Dividends vs buybacks

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selters
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Dividends vs buybacks

Post by selters » Sun Jul 23, 2017 4:45 am

As we all know, dividends are old-fashioned and tax-inefficient. Wouldn't it be a lot better of all companies stopped paying dividends and started using share repurchases as their sole means of returning cash to shareholders?

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celia
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Re: Dividends vs buybacks

Post by celia » Sun Jul 23, 2017 5:03 am

A share buyback is done on the open market, not on your shares, unless you want to sell them. (After you sell them, you won't get dividends or buyback offers any more.)

When there are fewer outstanding shares on the market, they are then worth more. But you won't benefit from this until you sell your shares.

If you want a somewhat steady stream of money each year, getting dividends is one way to do it. And if they are "qualified" dividends, they are taxed favorably, at the 0% or 20% rate. So I want my dividends while keeping my shares.

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Re: Dividends vs buybacks

Post by MotoTrojan » Sun Jul 23, 2017 5:28 am

celia wrote:A share buyback is done on the open market, not on your shares, unless you want to sell them. (After you sell them, you won't get dividends or buyback offers any more.)

When there are fewer outstanding shares on the market, they are then worth more. But you won't benefit from this until you sell your shares.

If you want a somewhat steady stream of money each year, getting dividends is one way to do it. And if they are "qualified" dividends, they are taxed favorably, at the 0% or 20% rate. So I want my dividends while keeping my shares.
Steady income stream could be achieved from a 0% dividend yield stock, sold periodically. No?

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Re: Dividends vs buybacks

Post by z3r0c00l » Sun Jul 23, 2017 6:10 am

Yes imagine if Kodak only did share buybacks for those decades... today your shares would be worth some multiplier of zero. Dividends are only a problem because of current and arbitrary aspects of tax code. There is a valid reason why companies should pass profits directly through to shareholders rather than hording it. In the event of a scandal or even a prolonged downturn in the industry, the company will burn through that cash quickly leaving shareholders with nothing. A stock like Enron is a good example, swelling into the tens of billions in market cap and then promptly going to zero. If taxes allowed it, I would much prefer dividends that could be reinvested in the whole stock market rather than having a company like Apple that just swells in size dramatically and then someday fades to zero once the industry moves on or they are determined to have lied about profits. Perhaps one can sell the shares at a high during retirement, or perhaps one will be unlucky and not have anything. I welcome the behavior dividends enforce in management, an emphasis on steady profit rather than endless and unsustainable growth in share price at any cost. That is how you get Enrons in the first place.

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Watty
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Re: Dividends vs buybacks

Post by Watty » Sun Jul 23, 2017 7:24 am

Dividends vs buybacks
Most companies also have a third option which would be to pay down debt.

One problem to watch out for with buybacks is that at the same time they are buying back shares of their stock some companies are also giving employees lots of stock options so that they number of shares of outstanding stock may not actually be decreasing. The stock buybacks will tend to hide the impact of issuing all the stock options.

Another problem with stock buybacks is that if they work as planned they should in theory cause the stock price to increase by the same percentage that that a dividend would have paid, for example 2% a year. This means that employee stock options will increase in value by 2% a year even is the company's stock price would otherwise have been flat. This is significant incentive for company executives to favor stock buybacks instead of paying dividends so you have to take what they say with a grain of salt.

Choosing to do stock buybacks while a company has debt is in effect taking out a loan to do the stock buyback. The same is true with dividends but at least in that case they don't have the conflicts I mentioned above.

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Re: Dividends vs buybacks

Post by jbolden1517 » Sun Jul 23, 2017 8:03 am

selters wrote:As we all know, dividends are old-fashioned and tax-inefficient.
No we don't. The price for a stock is ultimately the discounted value of its stream of future dividends (including a final M&A payout as a dividend). Stocks that never pay dividends are worth $0. Investors in the aggregate have already lost whatever the current market cap of that company, they just haven't realized those loses yet. The only question is how those loses are going to be distributed among investors.

Moreover the stream of realized dividends is discounted at a much lower rate than streams of future dividends.
When you are computing yield: (current dividend) + (dividend growth due to inflation) + (dividend growth due to changes in payout structure) +(dividend growth due to real earnings growth).

(current dividend) and (dividend growth due to inflation) get a much lower discount because they are much safer than (dividend growth due to real earnings growth). They together are sort of like the high yield bond equivalent of TIPS. (dividend growth due to changes in payout structure) gets a higher discount. (dividend growth due to real earnings growth) is a high risk asset for which an investor should demand a high return.

The value of a company changes with its payout structure. One of the legitimate ways a company can raise its stock price and thus be able to access the equity markets for later rounds of financing, for example to deleverage, is changing its dividend policy.
selters wrote: Wouldn't it be a lot better of all companies stopped paying dividends and started using share repurchases as their sole means of returning cash to shareholders?
No. Under most conditions share buybacks are harmful to buy and hold investors. One of the very good things that index funds are doing is punishing buybacks and having them play less of a role in the broader market.

Here is why. Most stocks have a P/B over 1, especially when they are doing buybacks.
Let's take a stock with a P/B of 5. Say the company is worth $5b. Say it has $2b in productive assets returning $200m / yr. That return is growing at 5%. They are paying a 5% interest charge on the $1b in debt and reinvesting profits into assets to get the growth. They are borrowing at 5% and earning 10% on the money.
So earnings are (200m - 50m). P/E is 33.33. The high P/E is caused by the fact that earnings growth is 6.7% on top of the 3% earnings
earnings + earnings growth is 10.7%. This is a growth stock but not a bubble stock. A garp investor might carry this stock. I'm being fair here.

Now let's have them buy back $1b in shares. That surge in buying causes a rise in price. Let's say it isn't too extreme. But the P/B goes from 5 to 6 during the buying surge. At that price they can buyback 16.7% of outstanding shares. What does the company look like?
It still has $2b in productive assets returning $200m / yr. growing at 5%.
They now have $2b in debt, The new debt isn't backed by assets at the same ratio. Bond holders rightfully don't like their money going sideways. Your share of the equity on company assets are gone to the bond holders after the extra $1b. Their collateral matches the debt. The bondholders don't have a cushion. So that new debt is at 8%. For you the P/B is infinite now because debt matches the productive assets. For the bondholders this is high yield debt not high quality corporate debt.
Earnings are (210m-50-80) = 80m. Earnings growth in theory has doubled however to 12.5%, the fun of leverage.
There are 1/6th fewer shares. So to the investor who held only saw their share of earnings drop from their percentage of 150m to same percentage on 96m they didn't experience the entire drop.
So price went up by 16.7% (the increase in P/B from 5 to 6, increased P/E to 40). Earnings dropped from 150m to 96m. The new P/E is 62.5.
This stock is based on 1.6% earnings and 12.5% earnings growth = 14.1%. Which looks better than 10.7%.

