Dividends vs Buybacks, why not more Buybacks?

[Luca]

Listened to Buffett on the way home, was talking about Sees Candy, dividends, opportunities to reinvest and what to do if that is not possible. 

 

Key was that when business cant reinvest, excess cash should be sent to shareholders via dividends as we know. 

 

If we look at dividends going to our pockets vs shares bought back, assuming no earnings or multiple change: If business A buys back 98% of its Stock in 25 years we will get a 50x vs business B that just sends you the yearly dividend, we wont see a 50x return on our money with the dividend. 

 

Considering that the business buys back stock at reasonable valuations (10xEarnings) and can do that for a very long time, why would one argue for dividends vs buybacks? 

 

Buybacks are only negative if they buy back overvalued shares as we know but if the business can not reinvest, would you prefer the dividend or the steady buyback compounding? 

 

Also: How difficult is it for a business to buy back more than 95% of shares outstanding? There are some businesses that have done it but what would be some problems that could occur? People not willing to sell the shares/not enough float? 

 

Let me know what you think

[Luca]

Apple as an example buys back shares at 20+ earnings and Buffett still likes it, not so sure how good of an idea that is if there are bad years with a multiple reevaluation, we saw the same with Meta where the could have bought significantly more shares now . Could have instead issue dividends at a trillion dollar market cap than buying back shares.

Edited January 10, 2023 by Luca

[Jaygo]

I personally like a bit of both. Dividends are great because it lowers your cost base. But not tax efficient when in a taxable account so I would say a 50/50 mix or the company should make it clear that they will not pay a dividend ever so we can place the business in the correct type of account. Brk sits in my taxable account, Tobacco in my Registered.

 

The trouble with buybacks is most companies dont do them well. When done properly they are powerful, Autozone is the king in this regard. They have bought back 50% of shares in ten years. An important aspect is that they have consistent earnings and a relatively good value on the share price.

 

I cringe when I hear every company doing buybacks last year since it is the "thing" to do. 

[thepupil]

in short, they are the same thing (except for tax treatment which for US taxable investors favors buybacks).

 

 

Company A distributes 50% of earnings in form of dividend and earns 10% on reinvested earnings. Company A is purchased for 15x earnings / 3.3% yield. It grows by 5% / yr and is exited at 15x earnings. Dividends are reinvested. Sold in 20 years.

 

For a nontaxable holder: 

 

Investor makes 8.6% IRR

 

 

 

Company B is same company but repo's instead of divvy. Same assumptions (excuse the quick and ugly spreadsheet). 

 

8.6% IRR. 

 

 

 

Company B 

 

 

 

 

 

[thepupil]

that's the theory, practically I want everything in my taxable account to buy back stock, and everything in my IRA's to pay dividends (though can always create divvy via sale).

[ValueArb]

36 minutes ago, Luca said:

Apple as an example buys back shares at 20+ earnings and Buffett still likes it, not so sure how good of an idea that is if there are bad years with a multiple reevaluation, we saw the same with Meta where the could have bought significantly more shares now . Could have instead issue dividends at a trillion dollar market cap than buying back shares.

 

Neither Buffett or Apple know when the market is going to re-evaluate the PE, if ever. 

 

Buybacks have enabled Apple to grow EPS 16% annualized for the last decade. If you think it's going to be able to do 12-15% EPS growth the next decade, buybacks at a 20 PE are likely very accretive to earnings. The break-even mark is probably 25-30 times earnings. So no reason to wait for cheaper years that might not come any time soon if you can return capital tax free at 25x earnings. At 30x+ PE, yea they should wait or switch to dividends.

 

 

[Luca]

29 minutes ago, thepupil said:

in short, they are the same thing (except for tax treatment which for US taxable investors favors buybacks).

 

 

Company A distributes 50% of earnings in form of dividend and earns 10% on reinvested earnings. Company A is purchased for 15x earnings / 3.3% yield. It grows by 5% / yr and is exited at 15x earnings. Dividends are reinvested. Sold in 20 years.

