict the behavior of a subset of the entire system?
2) Can the model predict the behavior of a collection of subsystems?

#1 does not necessarily imply #2. Take the classic 3 body problem in physics. Even if you assume that the world works according to Newtonian laws, it turns out that the theory can't be used to predict the simple case of 3 bodies revolving around one another. Only 2 bodies is solvable. That is chaos in action.

Let's assume that the standard theory of corporate finance is a completely accurate model. Then, I think we all agree that mathematically, a stock buyback is completely equivalent to a dividend. You can easily verify this with a simple thought experiment.

However, does that mean that in a market with million buyers and sellers, the two are equal? A dividend is a irreversible transfer of $x of company value into cash for each shareholder. A stock buyback is in theory the same.
Thanks for this more eloquent explanation than mine from which we should ask how many people have tried to feed their family from a theory and failed!

:oops:

fd
I love simulated data. It turns the impossible into the possible!
User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by ogd »

Chan_va wrote:For every mathematical model of some phenomena, we can ask

1) Does the model accurately predict the behavior of a subset of the entire system?
2) Can the model predict the behavior of a collection of subsystems?

#1 does not necessarily imply #2. Take the classic 3 body problem in physics. Even if you assume that the world works according to Newtonian laws, it turns out that the theory can't be used to predict the simple case of 3 bodies revolving around one another. Only 2 bodies is solvable. That is chaos in action.

Let's assume that the standard theory of corporate finance is a completely accurate model. Then, I think we all agree that mathematically, a stock buyback is completely equivalent to a dividend. You can easily verify this with a simple thought experiment.

However, does that mean that in a market with million buyers and sellers, the two are equal? A dividend is a irreversible transfer of $x of company value into cash for each shareholder. A stock buyback is in theory the same.
I can't resist a good physics analogy!!!

So indeed 3 bodies is chaotic, 4 bodies not a chance in heck, and we can keep going... clearly 10^9 bodies, or, worse, 6e23 unpredictable quantum critters should be beyond the abilities of even an army of Hawkings, right? But in practice we have astrophysics and gas laws, respectively, giving us simple and elementary insights out of that suddenly smooth chaos.

What's the equivalent here? What I said above: if there were systematic mispricings around either dividends or buybacks, we'd see relevant fund strategies succeed wildly. But we don't, so the chaos is smooth overall. And unlike physics, if we did see such funds their very success would eventually drive the statistical discrepancy to zero.
User avatar
Chan_va
Posts: 869
Joined: Wed Dec 05, 2012 6:15 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Chan_va »

ogd wrote: What's the equivalent here? What I said above: if there were systematic mispricings around either dividends or buybacks, we'd see relevant fund strategies succeed wildly. But we don't, so the chaos is smooth overall. And unlike physics, if we did see such funds their very success would eventually drive the statistical discrepancy to zero.
ogd, I agree that there are average properties that can emerge out of chaos. However, I don't think your arbitrage theory holds. A fund couldn't systematically determine mispricings since they would be chaotic, and hence unpredictable.

Another physics analogy :) A dividend is like making a measurement on a quantum system. It forces the wave-function to collapse to a defined value at that time. A buyback does not.
User avatar
ogd
Posts: 4876
Joined: Thu Jun 14, 2012 11:43 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by ogd »

Chan_va wrote:ogd, I agree that there are average properties that can emerge out of chaos. However, I don't think your arbitrage theory holds. A fund couldn't systematically determine mispricings since they would be chaotic, and hence unpredictable.
They could come up with a theory of systematic mispricing and buy as many events as they can affected by that mispricing; e.g. all the buyback stocks after their buybacks. Then they would extract a consistent bias out of the chaos, enough (over hundreds of securities and thousands of events) to ovewhelm the risk penalty from individual events. Such a theory of mispricing is, I think, what's hinted at here.
Chan_va wrote:Another physics analogy A dividend is like making a measurement on a quantum system. It forces the wave-function to collapse to a defined value at that time. A buyback does not.
Thanks for the continued analogy, I am having a blast :D So the wave-function collapse has IMHO the strange observational effect of influencing the executives that created the wave-function, for example to forsake a great investment opportunity in order to not reduce the upcoming dividend. I prefer not to observe the collapse and just demand that they do as well as they can for my total return.

And as always my pet peeve is that the wavefunction collapse costs me 5-10% in tax deferral, since I'm not actually spending the dividend. Hmmm, let's try this one: a quantum computer works much better with uncollapsed wave-functions; if you insist on collapsing every time you get a classical computer and a significant penalty in computing power. Perhaps a bit forced, this last one :mrgreen:
Beliavsky
Posts: 1233
Joined: Sun Jun 29, 2014 10:21 am

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Beliavsky »

FinancialDave wrote:
backpacker wrote:^Yes. Share buybacks aren't really cash payments to shareholders who continue owning the stock.