But there is a problem. They now have to borrow at 8% to earn 10%. Their existing 5% bond with no equity is going to rollover at 8% not at the same 5%. The company is now paying higher interest on its debt because the bondholders have less margin. That first $1b in debt rolls over at 8% and not 5%. Which means you just wiped out 3 years earnings growth on the assets. They are going to be in a desperate struggle to hit that 12.5% target. There is still growth borrowing at 8% and earning 10% so the company isn't going to go broke. But you are sitting on a P/E 62.5 stock with no earnings growth for 3 years which means you likely lose about 5/6ths of your share price almost instantly as they struggle with financing their debt. If that doesn't happen and they handle debt financing well you go through almost 20 years of earnings growth to get the P/E down to a sane level. So say you don't experience any capital gains for two decades while this now highly leveraged company handles its debt problem. And all this for that one time 16.7% return from the buy back.

You took a 10% semi-safe return and converted it into a 16.7% "windfall" and a real possibility of almost no return for 2-decades, under the best case and a 80% stock drop in the worst case.

Hope this helps.
Last edited by jbolden1517 on Sun Jul 23, 2017 8:11 am, edited 4 times in total.

jbolden1517
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Re: Dividends vs buybacks

Post by jbolden1517 » Sun Jul 23, 2017 8:06 am

Watty wrote:
Dividends vs buybacks
Most companies also have a third option which would be to pay down debt.

One problem to watch out for with buybacks is that at the same time they are buying back shares of their stock some companies are also giving employees lots of stock options so that they number of shares of outstanding stock may not actually be decreasing. The stock buybacks will tend to hide the impact of issuing all the stock options.

Another problem with stock buybacks is that if they work as planned they should in theory cause the stock price to increase by the same percentage that that a dividend would have paid, for example 2% a year. This means that employee stock options will increase in value by 2% a year even is the company's stock price would otherwise have been flat. This is significant incentive for company executives to favor stock buybacks instead of paying dividends so you have to take what they say with a grain of salt.

Choosing to do stock buybacks while a company has debt is in effect taking out a loan to do the stock buyback. The same is true with dividends but at least in that case they don't have the conflicts I mentioned above.
All excellent points.

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SimpleGift
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Re: Dividends vs buybacks

Post by SimpleGift » Sun Jul 23, 2017 8:27 am

selters wrote:As we all know, dividends are old-fashioned and tax-inefficient. Wouldn't it be a lot better of all companies stopped paying dividends and started using share repurchases as their sole means of returning cash to shareholders?
For a good empirical analysis of your question (buybacks vs. dividends, vs. debt reduction, vs. investment), see this 2016 study by McKinsey & Company: How Share Repurchases Boost Earnings Without Improving Returns

In the case of buybacks vs. dividends: If a company pays a dividend, shareholders retain their shares and receive cash. If the company repurchases shares, the selling shareholders receive cash and the remaining shareholders have shares with higher value (but they don’t receive any cash). Overall, there is no change in value, just a change in the mix of shareholders.
Cordially, Todd

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TD2626
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Re: Dividends vs buybacks

Post by TD2626 » Sun Jul 23, 2017 8:48 am

One should favor a total return approach in general, and especially in tax advantaged, in my opinion. However, note that in theory (Modigliani-Miller), it shouldn't matter whether returns to shareholders are in the form of buybacks or dividends. One can either use this to argue for a total return approach, or one can use it to defend the acceptability of a dividend stock or growth/buyback stock tilt. (If it doesn't affect total return too much, a tilt could be more defensible).

A dividend tilt is reasonable for convinience in my opinion. If one wants regular income in taxable without the hassle of tracking down cost basis and making regular spec id sales, a small tilt toward higher dividend yeild may be reasonable in my opinion.

A tilt toward growth type companies or companies that have most or all of their return in the form of buybacks could be reasonable in other situations. One could, in taxable, hold a portfolio of stocks that appreciate only through buybacks, never sell and never pay any taxes (in theory). One's heirs would get a step up in basis so no taxes would ever have to be paid.

Note that this analysis doesn't account for the possibility that growth and value could have different characteristics according to Fama-French theory.

Also, note that implementation should at most be in the form of a small tilt toward, say, buyback-focused companies or dividend-focused companies...one would still want exposure to the full market via a TSM type fund. There are diversification benefits to that over the long run. Also note that all stock investing is risky and overall asset allocation (stocks/bonds/cash) is far more important than what kinds of stocks/funds one buys.

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Re: Dividends vs buybacks

Post by snarlyjack » Sun Jul 23, 2017 8:49 am

jbolden1517,

I just graduated with a B.S. Degree in Finance (about a year ago).
When I was studying Finance the main analysis was what is a stock worth.
We always used the dividend level to help us get to fair market value.

It is really hard for me to figure out what a stock is worth if they
don't pay a dividend. It's kind of like the "bigger fool theory", it's
more of a emotional worth than a accounting worth. I much prefer
stocks that pay a dividend because I can analyze them. What I
don't like about the TSM & S & P 500 is at least 25% of the stocks
in the S & P 500 don't pay a dividend and more than 25% of the
TSM doesn't pay a dividend. Both funds perform very good but...

I agree with your analysis of the stock level to the bond level.
Their are checks & balances in Finance or the Bond Vigilantes
come out of the woodwork & start readjusting prices & worth.

Keep in mind that I only have a B.S. Degree in Finance NOT a
Masters or PHD level. This whole accounting worth can get
super complicated very quickly. But as a whole I agree with you!
Once a person starts to analyze small non dividend stocks &
international stocks it can be unbelievably complicated. Especially
since they have different accounting rules. That's why people buy
index funds. Throw your money into the pot & hope for the best
and get on with life...Sometimes in life that's the best you can do!

Thank You for your insight!

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SimpleGift
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Re: Dividends vs buybacks

Post by SimpleGift » Sun Jul 23, 2017 9:34 am

Why not dividends AND buybacks? Combined, they've provided a healthy return to shareholders since the 1980s:
  • • Dividend Yield = Trailing 12 months cash dividends / Market capitalization
    • Net Buyback Yield = (Trailing 12 month stock repurchases - stock issuances) / Market capitalization
In fact, if dividends and net buybacks continue at their recent pace, investors can expect to earn at least 3%-4% (real) on their U.S. large-cap stock investments — assuming no change in valuations.
Cordially, Todd

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BolderBoy
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Re: Dividends vs buybacks

Post by BolderBoy » Sun Jul 23, 2017 9:41 am

jbolden1517 wrote:Stocks that never pay dividends are worth $0.
Can you explain this a bit more. I believe that M$FT didn't pay dividends for decades.
"Never underestimate one's capacity to overestimate one's abilities" - The Dunning-Kruger Effect

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Re: Dividends vs buybacks

Post by snarlyjack » Sun Jul 23, 2017 9:53 am

BolderBoy,

Watch this quick video by Kevin O'Leary, it
might answer your question on how I look at things.
Kevin O'Leary has his problems but he is a
good/interesting storyteller.

https://www.bing.com/videos/search?q=ke ... ORM=VRDGAR

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Re: Dividends vs buybacks

Post by jebmke » Sun Jul 23, 2017 10:03 am

BolderBoy wrote:
jbolden1517 wrote:Stocks that never pay dividends are worth $0.
Can you explain this a bit more. I believe that M$FT didn't pay dividends for decades.
Google has never paid a dividend, right?
When you discover that you are riding a dead horse, the best strategy is to dismount.

