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cmattporter
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I have always been told that whenever a company is buying back their shares its a good thing for the shareholders. I ran some numbers on one company and starting to think otherwise.

 

ISRG- Intuitive Surgical

 

Equity at year end 2012 $3,580M

 

At year end 2013 ISRG bought around $1B of their stock, decreasing their shares outstanding from 40.2M to 38.2M. If they didn't buy the stock, assuming the cash went to cash asset the equity would have increased to $4,500M.

 

The book value on the equity of $4,500M w/40.2M shares equals about $112/share.

 

The 2013 Equity Value adding in for the buybacks is $3,501M w/new 38.2M shares equals about $91.66 Book value/share.

 

This doesn't make any sense to me. Can anyone explain?

 

Matt

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I have always been told that whenever a company is buying back their shares its a good thing for the shareholders. I ran some numbers on one company and starting to think otherwise.

 

ISRG- Intuitive Surgical

 

Equity at year end 2012 $3,580M

 

At year end 2013 ISRG bought around $1B of their stock, decreasing their shares outstanding from 40.2M to 38.2M. If they didn't buy the stock, assuming the cash went to cash asset the equity would have increased to $4,500M.

 

The book value on the equity of $4,500M w/40.2M shares equals about $112/share.

 

The 2013 Equity Value adding in for the buybacks is $3,501M w/new 38.2M shares equals about $91.66 Book value/share.

 

This doesn't make any sense to me. Can anyone explain?

 

Matt

 

Share repurchases are not ALWAYS good but in general they are (there are few absolutes).  The benefits of share repurchases has been discussed many times on the board so I won't rehash that. In this case, they repurchased shares at a price higher than book value.  That is not inherently bad.  Book was $90 per share.  EPS was $17 per share.  Cash and investments near $70 per share.

 

IF they had only paid $110 per share, that would have been higher than book value (meaning book value per share would decrease) yet I presume you would see it as highly beneficial (6x earnings and 2x net of cash/investments).  So I hope you would agree that the the issue is not that it was above book value, but rather if the actual price they paid ($420 per share average for 2.6 million shares) was beneficial versus paying a $25 special dividend?  The point is did they pay more than intrinsic value??

 

 

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I have always been told that whenever a company is buying back their shares its a good thing for the shareholders. I ran some numbers on one company and starting to think otherwise.

 

ISRG- Intuitive Surgical

 

Equity at year end 2012 $3,580M

 

At year end 2013 ISRG bought around $1B of their stock, decreasing their shares outstanding from 40.2M to 38.2M. If they didn't buy the stock, assuming the cash went to cash asset the equity would have increased to $4,500M.

 

The book value on the equity of $4,500M w/40.2M shares equals about $112/share.

 

The 2013 Equity Value adding in for the buybacks is $3,501M w/new 38.2M shares equals about $91.66 Book value/share.

 

This doesn't make any sense to me. Can anyone explain?

 

Matt

 

The problem with many share repurchase programs is they are executed with little to no consideration of the stock price. In recent memory, NFLX buying back shares during the period from 2010-2011 (largely to offset dilution) was an egregious use of shareholder funds.

 

The link below is a great read on stock buybacks, with particular emphasis on Henry Singleton of Teledyne, who is celebrated as one of the most shrewd allocators of capital, particularly during the 1970s.

 

http://www.scribd.com/doc/65650082/Teledyne-and-Henry-Singleton-a-CS-of-a-Great-Capital-Allocator

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I figure you would have to find the return on investment for two options

 

1.) Keeping the $1B in cash and its effect on value with 40.2M shares... Adds $25 per share to Assets

 

2.) Buying back $1B worth of shares (2M shares. Now would have 38.2M shares) and its effect on the value...

 

What would you do to figure out option 2 value?

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I figure you would have to find the return on investment for two options

 

1.) Keeping the $1B in cash and its effect on value with 40.2M shares... Adds $25 per share to Assets

 

2.) Buying back $1B worth of shares (2M shares. Now would have 38.2M shares) and its effect on the value...

 

What would you do to figure out option 2 value?

estimate intrinsic value per share

 

note you seem to be looking at the change in yearend share totals.  They repurchased 2.6 million shares.  So year end share total would have been 40.8 absent the repurchase.  I am not saying the repurchase was wise, that would take a great deal of effort to analyze, I am saying repurchases above book value per share are not inherently problematic. 