 

For a nontaxable holder: 

 

Investor makes 8.6% IRR

 

 

 

Company B is same company but repo's instead of divvy. Same assumptions (excuse the quick and ugly spreadsheet). 

 

8.6% IRR. 

 

 

 

Company B 

 

 

 

 

 

Thanks for sharing, exactly what i looked for. 

 

So Dividends with 0 downside and buybacks with more downside depending on when they buy back shares IRR wise? 

 

I came to the conclusion after watching pabrais uber cannibal framework that buybacks were superior compounding wise

[Luca]

10 minutes ago, ValueArb said:

 

Neither Buffett or Apple know when the market is going to re-evaluate the PE, if ever. 

 

Buybacks have enabled Apple to grow EPS 16% annualized for the last decade. If you think it's going to be able to do 12-15% EPS growth the next decade, buybacks at a 20 PE are likely very accretive to earnings. The break-even mark is probably 25-30 times earnings. So no reason to wait for cheaper years that might not come any time soon if you can return capital tax free at 25x earnings. At 30x+ PE, yea they should wait or switch to dividends.

 

 

True, at 20x and a stellar business i could still understand the buybacks. ASML as an example buys back shares at 30+ earnings as far as i read, i dont think that is a good idea

[Xerxes]

Tax aside, there are two different points of view. The “company“ and the “shareholder”

 

 

from a company point of view, in both cases a certain fixed dollar amount is being sent out of the company coffers. Whether given in big lumps to selling shareholders (buyback) or much smaller amounts to all continuing shareholders (dividend) they are the same. 
 

from a continuing shareholder point of view, while the math is the same when it comes to EPS. That said a continuing shareholder would prefer a buyback that is to the disadvantage of the exiting shareholders. (Buying below intrinsic value) Taking out a slug of shares below intrinsic value is not possible via a dividend policy, unless done mechanically by the shareholder by buying additional shares with that dividend. so it comes down to, who has the best judgment in terms of when shares are undervalued: the continuing shareholder or the company. 

[thepupil]

37 minutes ago, Xerxes said:

Tax aside, there are two different points of view. The “company“ and the “shareholder”

 

 

from a company point of view, in both cases a certain fixed dollar amount is being sent out of the company coffers. Whether given in big lumps to selling shareholders (buyback) or much smaller amounts to all continuing shareholders (dividend) they are the same. 
 

from a continuing shareholder point of view, while the math is the same when it comes to EPS. That said a continuing shareholder would prefer a buyback that is to the disadvantage of the exiting shareholders. (Buying below intrinsic value) Taking out a slug of shares below intrinsic value is not possible via a dividend policy, unless done mechanically by the shareholder by buying additional shares with that dividend. so it comes down to, who has the best judgment in terms of when shares are undervalued: the continuing shareholder or the company. 

 

with the caveat that this is a bit overly theoretical, I actually think that the responsibility ALWAYS rests upon the shareholder to decide what to do with capital return. I don't believe there are good/bad share repurchase prices and don't blame companies for buying back stock at "too high" prices.  It is simply a capital return and shareholders make the decision to either "reinvest" [by not selling the amount of shares equal to the repo] or "take the distribution" by selling enough shares to maintain constant ownership. Likewise with dividends. The shareholder must choose to buy more shares (creating own buyback) or to divert the capital elsewhere (expenses/other investments). 

 

I think most people think that the shareholder only gets to decide if the company pays a dividned. But that's not true IMO. The shareholder decides every day whether he buys/sells the stock and he can decide to create a dividend when shares are repo'd (or not). 

 

Generally I have a bias toward companies which return capital to shareholders (what is the point of a company if not to pay its owners?), and a bias against reinvesting all of that back into those same companies. Instead, I like to buy other investments because dividend reinvestment (and continuing to hold share repurchasers blindly) is effectively doubling down on those companies. the world is uncertain and in most cases, I want capital return to derisk and diversify me over time. 

 

 

Edited January 11, 2023 by thepupil

[Sweet]

Depends on company.  