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Ketawa
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Re: Dividends vs buybacks

Post by Ketawa » Sun Jul 23, 2017 10:37 am

BolderBoy wrote:
jbolden1517 wrote:Stocks that never pay dividends are worth $0.
Can you explain this a bit more. I believe that M$FT didn't pay dividends for decades.
The statement has no applicability to the real world. If it was truly impossible for a company to pay a dividend, that could be a problem. In the real world, companies that have never paid a dividend have the option to at some point in the future. That option means they can still be valued by the market based on their fundamentals. And of course, they could also return value to shareholders with stock buybacks, or they could be bought out by another company.

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Re: Dividends vs buybacks

Post by jbolden1517 » Sun Jul 23, 2017 12:52 pm

snarlyjack wrote:jbolden1517,

I just graduated with a B.S. Degree in Finance (about a year ago).
When I was studying Finance the main analysis was what is a stock worth.
We always used the dividend level to help us get to fair market value.

It is really hard for me to figure out what a stock is worth if they
don't pay a dividend. It's kind of like the "bigger fool theory", it's
more of a emotional worth than a accounting worth. I much prefer
stocks that pay a dividend because I can analyze them.
Me too. I'll use earnings yield if I can see where the earnings are going. If I can't I don't buy. There are many many assets no reason to hold ones I don't like.
snarlyjack wrote: I agree with your analysis of the stock level to the bond level.
Their are checks & balances in Finance or the Bond Vigilantes
come out of the woodwork & start readjusting prices & worth.
For corporate debt yes, the bond market while high is still functioning relative to government debt.
snarlyjack wrote: Keep in mind that I only have a B.S. Degree in Finance NOT a
Masters or PHD level. This whole accounting worth can get
super complicated very quickly. But as a whole I agree with you!
Once a person starts to analyze small non dividend stocks &
international stocks it can be unbelievably complicated. Especially
since they have different accounting rules. That's why people buy
index funds. Throw your money into the pot & hope for the best
and get on with life...Sometimes in life that's the best you can do!

Thank You for your insight!
I'm not a finance guy either but thank you for the complement and kind words. Good talking to you.

CantPassAgain
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Re: Dividends vs buybacks

Post by CantPassAgain » Sun Jul 23, 2017 1:05 pm

Ketawa wrote:
BolderBoy wrote:
jbolden1517 wrote:Stocks that never pay dividends are worth $0.
Can you explain this a bit more. I believe that M$FT didn't pay dividends for decades.
The statement has no applicability to the real world. If it was truly impossible for a company to pay a dividend, that could be a problem. In the real world, companies that have never paid a dividend have the option to at some point in the future. That option means they can still be valued by the market based on their fundamentals. And of course, they could also return value to shareholders with stock buybacks, or they could be bought out by another company.
You are too kind. The statement is patently ridiculous, and completely false.

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celia
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Re: Dividends vs buybacks

Post by celia » Sun Jul 23, 2017 2:07 pm

MotoTrojan wrote:
celia wrote:A share buyback is done on the open market, not on your shares, unless you want to sell them. (After you sell them, you won't get dividends or buyback offers any more.)

When there are fewer outstanding shares on the market, they are then worth more. But you won't benefit from this until you sell your shares.

If you want a somewhat steady stream of money each year, getting dividends is one way to do it. And if they are "qualified" dividends, they are taxed favorably, at the 0% or 20% rate. So I want my dividends while keeping my shares.
Steady income stream could be achieved from a 0% dividend yield stock, sold periodically. No?
No. That's not income. That's just getting your principle back and the number of shares shrink until you have no more.

For example, suppose you put money into a checking account paying 0% interest. What happens when you "spend" some of it?

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Re: Dividends vs buybacks

Post by willthrill81 » Sun Jul 23, 2017 2:21 pm

celia wrote:
MotoTrojan wrote:
celia wrote:A share buyback is done on the open market, not on your shares, unless you want to sell them. (After you sell them, you won't get dividends or buyback offers any more.)

When there are fewer outstanding shares on the market, they are then worth more. But you won't benefit from this until you sell your shares.

If you want a somewhat steady stream of money each year, getting dividends is one way to do it. And if they are "qualified" dividends, they are taxed favorably, at the 0% or 20% rate. So I want my dividends while keeping my shares.
Steady income stream could be achieved from a 0% dividend yield stock, sold periodically. No?
No. That's not income. That's just getting your principle back and the number of shares shrink until you have no more.

For example, suppose you put money into a checking account paying 0% interest. What happens when you "spend" some of it?
Yes, it is absolutely income and mathematically provable to be such, given that the stock is increasing in value along the way (i.e. capital appreciation).

I put $1,000 into a mutual fund. It grows in value to $1,500 and I now sell $500 worth of shares. I still have my original $1,000, but I now have $500 of income.
Last edited by willthrill81 on Sun Jul 23, 2017 2:25 pm, edited 1 time in total.
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Re: Dividends vs buybacks

Post by willthrill81 » Sun Jul 23, 2017 2:24 pm

CantPassAgain wrote:
Ketawa wrote:
BolderBoy wrote:
jbolden1517 wrote:Stocks that never pay dividends are worth $0.
Can you explain this a bit more. I believe that M$FT didn't pay dividends for decades.
The statement has no applicability to the real world. If it was truly impossible for a company to pay a dividend, that could be a problem. In the real world, companies that have never paid a dividend have the option to at some point in the future. That option means they can still be valued by the market based on their fundamentals. And of course, they could also return value to shareholders with stock buybacks, or they could be bought out by another company.
You are too kind. The statement is patently ridiculous, and completely false.
Totally bogus.

Let's say that I buy a business outright. I never take any profit that the business generates because I don't need it or want it. As the business retains this profit, it becomes increasingly valuable. Eventually, I get tired of this business and sell it. Is it worth nothing because I chose to leave the profit in the business? Of course not.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Dividends vs buybacks

Post by nedsaid » Sun Jul 23, 2017 3:00 pm

selters wrote:As we all know, dividends are old-fashioned and tax-inefficient. Wouldn't it be a lot better of all companies stopped paying dividends and started using share repurchases as their sole means of returning cash to shareholders?
I would rather have dividends than share buybacks. First of all, companies often do not follow through on buyback announcements. Second, I remember companies buying back stock only to turn around to issue it back to employees as incentive compensation. Sometimes, this was done through stock options. Boards of Directors are very reluctant to cut dividend payments though it has happened.

But yes, in theory, share buybacks should be more efficient to the investor.
A fool and his money are good for business.

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Re: Dividends vs buybacks

Post by willthrill81 » Sun Jul 23, 2017 3:03 pm

nedsaid wrote:I would rather have dividends than share buybacks. First of all, companies often do not follow through on buyback announcements. Second, I remember companies buying back stock only to turn around to issue it back to employees as incentive compensation. Sometimes, this was done through stock options. Boards of Directors are very reluctant to cut dividend payments though it has happened.
In both of those instances, there was no net buyback. Clearly, a dividend is better than no net buyback.

I'd rather get my income when I want it rather than when the board wants to give it to me.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Dividends vs buybacks

Post by chinto » Sun Jul 23, 2017 3:27 pm

Dividends are very logical, in the overall scheme of things you take an equity stake in a company in order to get a return on your investment and a dividend represents this idea in its purest form. Taxation simply muddies the water.