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I have always been told that whenever a company is buying back their shares its a good thing for the shareholders. I ran some numbers on one company and starting to think otherwise.

 

ISRG- Intuitive Surgical

 

Equity at year end 2012 $3,580M

 

At year end 2013 ISRG bought around $1B of their stock, decreasing their shares outstanding from 40.2M to 38.2M. If they didn't buy the stock, assuming the cash went to cash asset the equity would have increased to $4,500M.

 

The book value on the equity of $4,500M w/40.2M shares equals about $112/share.

 

The 2013 Equity Value adding in for the buybacks is $3,501M w/new 38.2M shares equals about $91.66 Book value/share.

 

This doesn't make any sense to me. Can anyone explain?

 

Matt

 

The problem with many share repurchase programs is they are executed with little to no consideration of the stock price. In recent memory, NFLX buying back shares during the period from 2010-2011 (largely to offset dilution) was an egregious use of shareholder funds.

 

The link below is a great read on stock buybacks, with particular emphasis on Henry Singleton of Teledyne, who is celebrated as one of the most shrewd allocators of capital, particularly during the 1970s.

 

http://www.scribd.com/doc/65650082/Teledyne-and-Henry-Singleton-a-CS-of-a-Great-Capital-Allocator

 

"As profits have grown, buybacks have too. Meanwhile, dividend payouts haven‘t changed much at all. Leon Cooperman, an exceptional investor and founder of Omega Advisors, delivered a presentation on Singleton andbuybacks at the Value Investing Congress in New York. Cooperman is a real enthusiast of Singleton‘s career a Singleton junkie, in his own words. He‘s spent a lot of time studying the man and his methods. Cooperman cited many examples of companies that routinely spend billions buying back their own stock.  Unfortunately for those shareholders, the stock prices have subsequently gone down, flushing billions down theproverbial toilet bowl.The offenders make up a roll call of blue-chip companies: Microsoft, Intel, Lexmark, Masco, Pulte Homes, Circuit City, Chico‘s and many more. Countrywide is one of the most egregious recent examples. It spent nearly $2 billion on stock buybacks in the last two years. Countrywide‘s stock price has since lost 75% of its value.

 

James Grant, writing in his newsletter Grant‘s Interest Rate Observer, recently wrote about boneheaded buybacks intoday‘s marketplace. Grant then paid tribute to Singleton when he wrote: ―Henry E. Singleton, visionary builder of Teledyne Corp., set establishment tongues wagging by issuing stock at high prices and repurchasing it at low prices.People wondered what he was thinking about. Our postmillennial captains of industry seem not to understand, either."

 

From the article.  Exactly my sentiments on buy backs.  Most of them are just stupid and mostly a destruction of capital.  Unless, of course, the guy in charge is a great capital allocator.

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I'd love to see a study done on dividends that were paid out when a stock (as well as the market as a whole) was trading above intrinsic value.

 

My money says that the vast majority of dividends first suffered the insult of taxation, and then were just reinvested in overvalued stock by the dividend recipient (in the name of "dollar cost averaging") at the inflated price.

 

The idea that management shelters the investors by paying a dividend instead of buying back stock depends on the behavior of the (presumed to be ignorant) shareholder. 

 

It is generally presumed that the shareholder is protected by management by paying a dividend instead of buying back stock -- but who protects the cash-holding shareholder from himself? 

 

Is this just an ivory-tower argument?  In the real world, do ignorant shareholders who get a cash dividend sit patiently for the stock to crash before reinvesting it?  And if they are that savvy, why do they wait for the stock to crash without selling the very stock itself?

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In case of true overvaluation (so considerable, cannot be caused by small mistakes in valuation) I agree. There is an area around fair value that you don't sell yet but hold. In that range I much prefer dividends over stock repurchases.

 

I might have to add that for me dividends are not directly taxed (as are capital gains). I pay a fixed yearly percentage (1.2%) yearly as tax to account for income from holdings (and I can subtract foreignly withheld dividend taxes). So tax is not an issue to me in this specific situation.