 

If it is a company that might not be around in 20 years, and has declining revenue, give me the dividends.  There is no point buying back shares in a business that is in terminal decline.

If revenue and income are growing, and it looks like the company has a very long life, buybacks are probably better.

 

Then again you might have a company growing slowly, it’s a good valuation but you can find many companies with better ROIC, then it’s dividends again for me.

 

The problem with dividends is the tax, it’s a big drag.

[SHDL]

One thing I’ll add (somewhat related to thepupil’s post above) is that there can be a meaningful difference between the two in terms of passive investment flows.

 

What I mean is this:

 

Suppose I own SPY and I automatically reinvest the dividends. So every now and then JNJ pays a dividend to SPY, SPY sends the cash to me, which then gets reinvested in SPY. Let’s say my SPY position is such that the JNJ dividend is $1000. JNJ’s SPY weight is around 1.5% so this means I will be passively buying $15 worth of JNJ when the dividend comes.

 

Now suppose JNJ were to scrap the dividend and buy back shares with the same cash flows instead. Then I would no longer get the $1000 dividend but instead JNJ would buy $1000 worth of JNJ stock on my behalf.

 

This means that by switching from dividends to share buybacks JNJ was able to increase my passive investment flows from $15 to $1000.

 

Now this doesn’t have any impact on intrinsic value so it probably makes little difference long term but I tend to think that it can affect how the stock trades in the interim - for instance my own theory is that AAPL would not have held up as well during 2022 if they just had a big dividend instead of their share buyback program.

 

[ValueArb]

2 hours ago, Xerxes said:

Tax aside, there are two different points of view. The “company“ and the “shareholder”

 

 

from a company point of view, in both cases a certain fixed dollar amount is being sent out of the company coffers. Whether given in big lumps to selling shareholders (buyback) or much smaller amounts to all continuing shareholders (dividend) they are the same. 
 

from a continuing shareholder point of view, while the math is the same when it comes to EPS. That said a continuing shareholder would prefer a buyback that is to the disadvantage of the exiting shareholders. (Buying below intrinsic value) Taking out a slug of shares below intrinsic value is not possible via a dividend policy, unless done mechanically by the shareholder by buying additional shares with that dividend. so it comes down to, who has the best judgment in terms of when shares are undervalued: the continuing shareholder or the company. 

 

I'd argue buybacks benefit the selling shareholders, even at large discounts to intrinsic value, since they would be selling at even lower prices without the buybacks.

 

And sometimes selling below IV can be directly beneficial to a shareholder, if they are using the proceeds to buy shares in something even farther below IV, or something of great value that makes them far happier, such as a divorce. I tell myself this a lot because I'm heavily invested in SRG where Eddie Lampert is selling every single day, and it helps me sleep (a little) at night.

[Xerxes]

1 hour ago, ValueArb said:

 

I'd argue buybacks benefit the selling shareholders, even at large discounts to intrinsic value, since they would be selling at even lower prices without the buybacks.

 

And sometimes selling below IV can be directly beneficial to a shareholder, if they are using the proceeds to buy shares in something even farther below IV, or something of great value that makes them far happier, such as a divorce. I tell myself this a lot because I'm heavily invested in SRG where Eddie Lampert is selling every single day, and it helps me sleep (a little) at night.

 

I dont know about the US, but Canadian TSX has a rule of no more than 10% of daily volume or something like that. Therefore I would argue that (at least in Canada), that buyback is just displacing some body else who would be buying.

 

 

[Xerxes]

3 hours ago, thepupil said:

 

with the caveat that this is a bit overly theoretical, I actually think that the responsibility ALWAYS rests upon the shareholder to decide what to do with capital return. I don't believe there are good/bad share repurchase prices and don't blame companies for buying back stock at "too high" prices.  It is simply a capital return and shareholders make the decision to either "reinvest" [by not selling the amount of shares equal to the repo] or "take the distribution" by selling enough shares to maintain constant ownership. Likewise with dividends. The shareholder must choose to buy more shares (creating own buyback) or to divert the capital elsewhere (expenses/other investments). 