Share buybacks are loved by CEOs and the board of directors because for many it is the basis for their compensation. I wonder how much better off the company would be if they were simply granted shares they could never sell and had to rely on a steady stream of dividends for their compensation? That would force them to carefully weigh the value of mergers and acquisitions as well as make sure there were strategically investing to keep dividends in the pipeline in the long term. Right now, CEOs and the board of directors have a short term focus, aimed often at driving up share price at any cost in order to allow them to cash out.
Last edited by chinto on Sun Jul 23, 2017 6:34 pm, edited 1 time in total.

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Re: Dividends vs buybacks

Post by MotoTrojan » Sun Jul 23, 2017 3:30 pm

celia wrote:
MotoTrojan wrote:
celia wrote:A share buyback is done on the open market, not on your shares, unless you want to sell them. (After you sell them, you won't get dividends or buyback offers any more.)

When there are fewer outstanding shares on the market, they are then worth more. But you won't benefit from this until you sell your shares.

If you want a somewhat steady stream of money each year, getting dividends is one way to do it. And if they are "qualified" dividends, they are taxed favorably, at the 0% or 20% rate. So I want my dividends while keeping my shares.
Steady income stream could be achieved from a 0% dividend yield stock, sold periodically. No?
No. That's not income. That's just getting your principle back and the number of shares shrink until you have no more.

For example, suppose you put money into a checking account paying 0% interest. What happens when you "spend" some of it?
We can agree to disagree. Comparing a zero/low dividend stock to a checking account is not a reasonable thought. If I bought 10,000 shares of Amazon, Netflix, or Dominos 10 years ago, it would take quite some number of sold shares before I was dipping into my "principal".

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Re: Dividends vs buybacks

Post by willthrill81 » Sun Jul 23, 2017 3:41 pm

MotoTrojan wrote:
celia wrote:
MotoTrojan wrote:
celia wrote:A share buyback is done on the open market, not on your shares, unless you want to sell them. (After you sell them, you won't get dividends or buyback offers any more.)

When there are fewer outstanding shares on the market, they are then worth more. But you won't benefit from this until you sell your shares.

If you want a somewhat steady stream of money each year, getting dividends is one way to do it. And if they are "qualified" dividends, they are taxed favorably, at the 0% or 20% rate. So I want my dividends while keeping my shares.
Steady income stream could be achieved from a 0% dividend yield stock, sold periodically. No?
No. That's not income. That's just getting your principle back and the number of shares shrink until you have no more.

For example, suppose you put money into a checking account paying 0% interest. What happens when you "spend" some of it?
We can agree to disagree. Comparing a zero/low dividend stock to a checking account is not a reasonable thought. If I bought 10,000 shares of Amazon, Netflix, or Dominos 10 years ago, it would take quite some number of sold shares before I was dipping into my "principal".
The problem arises when people think that a certain number of shares represents their principal rather than the dollar value of the shares they own. Many, many misconceptions arise when this is reasoning used.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Dividends vs buybacks

Post by Valuethinker » Sun Jul 23, 2017 4:20 pm

nedsaid wrote:
selters wrote:As we all know, dividends are old-fashioned and tax-inefficient. Wouldn't it be a lot better of all companies stopped paying dividends and started using share repurchases as their sole means of returning cash to shareholders?
I would rather have dividends than share buybacks. First of all, companies often do not follow through on buyback announcements. Second, I remember companies buying back stock only to turn around to issue it back to employees as incentive compensation. Sometimes, this was done through stock options. Boards of Directors are very reluctant to cut dividend payments though it has happened.

But yes, in theory, share buybacks should be more efficient to the investor.
This is the nub of it.

Modigliani and Miller showed that the Dividend policy of a company is irrelevant to its final value in the absence of:

- taxes
- agency costs (informational asymmetries between managers and owners i.e. shareholders so that the owners cannot write a contract which governs every possible conflict of interest)

Corollary of that is a shareholder is indifferent between dividends and share buybacks if there are no agency costs or taxes.

Warren Buffett in fact wrote a letter to shareholders explaining that: Berkshire Hathaway buys back shares when he believes they are undervalued, but does not pay dividends (and never has). Note BH gives very few share options (if any).

Microsoft, whose largest shareholder, Bill Gates, is a close personal friend of Buffett's, *does* pay a dividend. However it does not award stock options, AFAIK, but rather Restricted Stock Units. The problem with dividends lowering the value of stock options does not occur then.

It's something of a puzzle why companies pay dividends (and why shareholders welcome them) but the strongest explanation is Agency Costs. Dividends act as a signal from insiders to outside shareholders. In addition, the cash cost of dividends is a break on unnecessary corporate investments made by managers to improve their own positions.

The alternative is the Private Equity/ LBO approach, which is raise the leverage of portfolio companies so that there is little or no free cash flow that can be wasted by management.

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Re: Dividends vs buybacks

Post by celia » Sun Jul 23, 2017 6:15 pm

MotoTrojan wrote:
celia wrote:
MotoTrojan wrote: Steady income stream could be achieved from a 0% dividend yield stock, sold periodically. No?
No. That's not income. That's just getting your principle back and the number of shares shrink until you have no more.

For example, suppose you put money into a checking account paying 0% interest. What happens when you "spend" some of it?
We can agree to disagree. Comparing a zero/low dividend stock to a checking account is not a reasonable thought. If I bought 10,000 shares of Amazon, Netflix, or Dominos 10 years ago, it would take quite some number of sold shares before I was dipping into my "principal".
I was focusing on the "steady income stream" that dividends often provide. Sure, you can sell some shares, but what do you do if they don't grow or they shrink? That does not look like an opportunity to generate a "steady Income stream" unless you eat into your principal.

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Re: Dividends vs buybacks

Post by chinto » Sun Jul 23, 2017 6:39 pm

We can agree to disagree. Comparing a zero/low dividend stock to a checking account is not a reasonable thought. If I bought 10,000 shares of Amazon, Netflix, or Dominos 10 years ago, it would take quite some number of sold shares before I was dipping into my "principal".
True, but not if you bought say Target. It has round tripped essentially back to where I bought it at over a decade ago. Thank gosh I got dividends and reinvested them into the S&P500.

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Re: Dividends vs buybacks

Post by jbolden1517 » Sun Jul 23, 2017 6:45 pm

BolderBoy wrote:
jbolden1517 wrote:Stocks that never pay dividends are worth $0.
Can you explain this a bit more. I believe that M$FT didn't pay dividends for decades.
That’s correct. But it has since then. An investor in 1990 was buying the future stream of dividends not the current yield.
jebmke wrote: Google has never paid a dividend, right?
Correct. But the dividend discount of Google includes those dividends in the future. Given its success it likely will pay dividends. Its generating $27b / yr in cash and growing earnings 13.5-28% depending on how you want to count. Investors are still getting a great return on reinvested capital. No reason for it to pay a dividend yet. Eventually obviously it will and likely it won’t have much problem growing towards a sizable one.
willthrill81 wrote: Let's say that I buy a business outright. I never take any profit that the business generates because I don't need it or want it. As the business retains this profit, it becomes increasingly valuable. Eventually, I get tired of this business and sell it. Is it worth nothing because I chose to leave the profit in the business? Of course not.
Depends. If the next owner is unable to extract profits from the business because it goes under too fast then yes it was worth nothing. If the next owner is able to extract profits then his extracted profits discounted are what it is worth. What he paid you for it is a different matter.

