Share Buybacks

[Palantir]

 

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.     

 

Dividends are one way that the gap between market price and IV closes. You have a stock with an IV of 10, and a price of 5 (Gap =5). You get a dividend, IV moves to 9, and price becomes 4 ex dividend. Now the gap between IV and your investment is 9-4-1 = 4.

[Tim Eriksen]

 

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.     

 

Dividends are one way that the gap between market price and IV closes. You have a stock with an IV of 10, and a price of 5 (Gap =5). You get a dividend, IV moves to 9, and price becomes 4 ex dividend. Now the gap between IV and your investment is 9-4-1 = 4.

 

I get your point, but two issues.  First, I would argue that is the worst scenario to pay a dividend.  A share repurchase has more bang for the buck. You should want the company to repurchase all it can at $5 because it is immediately accretive to intrinsic value per share regardless of whether the IV is based on earnings power or assets.  Second, your 5 has just become 4+1, which is the same, except you may now owe taxes on the $1.  (To be clear I am not arguing that if a cash rich company paid a large dividend that it would not unlock value, it usually does, just that a large repurchase would be better).

 

To  put it another way.  Share repurchases are nearly the same as a dividend when a stock trades near intrinsic value.  When the stock is above IV, a dividend is better.  When the stock is trading at a discount to IV, repurchases are better, and the greater the discount the more bang for the buck.  That is why Buffett loves repurchases below conservatively calculated intrinsic value. 

[KinAlberta]

^That was well said in buy backs and IV.  I've argued many times that I do not want Berkshire Hathaway to pay a dividend because of it's track record of superior capital allocation. 

 

I'm wondering what my approach should be towards index funds that I eventually plan to buy and hold.  (I believe Buffett has said that in his last will and testament he will recommend that the inheritance be put 90% towards equity indexes like the S&P 500, and 10% cash.)

 

I don't agree with Buffett.  Here's my thoughts:

 

First let me say, I'll never have enough money that I could say I could hold it for 20+ years without ever having to dip into the account for some or the other expenditure - this raises the attraction of dividends.

 

Choosing non-dividend payers may be more tax efficient and when looking at individual companies and aggregating them in the form of the S&P 500 gives one a mix of dividend payers, companies buying back shares, non-payers (reinvestors), etc.  However, I don't know the general corporate record of share buy backs at below intrinsic value. I suspect a lot, if not most corporations' buy backs occur with less than optimum timing. So I don't know how much value they would add to intrinsic value growth (vs destruction) in an index fund or ETF.

 

Now, if one considers published index returns, clearly an equity index can return zero over extended periods of time - 15 to 20 years - the buy backs aren't benefitting the index growth in the short run, though eventually you'd think would have to be reflected in long term pricing (potentially over the 20+ year horizon). Value may be building, intrinsic value growing, but the pricing doesn't reflect it.

 

Published returns on "Total Return Indexes" are a different thing and sort of reflect reality.  Generally investors seldom have lost money over some period, say 10 years, once dividends are factored into the equation. (Though published returns on Total Return indexes would be a bit misleading for lack downward adjustment on the return for payment of taxes in non-registered accounts but close reflect returns for index funds/ETFs held in RRSPs, TFSAs, 401Ks etc. I believe.)

 

Another factor would be the growing strength and surviorship or survivorship bias of more mature companies in a recession or conditions where an index could return zero over 15 - 20 years.  Over that time span some of the growth companies would mature and then pay dividends - some for quite a while during that period of time.

 

So, wouldn't one want to bias their allocation of indexed funds towards dividend indexes, dividend orientated index funds vs. standard total return indexes?  Wouldn't that assure you of more cash flow for either reinvesting or avoiding forced sales in down markets due to unexpected life events?  Wouldn't this directly beneficial cashflow flexibility outweigh any weighted average tax advantages and growth company potential of holding a broadly indexed/market index fund where a portion of the indexed companies are non-dividend paying companies.?  Thoughts on this would be greatly appreciated.