Dividends vs buybacks

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nedsaid
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Re: Dividends vs buybacks

Post by nedsaid »

mcraepat9 wrote:
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.
Thank you for your comments. GE is one of my "Four Horsemen of Underperformance", so I know a lot about this.
A fool and his money are good for business.
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willthrill81
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Re: Dividends vs buybacks

Post by willthrill81 »

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?
I am actually a business professor myself, and I regularly lament to my students about the short-term focus of Wall Street. But the problem goes beyond CEOs: boards of directors, shareholders, and the media are all impatient. If a firm's quarterly performance isn't at least as good as their last quarter (or at most the same quarter last year), the sky begins to fall.
Valuethinker wrote: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).
Unfortunately, that's a pretty fair assessment of the situation. Other, likely more descriptive and useful, strategies have been offered through the years, but none of these have gained a lot of traction. And yes, untenured professors are strongly encouraged by the whole system to focus on incremental contributions to their discipline. The situation improves somewhat once they cross this hurdle, but their motivation to rock the boat often dwindles as well.
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not4me
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Re: Dividends vs buybacks

Post by not4me »

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?
I haven't read every word of every post, but think there are a couple of things that haven't come up yet.

First, every investor isn't an index investor nor is every investor in strictly a tax-deferred account. So, even if it was the same for the index investor in tax-deferred accounts, there are other circumstances to consider. For example, especially consider the investor in a regular account that wasn't tax-deferred & did NOT re-invest dividends.

There is a line of thinking that comes up in many of these threads that seems to mostly be held by those who are unfamiliar with trading individual stocks. The idea is that an individual stock price goes up/down in lock step with the book value of the company, specifically the cash account. So, if cash is spent (for example, meeting payroll, dividends, etc) that equates to $0.10 a share, then the stock price will automatically fall by the exact same amount. Of course, this isn't true, but if it were it would make the math work out for statements about getting "the exact same return".

Other problems have already been mentioned about how buybacks are actually implemented. But here's another. Stock price is heavily impacted by the supply/demand for the stock. So, in the absence of an offsetting diluting action by the company, when the company buys back stock on the open market, the demand would increase relative to the supply of the stock. However, the company can also use "block trades" to affect the buyback. So, if an institutional buyer was going to sell a large block of stock anyway, the buyback may distort what would have been seen as a decrease in demand for the stock. I suppose this is just an example of the financial engineering previously mentioned by others
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HomerJ
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Re: Dividends vs buybacks

Post by HomerJ »

nedsaid wrote:I chalk a lot of it to CEO boredom and the need to "do something."
This.

I worked at a company where they hired a new CIO, and he immediately started diversifying our infrastructure so he could get the vendors in a bidding war with each other.

We were nearly 100% HP and VMware at the time, and ended up about 70/30 HP/Dell and VMware/Hyper-V.

Which created support issues as you might imagine for us front-line grunts.

He left after 3 years, and the new CIO came in and immediately said "Our support costs and support time is way too high. We need to standardize to make everything run smoother!".

By the time I left a few years later, they were nearly back to 100% HP and VMware.

New CxO has to change SOMETHING in order to justify that fat paycheck.
jbolden1517
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Re: Dividends vs buybacks

Post by jbolden1517 »

snarlyjack wrote: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.

There are two topics:
1) Is equity income superior to a broad market index for an income oriented investor who needs a reasonable draw?
2) Is equity income the best solution particularly as the draw is higher?

Those aren't the same question. I've been defending equity income, that is arguing point (1). You are asking point (2).

My favorite portfolio for income oriented investors is generally international stock + annuities. Annuities strongly negatively correlate with living longer than expected. They are the perfect retirement asset. The real threat to annuities (assuming they are not CPI adjusted) is sharp profound domestic inflation. International stock hedges that wonderfully since sharp inflation is going to correspond to a fall in the currency. So basically stay in a diversified portfolio of international stock (possibly equity income) and keep buying annuities as needed to get the income up. You can diversify a bit more if you want but that's the core. You can take almost any scenario: deflation depression, rapid reflation, inflation, high prolonged inflation, disinflation... that portfolio does well.

On question (1) though in early retirement with something like a 4-5% inflation adjusted equity income will often (depending on market levels) get you there much more safely than an index fund + intermediate high quality bonds. Index bond / index stock portfolios don't hold up for against stable inflation adjusted draws nearly as well as you would like them too. For example take a long depression. The high quality bonds do well, but you keep rebalancing them into the stocks that get murdered. The yield is good in the beginning but drops rapidly. Just as the stocks start recovering you rebalance into the bonds which get murdered by reflation. Of course inflation intermediate bonds lag and stocks get hurt. You end up having to sell the portfolio rapidly.