Suppose you, nisiprius, and I each own equal shares in a company worth $200. The company then makes $100 in cash and is worth $300. We each now own shares worth $100. Next, the company buys all of nisiprius' shares. Now the company is worth $200 and has two investors. So our shares are each still worth $100. The buyback didn't result in either of us having more cash or even in having shares that were more valuable that we could sell for cash.

Hmmm... Maybe buybacks are like dividends in the following sense? They help companies get rid of cash that they don't know how to use in a way that preserves shareholder value. Like dividends, this may suggest that a company is "shareholder friendly."
Let's be clear about one thing - buybacks and dividends are not at all equal.

Dividends are cash in your pocket which can NOT be affect by "Mr. Market, or spent by anyone but you."

Buybacks are really NOTHING in your pocket and are 100% dependent on "Mr. Market," and other investors perceived value of the stock.
Buybacks are equivalent to dividends, in the absence of market frictions, because if you want the "cash in your pocket" you just need to sell some shares. If a company buys back 4% of its shares in a year, instead of paying a 4% dividend, just sell 4% of your shares if you want the cash.
FinancialDave
Posts: 1819
Joined: Thu May 26, 2011 9:36 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by FinancialDave »

Beliavsky wrote:
FinancialDave wrote:
backpacker wrote:^Yes. Share buybacks aren't really cash payments to shareholders who continue owning the stock.

Suppose you, nisiprius, and I each own equal shares in a company worth $200. The company then makes $100 in cash and is worth $300. We each now own shares worth $100. Next, the company buys all of nisiprius' shares. Now the company is worth $200 and has two investors. So our shares are each still worth $100. The buyback didn't result in either of us having more cash or even in having shares that were more valuable that we could sell for cash.

Hmmm... Maybe buybacks are like dividends in the following sense? They help companies get rid of cash that they don't know how to use in a way that preserves shareholder value. Like dividends, this may suggest that a company is "shareholder friendly."
Let's be clear about one thing - buybacks and dividends are not at all equal.

Dividends are cash in your pocket which can NOT be affect by "Mr. Market, or spent by anyone but you."

Buybacks are really NOTHING in your pocket and are 100% dependent on "Mr. Market," and other investors perceived value of the stock.
Buybacks are equivalent to dividends, in the absence of market frictions, because if you want the "cash in your pocket" you just need to sell some shares. If a company buys back 4% of its shares in a year, instead of paying a 4% dividend, just sell 4% of your shares if you want the cash.
That's just crazy logic, because I would hope you know if the company also issues 4% new shares to it's company executives, like most large companies do, the buyback has gained you nothing!

fd
I love simulated data. It turns the impossible into the possible!
User avatar
nisiprius
Advisory Board
Posts: 52211
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by nisiprius »

Beliavsky wrote:
FinancialDave wrote:Let's be clear about one thing - buybacks and dividends are not at all equal.

Dividends are cash in your pocket which can NOT be affect by "Mr. Market, or spent by anyone but you."

Buybacks are really NOTHING in your pocket and are 100% dependent on "Mr. Market," and other investors perceived value of the stock.
Buybacks are equivalent to dividends, in the absence of market frictions, because if you want the "cash in your pocket" you just need to sell some shares. If a company buys back 4% of its shares in a year, instead of paying a 4% dividend, just sell 4% of your shares if you want the cash.
Well, I agree with both of these... sort of. I stick at the word "equivalent,", though. To amplify what FinancialDave said:

It is the thing I mentioned earlier. "Tightly coupled" is not really the same as "equivalent." The two situations may be quantitatively so similar under all normal circumstances that a sane person shouldn't care about the difference, but they are not the same.

The reason is that even though a share of stock is entitles you to a) vote, and b) receive a share of dividends, as far as I know you do not have a legal right to redeem your share of stock for your share of the company's assets. You cannot walk up to the counter at 3135 Easton Turnpike, Fairfield, CT, hand over a certificate for 100 shares of stock, demand 1/100,000,000th of GE's assets, and receive a cardboard boxful of $2,500 worth of tungsten wire and jet engine parts.

When a dividend is paid, if you own 100 shares of GE stock, GE mails you a check for $39. There is no market transaction and no third party is involved. Money moves directly, immediately, and irrevocably from the company's earnings into your checking account. What you do with it then is up to you--perhaps you feel like using it to buy more shares of the company, but you don't have to.

If there is a buyback instead, perhaps everyone can see that there is $39 with your name on it, sitting in a Scrooge McDuck money bin behind a glass window inside the company somewhere, but the company will not pay it to you. If you say "Gee, I'd rather have $39 cash instead of $39 in price appreciation," the company will not give it to you. You get it from a third party. You need to go to the marketplace and find a buyer who
  • agrees that 100 shares of stock are now represent an extra $39 more in tungsten wire and jet engine parts than it did before, and
  • is ready, willing, and able to buy it from you at that price.
You can argue all you like that any buyer ought to agree to the $39 figure, and you can argue all you like that under normal conditions you can always find such a buyer, but it is still a marketplace transaction and you still receive the money from a third party. You have not received it from the company itself, nor have you liquidated the extra company assets you "own" as a result of the buyback.