 

I think most people think that the shareholder only gets to decide if the company pays a dividned. But that's not true IMO. The shareholder decides every day whether he buys/sells the stock and he can decide to create a dividend when shares are repo'd (or not). 

 

Generally I have a bias toward companies which return capital to shareholders (what is the point of a company if not to pay its owners?), and a bias against reinvesting all of that back into those same companies. Instead, I like to buy other investments because dividend reinvestment (and continuing to hold share repurchasers blindly) is effectively doubling down on those companies. the world is uncertain and in most cases, I want capital return to derisk and diversify me over time. 

 

 

 

I am guessing you are not a fan of DRIP

[Seanzy]

@thepupil, question.

 

If the company buys back shares at a terrible price way above intrinsic value, and the long-term shareholder does not wish to "reinvest" and chooses to sell shares equal to the repo, then is the company forcing the shareholder's hand in paying a potential capital gains tax?

 

Does the shareholder have to decide whether or not he will earn a greater return by holding the stock than he would by reinvesting the after-tax proceeds in an alternative investment?

 

 

[Gamecock-YT]

Because they are incentivized to do so. There’s certain ETFs you only can get into by paying dividends. (Dividend Achievers/Aristocratic). Keeps a floor on your investor base if you can keep the ETFs in your corner. Also once a dividend is issued by a company it’s hard to get the genie back in the bottle without a massive hit to the share price. 

Edited January 11, 2023 by Gamecock-YT
I can’t type

[thepupil]

7 hours ago, Seanzy said:

@thepupil, question.

 

If the company buys back shares at a terrible price way above intrinsic value, and the long-term shareholder does not wish to "reinvest" and chooses to sell shares equal to the repo, then is the company forcing the shareholder's hand in paying a potential capital gains tax?

 

Does the shareholder have to decide whether or not he will earn a greater return by holding the stock than he would by reinvesting the after-tax proceeds in an alternative investment?

 

 

yes the company is “forcing” the shareholder to realize a sale in order to take the repurchase as a “dividend”, but that doesn’t necessarily mean it will result in a capital gain because the shareholder’s basis could be higher than the current price. This is another tax efficiency thing that favors share repurchases. Your basis may be higher or close to current share price so there are instances where creating divvies via sales of repurchases doesn’t realize any tax.

 

if the company pays a dividend, then shareholder must deal with tax consequences of that too. 
 

a dividend and share repurchase are the same thing.

 

I like @SHDL’s point that various market dynamics may affect valuation differently b/w the two in the real world, but theoretically there’s no real difference and the capital allocation decision is in the shareholder’s hands. They just start with a different default decision. Share repurchase make the default reinvestment (the company has made the decision to reinvest  for you and you must reverse it to take a dividend). Dividends make the default decision to take cash out (and you must reverse it to reinvest). 

 

 

[Gregmal]

I dont think it really matters without properly observing the context of it all.

 

Ive seen companies pay out dividends that arent close to covered, for far longer than you'd expect. Vector Group was probably one of the best examples. Alexanders too. Ive seen companies refuse to do anything...Berkshire. Ive seen companies that do it once in a while...National Beverage. Same with buybacks. 

 

The only thing I think is absolute is that if you find a company that has a long track record of truly being committed to returning capital, it almost always turns out well. Whether its the old school dividend aristocrat stocks, or stuff like AZO, DDS, NVR.

[Castanza]

I like dividends in my non-taxable accounts and buybacks in my standard brokerage. 

[Jaygo]

Dividends are probably better since we are the owners getting money that is rightfully ours. We can then allocate ourselves. 
 

brk, tjx,Azo, Home Depot bought back 12% of the shares in the gfc. Hell ya that’s how you do it! .These are excellent allocators so it’s better for them to buyback since they are far better investors than I am. There is good operators and good allocators imo, sometimes a company has both or just one. As a business owner I would like to decide if I have both or not. 