As I've said before dividends are much more stable than share prices. For example if someone were retiring today, that didn't want to go quite as extreme as international+annuity that would be my advice. In 1999 or 2008 it wouldn't have been, you couldn't get the yield up that high without being some really awful stocks. The market was just too high. Remember though an investor starting retirement in 1999 or 2008 who had been reasonable in their planning likely needed a draw around 2% since they likely would have over performed their target in the run up. Equity income does a lot to get an extra percent or two of draw safely from a portfolio, it doesn't fundamentally change the game (though the failure rate on a 5% portfolio using a broad index is so high you could easily disagree and say it does change the game).

As for my advice part since you asked... if I remember correctly you are young. Portfolios are designed for particular situations and you aren't facing the situation the portfolios you are drawn to are designed to solve. What likely is drawing you towards equity income is avoiding overpriced stocks which can't possibly produce a good return at the price you are being asked to buy them at. I understand completely, I couldn't sleep either holding the stuff in those growthy index funds. The idea of just tossing my money in the index pot "sure Tesla worth $60b, Celegene is worth $100b and Amazon is worth $500b" is nauseating. I couldn't stand it in the 1990s when I started and I can't now. I have no regrets about not losing everything I made to the internet stock craze like many of my peers. Virtually every stock I missed 20 years ago I could have picked up over the last 5 years for less, Amazon being the only exception (and the Amazon of the late 1990s was carrying most of its corporate assets from 14% convertible bonds... I would have bet roulette before I put money on Amazon then).

I totally get where your head is at. Dependable dividend companies will keep you out of the market insanity. A company capable of paying out 3% of its market cap isn't just hot air trend of the week. But there are other value factors that you can take advantage of because you don't need income. For example you can buy stocks full of distressed assets at 70% off that might not pay a nickel for 2-5 years. You can buy defaulted bonds that banks and insurance companies dump for pennies on the dollar (not now the hedgefunds have all the good ones, but they will be back). You can buy companies that have tremendous sales volumes but are having temporary problems with margins. You can buy companies that have solid earnings and slightly negative earnings growth that are focusing on restructuring their debt.

You have a much much wider range of options open to you. So if you are asking for my advice, my advice is take advantage of value where ever you find it. There still is a lot of it around. Absolutely dividends are important. Absolutely there are great dividends stocks right now (pipelines, telecommunications, reits...). I'm grabbing that stuff up. But there is no reason to limit yourself to just dividends because there will be years when the pickings aren't hot like now. You don't need the income don't limit yourself. That being said, starting to specialize in dividends is as good a way as any to learn the game. So if you really like dividends go for it you have plenty of time to expand out.

I think you indicated you don't want to stock pick. That's fine you are young and there are lots of ways to go wrong stock picking when you start out (if you can keep your head you will make bank doing it). There are plenty of excellent value houses. Oakmark was my early favorite, they will keep you out of the crap, you will be sitting on a portfolio of stocks you can sleep at night with (they aren't dividend focused however). Schwab and Wisdomtree are more 2010 etf passive.... alternatives (I did meet you here so I assume that low ER passive approach appeals to you). WisdomTree does have some dividend focused ets that are sort of like the Vanguard funds you were looking at. Interestingly Oppenheimer and GoldmanSachs ETFs are also worth looking at they have some nice value offerings.

As your are in mainstream value decide if you want to explore deep value or not. There are some terrific opportunities as you go deeper in value but that road leads to some bad places mentally. So if you go deep value keep it in moderation. For value investors the temptation on our side is to become so disgusted by the insanity you forget how to make money. The deeper you go you start running into the bearish equivalent of the Alibaba investors. Try not to get too drawn into the truly bearish stuff (physical gold, sitting on cash for years...). Try and find something with a high expected return you can stomach being in, if you can. Absolutely read one of Marty Whitman's books, but don't make it your first stock picking book. Listen to Jim Grant he knows more about the market's than almost anyone else alive, but take it with a grain of salt. Similarly as a value investor as any sort of reasonable valuations disappear in a late bull (i.e. if this thing keeps running for another 2 years or so) the short side gets far more tempting. Make sure you don't try it before you've been stock picking for a few years and then always keep it under 15% of your portfolio. The people buying in a late bull market are both ignorant and insane, but the government is generally on their side. To make money on the short side you have to get the stock right and the timing right. On the long side either one will do.

So my advice to you is go with mainstream value and not focus on a current stable income you don't need. But if you love dividends, dividends will keep you out of the bad stuff. And staying out of the bad stuff is how you don't lose big. (Jumping off the soapbox).
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aegis965
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Re: Dividends vs buybacks

Post by aegis965 »

Inb4 "active investing is a losers game"
Great advice though. I do deep value myself so it's always helpful and educative to read others advice on the topic.
Thanks for sharing.
I may be biased.
snarlyjack
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Re: Dividends vs buybacks

Post by snarlyjack »

jbolden,

Just checking the board before I go to bed.