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Re: Dividends vs buybacks

Post by avalpert » Sun Jul 23, 2017 7:02 pm

celia wrote:
MotoTrojan wrote:
celia wrote:
MotoTrojan wrote: Steady income stream could be achieved from a 0% dividend yield stock, sold periodically. No?
No. That's not income. That's just getting your principle back and the number of shares shrink until you have no more.

For example, suppose you put money into a checking account paying 0% interest. What happens when you "spend" some of it?
We can agree to disagree. Comparing a zero/low dividend stock to a checking account is not a reasonable thought. If I bought 10,000 shares of Amazon, Netflix, or Dominos 10 years ago, it would take quite some number of sold shares before I was dipping into my "principal".
I was focusing on the "steady income stream" that dividends often provide. Sure, you can sell some shares, but what do you do if they don't grow or they shrink? That does not look like an opportunity to generate a "steady Income stream" unless you eat into your principal.
And if a company keeps giving out dividends but doesn't grow it's share price will shrink and your investment (including dividends received) will be less than where it started - eating into principal in the same way - the problem isn't that the company was/wasn't paying dividends it was that it was a bad investment.

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Re: Dividends vs buybacks

Post by avalpert » Sun Jul 23, 2017 7:04 pm

chinto wrote:
We can agree to disagree. Comparing a zero/low dividend stock to a checking account is not a reasonable thought. If I bought 10,000 shares of Amazon, Netflix, or Dominos 10 years ago, it would take quite some number of sold shares before I was dipping into my "principal".
True, but not if you bought say Target. It has round tripped essentially back to where I bought it at over a decade ago. Thank gosh I got dividends and reinvested them into the S&P500.
Yes, if you invested in a company that isn't succeeding you would be better off reducing that investment whether via dividends or sales

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Re: Dividends vs buybacks

Post by jbolden1517 » Sun Jul 23, 2017 7:34 pm

Simplegift wrote:Why not dividends AND buybacks? Combined, they've provided a healthy return to shareholders since the 1980s:

In fact, if dividends and net buybacks continue at their recent pace, investors can expect to earn at least 3%-4% (real) on their U.S. large-cap stock investments — assuming no change in valuations.
Excellent graphic! The data you gave credit for is the graphic yours? Buybacks are often terrific for shareholders for low P/B stocks. Most of the time though they are done to boost stock prices when they are already high as my example above shareholders don't benefit much and quite often are harmed. One of the good things about indexing is it is making the buyback strategy less effective and thus shifting companies back toward yield.

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Re: Dividends vs buybacks

Post by HomerJ » Sun Jul 23, 2017 7:50 pm

selters wrote:As we all know, dividends are old-fashioned and tax-inefficient. Wouldn't it be a lot better of all companies stopped paying dividends and started using share repurchases as their sole means of returning cash to shareholders?
(1) Dividends make total sense. I buy 10% of your company, I want 10% of the profits.
(2) Stock buybacks can be totally manipulated. Let's give our executives a ton of stock options, then let's do stock buybacks to bump up the price. The shares you own? You break even because of the stock dilution from the executive options.

Personally, I think the whole idea of NEVER getting a single dime from the company where you are part-owner except when you sell stock to a bigger fool is ludicrous. However, I am a participant in the modern stock market, and it has made me rich, so I guess I shouldn't complain.

Still doesn't make any sense to me.

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Re: Dividends vs buybacks

Post by ny_knicks » Sun Jul 23, 2017 7:50 pm

Dividends to me signal that a company has determined that it cannot reinvest that cash into the business and earn a higher rate of return than its cost to capital. A company like Google doesn't pay a dividend because it believes it can reinvest that money into positive NPV projects that will ultimately bring more value to shareholders in the future. However, these tech companies are amassing huge cash reserves that they can't possibly be utilizing/reinvesting appropriately and so investors are starting to demand some return. Look at Apple and how it has shifted from not paying a dividend pre-2012 to having the largest dividend payout (by dollars not yield) in the world. With companies like Google its valuation is all driven off the premise that investors will forgo the $.10 dividend now for the $1 dividend sometime in the future. There has to be some return or expected return (could come all from terminal value if they are expecting a sale or something) for the shareholder in the future...even if it is way off in the distance.

Buybacks are just another way for companies to reinvest cash. If firms are buying back shares for the right reasons, such as they believe their stock is currently undervalued, than it is a good use of capital. But they can also be a tool for CEOs to manipulate ratios (that their compensation is likely tied to) like EPS or help offset the dilutive effects of things like employee stock options. I am assuming these factors are what often drive companies down this route when they are determining whether to pay a dividend or do a share buyback.

I believe financial theory will say an investor should be indifferent but in practice I believe investors would prefer the actual return of cash instead of relying on the firm to properly execute their buyback plan for the right reasons.

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Re: Dividends vs buybacks

Post by willthrill81 » Sun Jul 23, 2017 8:06 pm

jbolden1517 wrote:
willthrill81 wrote:Let's say that I buy a business outright. I never take any profit that the business generates because I don't need it or want it. As the business retains this profit, it becomes increasingly valuable. Eventually, I get tired of this business and sell it. Is it worth nothing because I chose to leave the profit in the business? Of course not.
Depends. If the next owner is unable to extract profits from the business because it goes under too fast then yes it was worth nothing. If the next owner is able to extract profits then his extracted profits discounted are what it is worth. What he paid you for it is a different matter.
That's a very extenuating and unlikely circumstance. The business will, at a minimum, have almost certainly increased in value by at least the value of the profit left in it during the period that I owned it. Regardless, it's clear that the profit didn't 'disappear'.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Dividends vs buybacks

Post by aegis965 » Sun Jul 23, 2017 8:19 pm

ny_knicks wrote:I believe financial theory will say an investor should be indifferent but in practice I believe investors would prefer the actual return of cash instead of relying on the firm to properly execute their buyback plan for the right reasons.
On whether a firm properly execute their buyback plan for the right reasons, one can divide buybacks into two groups: low conviction (0-5%) and high conviction (5%+), as Patrick O'shaughnessy has done in his research.
Here's the conclusion of the paper:
The common criticism of share buybacks is that they are myopic and mistimed and that the money should be allocated toward capital expenditures and research rather than toward boosting short-term stock prices. At the broad market level—and also for many individual firms—this may be true. Buybacks peaked in 2008 at what turned out to be an inopportune time.
But most of the money spent on buybacks is put forward by firms buying back a fairly low percentage of their shares. On the other hand, firms with high conviction have tended to buy back shares at much cheaper relative valuations than others. In turn, these high conviction firms have gone on to outperform the broader market by large margins, on average, and have done so consistently since 1987.
Whereas peaking buybacks may or may not spell trouble for the market, high conviction buybacks—coupled with quality and attractive valuations—have historically signaled an opportunity.
"Value investing is at its core the marriage of a contrarian streak and a calculator." —Seth Klarman