 

This blanket statement saying buybacks are better has persuaded good operators and bad allocators to the point that most companies now buyback at any price and that is detrimental to us, the owners. Bby is the obvious one here but there are so many that do it. Buy on the way up and stop when the cycle turns against them. 

 

 

[thepupil]

15 minutes ago, Jaygo said:

Dividends are probably better since we are the owners getting money that is rightfully ours. We can then allocate ourselves. 
 

brk, tjx,Azo, Home Depot bought back 12% of the shares in the gfc. Hell ya that’s how you do it! .These are excellent allocators so it’s better for them to buyback since they are far better investors than I am. There is good operators and good allocators imo, sometimes a company has both or just one. As a business owner I would like to decide if I have both or not. 

 

This blanket statement saying buybacks are better has persuaded good operators and bad allocators to the point that most companies now buyback at any price and that is detrimental to us, the owners. Bby is the obvious one here but there are so many that do it. Buy on the way up and stop when the cycle turns against them. 

 

 

 

the shareholder gets to decide what to do with the increase in proportionate ownership which occurs with share repurchases (at any price, "good" or "bad"). BBY Shareholders who sold into the repo to maintain their stake, realized the share repurchases as a dividend. 

 

I wouldn't say buybacks are universally better (they are the same), but in a united states context, buybacks are almost always more more tax efficient. 

 

For a $1 of pretax corporate income a dividend realizes 

$0.2 of corporate tax  (20%)

$0.08-$0.25+ of individual tax

 

For me personally $1 of pretax income distributed via divvy becomes about $0.56 of post tax income via the combo of corporate, state, federal taxes.  If the corporation repurchases, the tax is deferred until when i want to create a dividend via sale of stock (which I may be able to offset with losses or push to a low income year etc). The share repurchase leaves the shareholder in control of choosing if/when to realize the individual tax and in the event one's basis is equal or > current price. the share sale may not trigger tax 

 

For a retired couple w/o much W2 / ordinaryh income, there's a pretty generous exemption for qualified divvies, so that type is more ambivalent b/w the two forms of capital return. Likewise IRA money is completely indifferent. 

 

Edited January 11, 2023 by thepupil

[Jaygo]

Sorry i meant BBBY as in Bed Bath & beyond not BBY for Best buy.

 

I understand the tax consequences but unless you own shares in a excellent capital allocator as well as a strong operator than the dividend is better imo. 

 

If you have a great company like Polaris industries, who are excellent operators, but not the best allocators. Their buybacks ramped at $150 but stoped at $ 80 id say the dividend would be better taxes or not. I guess I just want to be the one to choose how to handle our excess capital.

 

Polaris is an exceptional company who defined at category for years with the polars RZR. they have 7x earnings since 2005, well they bought back 3 million shares at 21/PE and now only 1 million at half the share price and a 10PE. 

 

I want to own Polaris for their operating savvy and not the allocation. Alas I do not own it. With a dividend I could decide to drip in times like these and gather cash in times of 21 PE.

 

I feel the same with Apple as I do Polaris by the way. Now you have DOO, a rival of Polaris has shown to be extremely astute with their capital allocation and operations so I am happy shareholder since I know they will buy stock hand over fist if the cycle turns like it seems it is now.

 

 

[StevieV]

Buybacks done well are great.  Unfortunately, most buybacks aren't done well.  BBBY is a good example - heavy buybacks, then collapse.

 

In practice, I think dividends are different than buybacks.  Companies just use them differently.  Typically a company wants to offer a stable and growing dividend.  They'll be cautious to raise and even more cautious to cut.

 

It can also be different to an investor. I understand investors are often told they can just sell, but you have way more volatility in share prices.  If you have a big bear market sell-off, but earnings hold up, an investor still gets their dividend and can use that rather than selling stock at a depressed price.  Sure, preferably an investor has cash and doesn't have to fire sale, but I don't think a reliable stream of dividends can't hurt.  Basically, a dividend investor isn't as reliant on share price for realizing some funds.