First of all, I want to thank you for your excellent advice & answering my questions!

Deep down in my heart of hearts I' am a value investor. Even though I don't need income
(if the markets were to tank) I like the idea of my dividend's being reinvested at better
prices. I guess I' am one of those people who believe the more shares the better & the
more shares at a better price is even better yet. (I know I' am going to get lectures
from my fellow Bogleheads at that).

At my age I don't think an annuity is the answer. I really don't think individual stocks
is the answer for me. But I do think a blend of dividend paying stocks with bonds
might be the answer. I keep looking at Wellington (I like Wellington), it's a excellent fund.
But I also really like the Vanguard High Dividend Yield Index Fund. Along with the Total
Bond Fund with some cd's might be the cat's meow. I can relate to Kevin O'Leary when he
say's everything must provide a income (maybe not a great income but something). I
really like Warren Buffett but I would not buy Berkshire Hathaway for the no income reason.

I would not consider myself a deep value investor but more of a dividend investor. But I' am
keeping my options open & thinking about the whole thing. Going hum mm...

jbolden, I want to thank you for your excellent advice & taking the time to help me!
It is much appreciated. I think you have given the Bogleheads some excellent advice
in your posts...Thank You for all your time & expertise! :)
OnTrack
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Re: Dividends vs buybacks

Post by OnTrack »

As a stockholder, I am a part owner of the company. As such, I am also a part owner of the cash in the company. When the company uses that cash to pay expenses or to expand the business, I expect that. But if it uses the cash to buy back shares, the company is essentially making a decision to use cash that is partially mine to buy more shares of the company's stock. At this point in time I might not want more equity in this particular company. It seems to me that a company that buys back its own shares is making an investing decision for me. I would prefer to have the cash dividend and decide for myself what to do with it; maybe invest it in a different company or in fixed income for example.
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Pajamas
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Re: Dividends vs buybacks

Post by Pajamas »

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. 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!
So you would conclude that Berkshire Hathaway (as an example) is worth absolutely nothing because it doesn't pay a dividend? That defies common sense.
jbolden1517
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Re: Dividends vs buybacks

Post by jbolden1517 »

Pajamas wrote: So you would conclude that Berkshire Hathaway (as an example) is worth absolutely nothing because it doesn't pay a dividend? That defies common sense.
What are Berkshire Hathaway's dividends in 2030, 2031... the statement is discounted value of future dividends. Past dividends don't do someone who is deciding whether to buy the stock today much good.
Last edited by jbolden1517 on Tue Jul 25, 2017 6:12 am, edited 1 time in total.
jbolden1517
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Re: Dividends vs buybacks

Post by jbolden1517 »

snarlyjack wrote: First of all, I want to thank you for your excellent advice & answering my questions!
Glad you found it helpful.
snarlyjack wrote: Deep down in my heart of hearts I' am a value investor.
It ain't even deep down.
snarlyjack wrote: Even though I don't need income
(if the markets were to tank) I like the idea of my dividend's being reinvested at better
prices. I guess I' am one of those people who believe the more shares the better & the
more shares at a better price is even better yet. (I know I' am going to get lectures
from my fellow Bogleheads at that).
Yes and they would mostly be wrong. As I said starting with dividends is not a bad way to start. Its not the best way, it does keep it simple. Mostly the worst stuff doesn't pay dividends. Focusing on yield will force you (or the fund) to sell off some companies as they individually get too high. If this bull ends soon (a year or so) that will be enough. But one of the reason BTW I don't like the Vanguard fund is that it is doing relative valuation (though using dividend as the benchmark) Relative dividends is not a great strategy. As the market rises the stuff paying 50% higher dividend is quite often considerably worse and not for that much more absolute yield.

Just keep your eyes on what's inside the fund. The top holding will be biased towards growth, but take look and ask yourself if you think they are a little too high or a lot too high. If a lot to high, you are going to need to move out. Some dividends won't save you, the way a lot of dividends will. A pure equity income fund with a fixed target (say 3% or more) the dividends will help. But as relative valuations get worse the stocks that have to pay 3% get progressively worse. That will buy you more time but not a lot more time. Just remember at least for now other markets outside the USA exist as well. So try the first 2 years or so.