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Re: Dividends vs buybacks

Post by jbolden1517 » Sun Jul 23, 2017 9:03 pm

willthrill81 wrote:
jbolden1517 wrote:
willthrill81 wrote:Let's say that I buy a business outright. I never take any profit that the business generates because I don't need it or want it. As the business retains this profit, it becomes increasingly valuable. Eventually, I get tired of this business and sell it. Is it worth nothing because I chose to leave the profit in the business? Of course not.
Depends. If the next owner is unable to extract profits from the business because it goes under too fast then yes it was worth nothing. If the next owner is able to extract profits then his extracted profits discounted are what it is worth. What he paid you for it is a different matter.
That's a very extenuating and unlikely circumstance. The business will, at a minimum, have almost certainly increased in value by at least the value of the profit left in it during the period that I owned it. Regardless, it's clear that the profit didn't 'disappear'.
No one is claiming it did. A company can make tons of money for many years and then lose it all before they pay a dividend. The discounted value of future dividends is $0. A company can be losing money and have foolish financiers allowing it to pay out a dividend for 5 years. Those five years of dividends create the value for the stock. A stock is worth ultimately what it pays out. The underlying business is closely connected to the payout but the two aren't identical. The relationship between the stock and business is very close to the relationship between a call option and a stock, they move together but it isn't 1::1. Think of a stock as a call on the assets with a strike price equal to the required debt payment on the assets of the business.

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Re: Dividends vs buybacks

Post by jbolden1517 » Sun Jul 23, 2017 9:06 pm

aegis965 wrote:
ny_knicks wrote:I believe financial theory will say an investor should be indifferent but in practice I believe investors would prefer the actual return of cash instead of relying on the firm to properly execute their buyback plan for the right reasons.
On whether a firm properly execute their buyback plan for the right reasons, one can divide buybacks into two groups: low conviction (0-5%) and high conviction (5%+), as Patrick O'shaughnessy has done in his research.
Here's the conclusion of the paper:
The common criticism of share buybacks is that they are myopic and mistimed and that the money should be allocated toward capital expenditures and research rather than toward boosting short-term stock prices. At the broad market level—and also for many individual firms—this may be true. Buybacks peaked in 2008 at what turned out to be an inopportune time.
But most of the money spent on buybacks is put forward by firms buying back a fairly low percentage of their shares. On the other hand, firms with high conviction have tended to buy back shares at much cheaper relative valuations than others. In turn, these high conviction firms have gone on to outperform the broader market by large margins, on average, and have done so consistently since 1987.
Whereas peaking buybacks may or may not spell trouble for the market, high conviction buybacks—coupled with quality and attractive valuations—have historically signaled an opportunity.
Excellent analysis! I like that phrasing quite a bit between high conviction and low conviction.

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Re: Dividends vs buybacks

Post by willthrill81 » Sun Jul 23, 2017 9:12 pm

jbolden1517 wrote:
willthrill81 wrote:
jbolden1517 wrote:
willthrill81 wrote:Let's say that I buy a business outright. I never take any profit that the business generates because I don't need it or want it. As the business retains this profit, it becomes increasingly valuable. Eventually, I get tired of this business and sell it. Is it worth nothing because I chose to leave the profit in the business? Of course not.
Depends. If the next owner is unable to extract profits from the business because it goes under too fast then yes it was worth nothing. If the next owner is able to extract profits then his extracted profits discounted are what it is worth. What he paid you for it is a different matter.
That's a very extenuating and unlikely circumstance. The business will, at a minimum, have almost certainly increased in value by at least the value of the profit left in it during the period that I owned it. Regardless, it's clear that the profit didn't 'disappear'.
No one is claiming it did. A company can make tons of money for many years and then lose it all before they pay a dividend.
If you want to 'create' your own 'dividend' from a company that isn't paying them for whatever reason, you just sell an appropriate number of shares. With a dividend, this is just being done for you; a part of the company is being carved out to give you some cash.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Dividends vs buybacks

Post by selters » Mon Jul 24, 2017 3:06 am

willthrill81 wrote:
If you want to 'create' your own 'dividend' from a company that isn't paying them for whatever reason, you just sell an appropriate number of shares. With a dividend, this is just being done for you; a part of the company is being carved out to give you some cash.
But what difference does it make for an index fund investor?

I get the impression that supporters of buybacks claim that it makes no difference at all for index fund investors in a tax-deferred account if the companies in the S&P 500 index use only dividends or only buybacks.

I don't know how to run the math on this, but are they saying that if Kodak (and all the other companies that went under) never paid a single dividend, but used buybacks instead, an index fund investor would still have gotten the exact same return as they actually got historically, where these companies actually paid dividends?

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Re: Dividends vs buybacks

Post by Valuethinker » Mon Jul 24, 2017 3:52 am

ny_knicks wrote:Dividends to me signal that a company has determined that it cannot reinvest that cash into the business and earn a higher rate of return than its cost to capital. A company like Google doesn't pay a dividend because it believes it can reinvest that money into positive NPV projects that will ultimately bring more value to shareholders in the future. However, these tech companies are amassing huge cash reserves that they can't possibly be utilizing/reinvesting appropriately and so investors are starting to demand some return. Look at Apple and how it has shifted from not paying a dividend pre-2012 to having the largest dividend payout (by dollars not yield) in the world. With companies like Google its valuation is all driven off the premise that investors will forgo the $.10 dividend now for the $1 dividend sometime in the future. There has to be some return or expected return (could come all from terminal value if they are expecting a sale or something) for the shareholder in the future...even if it is way off in the distance.
Yes. But you need also to consider the goals of the Founders.

The Founders no longer run Apple and Microsoft. However in the case of Google and Amazon and Facebook, they do. And they do in Berkshire Hathaway (Munger & Buffett).

The Founders have the majority of their wealth in the company, and they control the company. Thus, they feel no need to pay dividends which would create tax problems for them. The companies do buy back shares in proportion to the exercise of employee stock options, however, thus minimizing dilution of interest for the founders.
Buybacks are just another way for companies to reinvest cash. If firms are buying back shares for the right reasons, such as they believe their stock is currently undervalued, than it is a good use of capital. But they can also be a tool for CEOs to manipulate ratios (that their compensation is likely tied to) like EPS or help offset the dilutive effects of things like employee stock options. I am assuming these factors are what often drive companies down this route when they are determining whether to pay a dividend or do a share buyback.
Yes. Also if you do stock buybacks, it lowers the cash cost of future dividends (fewer shares in issue).
I believe financial theory will say an investor should be indifferent but in practice I believe investors would prefer the actual return of cash instead of relying on the firm to properly execute their buyback plan for the right reasons.
There is an agency problem there, and dividends are one way of signalling between high information shareholders (management) and low information external shareholders (the rest of us).

As Buffett points out, as a shareholder one should be indifferent, and buybacks are significantly more tax efficient. However Berkshire Hathaway does not have a meaningful agency problem. AFAIK it does not issue stock options, and Buffett's compensation is modest (to say the least-- less than $2m I believe, including $500k for personal security provided by the company which for 24-7 guarding seems to me to be cheap at the price).