They may be so closely coupled that for investing purposes the difference should not matter, but they are not equivalent.

I don't see why people have trouble acknowledging a difference between
  • a direct transfer of money from company to shareholder, versus
  • a market-based transaction involving a third party, which logically should be, and in practice usually is, a transfer of almost the identical amount of money from the third party to the shareholder
.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.
User avatar
JoMoney
Posts: 16260
Joined: Tue Jul 23, 2013 5:31 am

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by JoMoney »

FinancialDave wrote: ...
That's just crazy logic, because I would hope you know if the company also issues 4% new shares to it's company executives, like most large companies do, the buyback has gained you nothing!

fd
Regardless of new share issuance, you've gained more from the buyback than if there was no buyback. Any new share issuance would have a larger dilutive affect without the buyback. Buybacks have been largely accretive, it's not a wash with executive compensation the way you imply. It could probably be done better, and there probably are some interests involved that don't put the common share holder first. It might be that dividends would give shareholders more options, and the choice of doing what they prefer, but hypothetical what ifs don't change anything. Buybacks and dividends are both good things for share holders.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham
Valuethinker
Posts: 49023
Joined: Fri May 11, 2007 11:07 am

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by Valuethinker »

FinancialDave wrote:
backpacker wrote:^Yes. Share buybacks aren't really cash payments to shareholders who continue owning the stock.

Suppose you, nisiprius, and I each own equal shares in a company worth $200. The company then makes $100 in cash and is worth $300. We each now own shares worth $100. Next, the company buys all of nisiprius' shares. Now the company is worth $200 and has two investors. So our shares are each still worth $100. The buyback didn't result in either of us having more cash or even in having shares that were more valuable that we could sell for cash.

Hmmm... Maybe buybacks are like dividends in the following sense? They help companies get rid of cash that they don't know how to use in a way that preserves shareholder value. Like dividends, this may suggest that a company is "shareholder friendly."
Let's be clear about one thing - buybacks and dividends are not at all equal.

Dividends are cash in your pocket which can NOT be affect by "Mr. Market, or spent by anyone but you."

Buybacks are really NOTHING in your pocket and are 100% dependent on "Mr. Market," and other investors perceived value of the stock.

Let's not get hung up on what you might think is the intrinsic worth of a company!

fd
You can tender your shares in the buyback and shrink your holding in proportion to the amount bought back.

OR

you don't tender your shares, and your share of the company's profits (and cash) is increased.

If you invest in private companies, sometimes this is done. Management wants to stay in place, and there is no liquid secondary market for the company's shares. So the company tenders to all shareholders offering a price, and the shareholders can offer as much or as little of their stock as they wish.

With a big quoted company the company gets a broker to buy the shares in the market, but it has the same net effect: there are fewer shares in issue and so my shares are worth more.
FinancialDave
Posts: 1819
Joined: Thu May 26, 2011 9:36 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by FinancialDave »

JoMoney wrote:
FinancialDave wrote: ...
That's just crazy logic, because I would hope you know if the company also issues 4% new shares to it's company executives, like most large companies do, the buyback has gained you nothing!

fd
Regardless of new share issuance, you've gained more from the buyback than if there was no buyback. Any new share issuance would have a larger dilutive affect without the buyback. Buybacks have been largely accretive, it's not a wash with executive compensation the way you imply. It could probably be done better, and there probably are some interests involved that don't put the common share holder first. It might be that dividends would give shareholders more options, and the choice of doing what they prefer, but hypothetical what ifs don't change anything. Buybacks and dividends are both good things for share holders.
I am not sure -- when a company such as GE buys back a bunch of stock at $30 a share and then resells it for $20 a few short years later, how is that helpful. If they had just kept the cash they would not have had to cut the dividend by 2/3rds and have everyone suffer.

Buybacks are the fortune tellers currency -- or hopium, as some people like to call it, betting that the money spent will be able to be used to an advantage - but just as my example above, once you have spent the money on your stock, you no longer have the cash to use in an emergency or for something that creates positive cash flow.

fd
I love simulated data. It turns the impossible into the possible!
FinancialDave
Posts: 1819
Joined: Thu May 26, 2011 9:36 pm

Re: Stock Dividend Yields & Share Buybacks — A Surprise

Post by FinancialDave »

Let's look at a more simple analogy.

A dividend is at the instant it occurs a cash transfer of some of a corporation's net worth into YOUR pocket.

A buyback is at the instant it occurs NO transfer of net worth to anyone.

What happens afterward is the fortune tellers folly.

fd

P.S. No disrespect meant to the fortune tellers!
I love simulated data. It turns the impossible into the possible!
Post Reply