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There is an area around fair value that you don't sell yet but hold. In that range I much prefer dividends over stock repurchases.

 

What tax rate do you pay on those dividends?

 

In California, at the top tax rate, you get a $1 dividend sliced down to 67 cents (approximately) by the tax man.

 

With what certainty is this Californian able to reinvest it into a 67 cent dollar stock (or cheaper)?

 

I'll bet he's better served with buying back stock at 100% of intrinsic value.  After all, if the investor sees a 50 cent dollar swimming around and he knows how to spot one, chances are good that he's already pouncing on it using the cash from selling these shares around 100% of intrinsic value.

 

And if he doesn't know how to spot a 50 cent dollar... then what the hell is he going to do with his 67-cent after-tax divided?  He's likely just going to reinvest his 67 cents back into some fully-valued stock.  So he gets screwed by the management's decision to pay a dividend.

 

So in this example, the buyback at 100% of intrinsic value is suitable for all stripes of investors, savvy or not.

 

But that's because of the high tax rate in the example.  Can't really discuss this without regard to the tax rate.

 

Buffett likes dividends but they only pay 14.5% tax rate or something like that on dividends in their insurance companies.

 

I would love to bump up Buffett's tax rate to that of the top California rate and then hear him weigh in on the topic.  Especially since he has mentioned that Berkshire's target is more like 80 cent dollars these days -- at 80 cent dollars for reinvestment, the current dividend tax rate doesn't destroy his value because his after-tax dividend exceeds 80 cents.  But knock his after-tax dividend dollar down to 67 cents -- I think he'll squeal.

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My money says that the vast majority of dividends first suffered the insult of taxation, and then were just reinvested in overvalued stock by the dividend recipient (in the name of "dollar cost averaging") at the inflated price.

 

 

 

Why do you assume that dividends will be reinvested into something? Investor could be buying booze...

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My money says that the vast majority of dividends first suffered the insult of taxation, and then were just reinvested in overvalued stock by the dividend recipient (in the name of "dollar cost averaging") at the inflated price.

 

 

 

Why do you assume that dividends will be reinvested into something? Investor could be buying booze...

 

True, but for Americans investing in taxable accounts, it makes more sense to sell equity into a buyback to optimize the amount of booze you can purchase no? No point in giving the government your beer money!

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My money says that the vast majority of dividends first suffered the insult of taxation, and then were just reinvested in overvalued stock by the dividend recipient (in the name of "dollar cost averaging") at the inflated price.

 

 

 

Why do you assume that dividends will be reinvested into something? Investor could be buying booze...

 

Similarly, I don't make the assumption that cash-flow for booze must come from cash dividends.  I am impartial as to whether they liquidate some shares to raise this cash, or whether they use their dividends to raise this cash.

 

Let's put it this way... are they going to sober up if the management cancels their dividends?

 

What do Berkshire shareholders do for beer money?

 

(except I'm not impartial -- the tax would be less if they sold their shares because they don't pay tax on the cost basis... so they can purchase either more beer, or higher quality beer)

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There is an area around fair value that you don't sell yet but hold. In that range I much prefer dividends over stock repurchases.

 

What tax rate do you pay on those dividends?

 

0% effectively. 15% is withheld in my IB account but I can subtract this from my Dutch taxes on net worth. I Holland we pay 30% tax on a hypothetical 4% yield on your net worth (above a threshold of ~20k Euro). That includes everything (so also dividend taxes and capital gains taxes) so if these are withheld in a foreign country we can subtract this (to avoid double taxation).

 

The system was introduced at least a decade ago to simplify the system and save money that way. People are complaining about this system because they put it in the bank at 1% interest and then get taxed more than they make :P. I hope they don't change the system though since beating the 4% threshold is quite easy (long term at least). Of course you can also interpret the tax as 15% on a 8% hypothetical yield (30% is very high imo) and then it seems way more in line with taxation in other countries.

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Looking at past ISRG financials, they don't need anymore cash, capital, etc. So I'm guessing management would distribute any unneeded funds, buyback shares, and/or hold onto the cash... Whatever creates the most return/value to shareholders. They could just wait until the opportune moment to buyback shares at a market fall, stock decline, etc. Unless that's too hard to do.

