"Macro" Musings

[Hielko]

How relevant is CAPD when companies use more and more share buybacks as a way to return capital?

[giofranchi]

How relevant is CAPD when companies use more and more share buybacks as a way to return capital?

 

Well, cannot be sure… But, if companies are buying back shares at these prices, they are not compensating shareholders by returning back capital… They are destroying value. At these general prices I’d rather receive a dividend than see my company buying back its shares… This I think is true, only if my company is an average S&P500 or Russell2000 company. Of course, there might still be value somewhere… and for those companies, with a stock that still is cheap, a buyback program might continue to make sense. :)

 

Gio

 

[obtuse_investor]

How relevant is CAPD when companies use more and more share buybacks as a way to return capital?

 

CAPD is definitely less relevant today than a few decades ago-- the payout ratios are relatively tiny today.

 

Although, buybacks in general are a very bad way to return capital to long term shareholders. Most buybacks are done irrespective of the stock price and often a dollar invested yields less than a dollar back. Negative rate of return eventually wastes the assets, even though in the short term the buybacks produce ebullient stock price-- like these days.

[ERICOPOLY]

Most buybacks are done irrespective of the stock price and often a dollar invested yields less than a dollar back.

 

You only get a dollar back through dividends if you don't pay taxes.

 

Supposing the dividend rate is 33% (like mine), the stock has to be 50% overvalued before the dividend is the better option on a relative basis.

 

Some people pay 45% on their dividends (an Australian holding a foreign stock).  That would be a situation where the buyback is always better unless the stock is overvalued by more than 81%.

 

Just run the math.

[ERICOPOLY]

Rising US consumer spending:

 

http://www.bloomberg.com/news/2013-11-12/bank-of-america-ceo-says-u-s-consumers-are-spending-more.html?cmpid=yhoo

 

[Hielko]

Most buybacks are done irrespective of the stock price and often a dollar invested yields less than a dollar back.

 

You only get a dollar back through dividends if you don't pay taxes.

 

Supposing the dividend rate is 33% (like mine), the stock has to be 50% overvalued before the dividend is the better option on a relative basis.

 

Some people pay 45% on their dividends (an Australian holding a foreign stock).  That would be a situation where the buyback is always better unless the stock is overvalued by more than 81%.

 

Just run the math.

If you own stocks where you need to pay 45% dividend taxes you probably made a mistake buying the stock in the first place. You can't ignore your tax situation when you invest.

[giofranchi]

You only get a dollar back through dividends if you don't pay taxes.

 

Supposing the dividend rate is 33% (like mine), the stock has to be 50% overvalued before the dividend is the better option on a relative basis.

 

Some people pay 45% on their dividends (an Australian holding a foreign stock).  That would be a situation where the buyback is always better unless the stock is overvalued by more than 81%.

 

Just run the math.

 

Well Eric, I think you are right. But only if you don’t look at cash as a strategic asset… There are not many people out there I trust to invest my free cash flow in my stead… And those whom I trust do not buy back shares at these prices… So, if someone instead is buying back shares at these prices, I don’t trust his judgment and I would much rather have the money to invest myself… Even if this means starting with 67% of the original money (assuming a tax rate of 33%). Do stupid things with $1, or do smart things with $0.67… which would you prefer? :)

 

Gio

 

[hyten1]

hielko,

 

i am curious, i don't see how you can avoid this. unless you actively avoid dividend paying stocks in your taxable accounts.

 

unless you have a way to invest always in non-taxable accounts? or you only invest non-dividend paying stock in tax able accounts?

 

because i have both tax able account and non taxable. my non tax able account is a lot smaller than my tax able.

 

hy

 

If you own stocks where you need to pay 45% dividend taxes you probably made a mistake buying the stock in the first place. You can't ignore your tax situation when you invest.

[Palantir]

I only invest through a non taxable account...so I for sure hope that my firms pay me dividends instead of buybacks.