Most companies have significant agency problems. Dividends are a way of disciplining management and also of management signalling to shareholders that the profits are not overstated, and that they are attentive to shareholders' best interests.

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Re: Dividends vs buybacks

Post by jbolden1517 » Mon Jul 24, 2017 4:48 am

willthrill81 wrote:
jbolden1517 wrote: No one is claiming it did. A company can make tons of money for many years and then lose it all before they pay a dividend.
If you want to 'create' your own 'dividend' from a company that isn't paying them for whatever reason, you just sell an appropriate number of shares. With a dividend, this is just being done for you; a part of the company is being carved out to give you some cash.
No not at all remotely the same. To use your business analogy assume you had a partner in the business. In the dividend case you are both drawing some sort of salary from the business. In the capital gains case your partner is slowing buying you out of your percentage in the business. If the underlying business were doubling in size every 5 years and you were selling off 14% of your holdings per year to your partner your cash value in the business would be constant. I think this what people here mean when they talk about it not mattering. Ultimately though if that business never pays a dividend the only way you make money from your share in the business is from your partner taking ever greater loses on the business. Any profit that you and your partner combined can make comes from the revenue you draw. The capital gains position is like the old joke about the woman hosting a poker game who starts with, "If we all play our cards carefully maybe we can all make money tonight".

What makes this confusing is that the life expectancy of a successful corporation is longer than the desire for accumulation of a human investor. So people have to create a shared framework for investing in these corporations. Stock and the stock market is a social contract to increase the time horizons for investment. This social contract works and allows us all to live in a world with a much larger economy than the one we would have if investors had to paid from investments during their time horizons. But the math is no different for say the 150 years of a successful public company than if they all lasted only 10 years and then were either sold off entirely or folded.

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Re: Dividends vs buybacks

Post by jbolden1517 » Mon Jul 24, 2017 5:03 am

selters wrote: But what difference does it make for an index fund investor?

I get the impression that supporters of buybacks claim that it makes no difference at all for index fund investors in a tax-deferred account if the companies in the S&P 500 index use only dividends or only buybacks.

I don't know how to run the math on this, but are they saying that if Kodak (and all the other companies that went under) never paid a single dividend, but used buybacks instead, an index fund investor would still have gotten the exact same return as they actually got historically, where these companies actually paid dividends?
Excluding inflows cap weighted index funds aim to hold a constant percentage of all businesses in the index. When a company buys back shares it concentrates the index fund's percentage above the target percentage. So the index fund responds by selling to get its percentage back down. Index funds buy dilution and sell concentration, that's their big picture trading strategy.

Imagine a small business with 5 partners. One of the partners, Alan, wants out and he takes his share of the business in cash. The other 4 partners concentrated because of Alan's sale and moved from a 20% stake in a larger business to a 25% stake in a smaller business. Now imagine that one of the partners, Van, responds to this by saying he only wanted to hold 20% of the business and sells 1/5th of his stake to another partner. After these trades the original partners hold 0, 20,25,25,30 percent. Alan's money came from the business. Van's money came from a partner not the business.

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Re: Dividends vs buybacks

Post by snarlyjack » Mon Jul 24, 2017 8:20 am

jbolden,

I like how you think & I think your giving out some
pretty accurate advice.

(Since our other thread was closed)...

I gather from reading your post's that if a investor was looking
out 70-80 years in designing a portfolio. If that investor didn't
really want to sell off the portfolio (using the 4% trinity study)
but would need income in the future that you would use a
dividend based strategy? A portfolio put into index funds &
left to float in the market just utilizing dividends to reinvest
or as a income source? Like a endowment fund at a University
& the dividends are used for University purposes but the principal
is never violated.

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Re: Dividends vs buybacks

Post by willthrill81 » Mon Jul 24, 2017 9:47 am

jbolden1517 wrote:
willthrill81 wrote:
jbolden1517 wrote: No one is claiming it did. A company can make tons of money for many years and then lose it all before they pay a dividend.
If you want to 'create' your own 'dividend' from a company that isn't paying them for whatever reason, you just sell an appropriate number of shares. With a dividend, this is just being done for you; a part of the company is being carved out to give you some cash.
No not at all remotely the same.
Essentially, yes it is. If the company pays me $100 in dividends, it's now worth $100 less than it was before. So rather than them paying me the dividend, reducing the value of the company in direct proportion to the dividend, I can sell $100 of my equity in the company. It's just simple accounting.

But it doesn't matter. You are sold on the idea that dividends are somehow 'special' and believe that people like Warren Buffett and countless others are dead wrong and that companies like Berkshire Hathaway aren't worth anything. Good luck.
“It's a dangerous business, Frodo, going out your door. You step onto the road, and if you don't keep your feet, there's no knowing where you might be swept off to.” J.R.R. Tolkien,The Lord of the Rings

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Re: Dividends vs buybacks

Post by nedsaid » Mon Jul 24, 2017 10:28 am

One point I want to bring up on the dividends vs buybacks discussion is that US corporate management is fixated on maximizing shareholder value and thus the focus of management is holding up the stock price. It seems to be more about the stock price than the underlying business. Thus we see what I consider to be silly financial engineering which might temporarily boost the stock price but in the end detract from the running of the actual businesses and is destructive to employee morale. The business world is dynamic enough without the silliness of financial engineering. I chalk a lot of it to CEO boredom and the need to "do something." My joke was that Coke would maintain 15% growth by spinning everything off but the logo and then making the logo 15% larger every year. Here is an utterly radical idea for business school professors and corporate CEO's: why not focus time and energy on actually running the business? If the business goes great, won't the stock price take care of itself?
A fool and his money are good for business.

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Re: Dividends vs buybacks

Post by garlandwhizzer » Mon Jul 24, 2017 11:23 am

nedsaid wrote:

One point I want to bring up on the dividends vs buybacks discussion is that US corporate management is fixated on maximizing shareholder value and thus the focus of management is holding up the stock price. It seems to be more about the stock price than the underlying business. Thus we see what I consider to be silly financial engineering which might temporarily boost the stock price but in the end detract from the running of the actual businesses and is destructive to employee morale. The business world is dynamic enough without the silliness of financial engineering. I chalk a lot of it to CEO boredom and the need to "do something." My joke was that Coke would maintain 15% growth by spinning everything off but the logo and then making the logo 15% larger every year. Here is an utterly radical idea for business school professors and corporate CEO's: why not focus time and energy on actually running the business? If the business goes great, won't the stock price take care of itself?
1+

Short term stock price manipulation through financial engineering often dominates long term effective management of the business these days. IMO one of Buffett's secrets to success is that he chooses to buy businesses whose management keeps a long term focus on growing the business rather than pumping up the stock price short term with accounting manipulations.