You'll learn a lot once you stop picking funds in theory and are actually gambling along with one fund in particular.
snarlyjack wrote: At my age I don't think an annuity is the answer.
Absolutely not. You are way too young to benefit much from the extra yield.
snarlyjack wrote: I really don't think individual stocks
is the answer for me. But I do think a blend of dividend paying stocks with bonds
might be the answer. I keep looking at Wellington (I like Wellington), it's a excellent fund.
But I also really like the Vanguard High Dividend Yield Index Fund.
Wellington you'll never go too wrong. I think its too conservative for you but the extra conservatism won't cost you too much. Vanguard High Yield as I mentioned Vanguard isn't really a value house. As the market gets higher it will tend to drift more and more towards being overvalued. But it is not there yet, and you have time to see. Just stay awake and use common sense.
snarlyjack wrote: Along with the Total Bond Fund with some cd's might be the cat's meow.
Bonds are more overvalued than stocks right now. And at your age an allocation that set towards high quality fixed income will turn the possibility of loss into the certainty of loss. Remember what I said above about the bearish temptation to live in cash for many years? You are falling into it right off the bat. There is no reason what-so-ever for you to ever be in a 2% CD. A little bonds won't hurt you. So Wellington as one of your funds is fine. A lot of high quality bonds will hurt you. Right now the risk premium for credit quality isn't great. Duration is scary high you are getting nothing for the duration risk. I'd consider something like HYND so you are short duration and long credit quality (I'm in that one my self). But I wouldn't hold too much even there, that play might work and might not. You are for example paying contango on interest rates every year, if interest rates don't move up in a few years that will get expensive. There may not be a good play in bonds right now. Most assets at most times aren't investable long or short. But there are lots and lots of markets filled with lots of assets each. You can always find something that's good and cheap.

There are bear markets and investable assets right now. USA bears are much scarier for USA investors than any other kind of bear. If you aren't buying other bears where you are detached you won't dive in when it is your friends being laid off, your house declining in value, the company you work for looking for emergency financing and talking about cost cutting, your bank being reorganized by the FDIC. If you open to my advice do not fall into the cash trap. It is a temptation you are going to need to fight, because it clearly is a temptation for you. If you can earn 8.5 in stocks on average and 3.5 on high quality intermediate bonds on average every 14 years you makeup the ground for having bought stocks for double what they are worth. Now that doesn't mean it is fine to lose 1/2 your money. Far better not to lose the first 1/2 of your money by buying good stuff. But it does mean over your investing horizon you'll lose 5 doubles holding a lot of cash like investments which is even worse than buying way too high. You will never see the broad market 30-to-1 overvalued. I'd rather you be 100% in TSM, or even an SP500 growth fund than holding a lot of cash.

If you want some cash and a focus on value and don't want to do it yourself. Take a look at Schwab Intelligent Portfolios. I really like their setup quite a bit.
snarlyjack wrote: I would not consider myself a deep value investor but more of a dividend investor. But I' am
keeping my options open & thinking about the whole thing. Going hum mm...
Good. You started by reading the dividend arguments. That's the train that will get you to value. My advice is that's the right train. This tread is a good example. The counter argument being presented in theory is that it doesn't matter if companies that can pay a dividend just retain their earnings and reinvest them for you. But underneath this argument is the more sinister one you see during bull markets. And that argument is it doesn't matter if companies can't pay a dividend or even have earnings. What matters is market price. The market is the final determiner of value... See how big my paper profits are! And they aren't lying. During the bubble the paper profits are really good. But as soon as investors in any numbers try and realize those paper profits and turn them into realized profits they disappear. In the aggregate investors make what a company pays out. That road of focusing on paper profits leads to devastating losses. I'm glad you see that already.

But my comment to you is that on the surface that counter argument has some truth to it you may be missing. There are huge advantages to an investor from a steady streams of income from their assets in terms of reinvestment. You are absolutely right about that. But what I want you to consider (when you are ready) there are advantages to the enhanced returns from management not being under pressure to make a fixed payment. In general (as I showed in the other thread) if the underlying company is holding the same assets the dividend will boost your return a lot. But in the real world everyone gets paid more for not having access to their money, risk, including company management. Not paying a dividend can often boost the risk management can take on and by chasing yield you end up trading earnings growth (and thus future dividend growth) for just a bit more fixed yield. There are good stocks in the USA today with little or no fixed yield. I stand by my point, utility funds are great for the old. But that doesn't mean they are great for you. You need growth not a stable inflation adjusted income. You just need to buy growth at a reasonable price so that you aren't losing 70 cents on the dollar when you throw your money in.

If you want to take stocks that don't have any income and create some you can sell off some of the upside in advance through covered call writing. That way you can take a stock with no yield and give it often as much as a 20% yield as long as you believe in the company and would be willing to hold (since you still are holding the downside).

And you are quite welcome for the advice. Glad to help.
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