 

My take, for ISRG and every other business, is why not sit on a hoard of cash until something develops that can't be questioned as being non-beneficial? Buying back shares of any company at 100% intrinsic value, as stated in earlier comments, is no problem. But buying back ISRG shares at $430? Their EPS is $15 and is going to drop for 2014.

 

The only rebuttal would be if $430 is their intrinsic value, ok that's fine. But I will add they deleted the shares they bought instead of adding to Treasury stock which is another wtf.

 

 

 

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For dividends, you have a tangible known return.  Of course, though, that company could cut or raise its dividend.  Nothing is guaranteed.  But, I am willing to bet that on average, a dividend is better overall than a buy back for share performance.  Although, I would really like to see a case study that analyzes this. 

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For dividends, you have a tangible known return.  Of course, though, that company could cut or raise its dividend.  Nothing is guaranteed.  But, I am willing to bet that on average, a dividend is better overall than a buy back for share performance.  Although, I would really like to see a case study that analyzes this.

 

Not really.  In theory, book value and intrinsic value drop the amount of the dividend.  You have a known tangible redistribution, or return of capital.  The actual returns of the business are its earnings, or you could argue the change in intrinsic value. 

 

Any study will be flawed due to the many companies that buyback shares to offset dilution not because the price is well below IV.  In general, if I own the stock I  want the company to be buying it back.  If I don't think they should buyback stock (absent substantial opportunity to invest in their business) why would I own it?? 

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For dividends, you have a tangible known return.  Of course, though, that company could cut or raise its dividend.  Nothing is guaranteed.  But, I am willing to bet that on average, a dividend is better overall than a buy back for share performance.  Although, I would really like to see a case study that analyzes this.

 

Not really.  In theory, book value and intrinsic value drop the amount of the dividend.  You have a known tangible redistribution, or return of capital.  The actual returns of the business are its earnings, or you could argue the change in intrinsic value. 

 

Any study will be flawed due to the many companies that buyback shares to offset dilution not because the price is well below IV.  In general, if I own the stock I  want the company to be buying it back.  If I don't think they should buyback stock (absent substantial opportunity to invest in their business) why would I own it??

 

Dividends remind the board to return cash to shareholders. Of course buy back at the right times are fine too but often boards will invest the money poorly (many of the large tech stocks did this) or just buy back to mask that they are diluting the shares to enrich themselves. In general I like dividend paying stocks, also because dividends are a continuing thing, companies don't like lowering their dividend making things way more transparent.

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For dividends, you have a tangible known return.  Of course, though, that company could cut or raise its dividend.  Nothing is guaranteed.  But, I am willing to bet that on average, a dividend is better overall than a buy back for share performance.  Although, I would really like to see a case study that analyzes this.

 

Read Shareholder Yield by Faber.

 

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Not really.  In theory, book value and intrinsic value drop the amount of the dividend.  You have a known tangible redistribution, or return of capital.  The actual returns of the business are its earnings, or you could argue the change in intrinsic value. 

 

 

As an investor, your goal is not necessarily to buy something that increases in intrinsic value, but something that gives you a high return. That can come from increasing in intrinsic value, or it can come from a dividend, so the fact that IV goes down is not a disadvantage of a dividend.

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Not really.  In theory, book value and intrinsic value drop the amount of the dividend.  You have a known tangible redistribution, or return of capital.  The actual returns of the business are its earnings, or you could argue the change in intrinsic value. 

 

 

As an investor, your goal is not necessarily to buy something that increases in intrinsic value, but something that gives you a high return. That can come from increasing in intrinsic value, or it can come from a dividend, so the fact that IV goes down is not a disadvantage of a dividend.

 

Huh?  You lost me.  As a value investor you want growth in IV and/or closing of gap between market price and IV. My point was what are dividends?  They are a return of capital.  Dividends don't create high return.  The business has to do that.  Dividends are just one way for the businesses returns to be allocated.  When paying a dividend there is no net change in IV.  A $10 stock that pays a a $1 dividend is all else equal, now a $9 stock.  IV is the same (10 = 9+1).  Your value is now a $9 stock plus the $1 dividend (less taxes on the dividend).  So you may be slightly worse off due to taxes.       

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