Garland Whizzer

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Re: Dividends vs buybacks

Post by Valuethinker » Mon Jul 24, 2017 12:26 pm

nedsaid wrote:One point I want to bring up on the dividends vs buybacks discussion is that US corporate management is fixated on maximizing shareholder value and thus the focus of management is holding up the stock price. It seems to be more about the stock price than the underlying business.
The average S&P 500 CEO lasts something less than 5 years, now, I believe. This is like professional athletes -- they have to make it whilst they can.
Thus we see what I consider to be silly financial engineering which might temporarily boost the stock price but in the end detract from the running of the actual businesses and is destructive to employee morale.
See capitalism in its early 21st century form. Make it while you can. The speed of change, and the rise and fall of company executives as well as companies and markets themselves, says that you have to.
The business world is dynamic enough without the silliness of financial engineering. I chalk a lot of it to CEO boredom and the need to "do something."
Institutional investors, who themselves only hold stocks for something like a quarter of the time they did on average in the 1960s (I have read the number, but it was a long time ago), suffer intense pressure from their investors for short term performance (hedge funds are even worse). So, they put pressure on management to be exciting-- do stuff.

Shareholder value is very much the mantra, now, and that's taken to mean buying back shares and other forms of cash distribution to shareholders.
My joke was that Coke would maintain 15% growth by spinning everything off but the logo and then making the logo 15% larger every year. Here is an utterly radical idea for business school professors and corporate CEO's: why not focus time and energy on actually running the business? If the business goes great, won't the stock price take care of itself?
Business school professors are tightly siloed these days by subject area. And tenure and promotion come from publishing articles in refereed academic journals. So the Finance professors preach shareholder value, and that's what gets absorbed. Strategy professors may have a different view, but corporate strategy is an academic problem child-- in some ways, it hasn't moved much beyond Porter's 5 Forces (1980).

Friends of mine went and worked for US tech cos-- Ebay, Amazon etc. The obsession with hitting quarterly numbers shapes the entire organization, top to bottom. So those are the most forward thinking and cutting edge large companies in the world, supposedly. But they are all about hitting their quarterly numbers (Microsoft is, I believe, similar).

Yes in the long run you are correct but it's obscure as to how to make the business go great. Whereas buying back shares (and even borrowing money to do it) has an immediate effect on a common performance metric (Earnings Per Share) and also on Return on Capital and Return on Equity. So it is pretty tempting to do it.

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nedsaid
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Re: Dividends vs buybacks

Post by nedsaid » Mon Jul 24, 2017 1:15 pm

Valuethinker wrote: Yes in the long run you are correct but it's obscure as to how to make the business go great. Whereas buying back shares (and even borrowing money to do it) has an immediate effect on a common performance metric (Earnings Per Share) and also on Return on Capital and Return on Equity. So it is pretty tempting to do it.
How to run a business successfully is not obscure or a secret. Indeed, entire forests have been leveled on such how to books. Of course, you can get college degrees in how to do it, we have discussed MBA programs. I am not against higher education, MBA degrees, academic research, or even maximizing shareholder value. What I am talking about is short term thinking which is having deleterious effects on American capitalism. Some obscure fellow, I think his name is Bogle, some guy who started an obscure mutual fund company called Vanguard, wrote a book called "Enough." He discusses in detail what I feel inside but I perhaps cannot quite describe.

What makes running a business tough is that you have competition. It is tough out there. You might be a pretty good businessman who faces being put out of business by somebody that is even better. Then you have economies of scale, which makes it tough for the small guys to compete, so you have to find a niche or create a unique experience that the big boys can't provide.

It used to be that people where fiercely loyal to their employers. Not so much anymore. Business and the economy is dynamic and this means individual businesses have to adapt or die and this makes lay-offs from time to time inevitable. Business needs change. What has happened is that employers have overdone this. As the pointy haired boss in the Dilbert comic strip would say, "Employees are our most valuable asset, lay some off and the stock price goes up!" What has happened is that loyalty is not returned and employees in today's environment have to consider themselves as, in effect, independent contractors with their employer as their number one client.

Problem is, there is no long term anymore. If you can get five years out of a job nowadays, that is pretty good. The incentive is to look out for yourself and not be concerned about the long term health of the company. You might not be there in a few years anyway. The every man for himself mentality does not facilitate company spirit or loyalty or a long term vision. It is sort of "eat, drink, and be merry for tomorrow you might be laid off." Hard to build a team on this sort of philosophy. When the company runs the company flag up the pole in the morning, I feel less willing to salute it because I know that while I might be valued today, I might be discarded tomorrow. So pretty much, you should have passion for your skills, your career, your contribution to mankind and the marketplace, but probably not your employer. Sad to say. Employers want passion and loyalty but are genuinely puzzled why it is harder to find.

You also hear that there are millions of jobs that can't be filled because of the lack of qualified people. I see this discussed all the time and I just have to laugh. Companies really don't want to invest in or train their employees as much as they are concerned that they will invest the time and money just to have the employee leave. Well, why aren't employees loyal? Not hard to understand.

So this short term thinking has negative affects and there gets to be a negative cycle to all of this. Pretty much trust has broken down. Profit and sort of a sanctified greed is what drives business and I am all for shareholder value and profits. But profit and shareholder value isn't all there is. There is also the sense of obligation to the community and society at large. There is also something about looking after your people.

What I want as a shareholder is a long term focus on building value. I am weary of the waves of silly short term decisions made for someone's quick buck that ultimately downgrades the long term value of my investment. A lot of these silly and faddish decisions wind up getting reversed with the new management team anyway. A lot of churn with little accomplished. I shake my head and wonder, why did the company put their employees through all of this in the first place?

Jack Welch is an illustration of what I am talking about. Since he left GE, the stock price has languished. His successor, Jeff Immelt wound up reversing a lot of Welch's decisions. Pretty much, Welch turned GE from an industrial company into a bank and Immelt switched it back again. When the wizard retired, the successor couldn't continue the financial engineering and the management of the stock price. An ugly thing called reality came calling. Welch wasn't as great as his legend, I am not suggesting he was a bad CEO, but he would have likely had to reverse course on a lot of things just as Immelt did. Jeff Immelt took a lot of criticism over the languishing stock price but he faced the ground shifting under GE's feet. During the financial crisis of 2008-2009, GE had to get a bail out from Warren Buffett as GE could not roll over its commercial paper. Business is tough.
Last edited by nedsaid on Mon Jul 24, 2017 2:24 pm, edited 3 times in total.
A fool and his money are good for business.

mcraepat9
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Re: Dividends vs buybacks

Post by mcraepat9 » Mon Jul 24, 2017 1:19 pm

nedsaid wrote: Jack Welch is an illustration of what I am talking about. Since he left GE, the stock price has languished. His successor, Jeff Immelt wound up reversing a lot of Welch's decisions. When the wizard retired, the successor couldn't continue the financial engineering and the management of the stock price. An ugly thing called reality came calling. Welch wasn't as great as his legend, I am not suggesting he was a bad CEO, but he would have likely had to reverse course on a lot of things just as Immelt did. Jeff Immelt took a lot of criticism over the languishing stock price but he faced the ground shifting under GE's feet. During the financial crisis of 2008-2009, GE had to get a bail out from Warren Buffett as GE could not roll over its commercial paper. Business is tough.
This is spot on - the general consensus at this point is that Welch wasn't a business genius (and Immelt is no slouch), but that GE was a master at earnings management ("smoothing") in an era well before the SEC started aggressively cracking down on the practice. During his tenure, there were so many levers at Welch's disposal to hit an earnings target that just aren't available now.
Amateur investors are not cool-headed logicians.

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