[ERICOPOLY]

You only get a dollar back through dividends if you don't pay taxes.

 

Supposing the dividend rate is 33% (like mine), the stock has to be 50% overvalued before the dividend is the better option on a relative basis.

 

Some people pay 45% on their dividends (an Australian holding a foreign stock).  That would be a situation where the buyback is always better unless the stock is overvalued by more than 81%.

 

Just run the math.

 

Well Eric, I think you are right. But only if you don’t look at cash as a strategic asset… There are not many people out there I trust to invest my free cash flow in my stead… And those whom I trust do not buy back shares at these prices… So, if someone instead is buying back shares at these prices, I don’t trust his judgment and I would much rather have the money to invest myself… Even if this means starting with 67% of the original money (assuming a tax rate of 33%). Do stupid things with $1, or do smart things with $0.67… which would you prefer? :)

 

Gio

 

I would prefer starting with the $1 rather than with the systematic destruction of 33% of value.

 

Especially since it's the democratic way.  People like you who don't want the stock buyback can just sell an offsetting amount of shares -- quite possibly tax-free if your cost basis is at or above where you are selling the stock.

 

So everybody wins.

 

[ERICOPOLY]

Ironically I believe high tax rates help support high asset prices.  I see it here in local luxury real estate.  The top income tax rate is over 46% in California. 

 

So, you see a property rented at gross rental yield of 4% and you would think it's overpriced, but keep in mind from the renter's perspective it eats up 7.5% pre-tax income .

 

So the homeowner earns 7.5% gross imputed rental yield if he buys the home he was renting previously. Even though he'd only earn 4% pre-tax if he turned around and rented it out!

 

Normally, 7.5% pre-tax gross rental yield from a landlord's perspective would be an appropriate rent.  That's the same rent the homeowner earns for himself.  Therefore, it makes sense to buy the home that you are renting even if your rents represent only a 4% cap rate for the landlord/investor.

[Hielko]

hielko,

 

i am curious, i don't see how you can avoid this. unless you actively avoid dividend paying stocks in your taxable accounts.

 

unless you have a way to invest always in non-taxable accounts? or you only invest non-dividend paying stock in tax able accounts?

 

because i have both tax able account and non taxable. my non tax able account is a lot smaller than my tax able.

 

hy

 

Tax situations differ for every person, buy you put yourself at a big disadvantage if you buy something that has a high tax rate for you, but a low rax rate for most investors.

 

Sometimes not buying a certain asset class might be the best move: if you indeed need to pay a 45% dividend tax as an Australian on a foreign stock you are basically screwed by the government, and owning a dividend paying foreign stock is just not an option. But you might be able to work around the issue. Buying derivatives (such as options, or CFDs) could be a solution: their pricing does include the expected dividend, but since you don't receive  the dividend you don't need to pay the tax and the party writing the option is most likely not paying any dividend taxes. Or maybe you could setup an offshore holding company. If you face high taxes you either have to find a way around it, or just not buy it in the first place.

[hyten1]

hielko, i hear ya and agree

 

i guess the point is, eventually high dividend tax will hit you at some point. i understand you take tax  into account as part of any investment (I wish i didn't have to, but oh well).

 

but at some point it will hit you as you invest long enough. UNLESS you completely avoid paying tax in ALL your investment which is possible but might not be the most optimal. (maybe this assumption is not correct, maybe there is a way by setting up a holding company etc to completely avoid tax, completely, which i know nothing about)

 

i guess it boil down to given you will get hit with the tax at some point, what do you prefer buybacks vs dividend etc.  some poster here prefer buyback (given the high tax) but some dont.

 

hy

 

EDIT: if someone knows about the personal holding company  and at what size of asset does it make sense to setup one up or any info about it, it would be greatly appreciated if you can share it with us.

 

hielko,

 

i am curious, i don't see how you can avoid this. unless you actively avoid dividend paying stocks in your taxable accounts.

 

unless you have a way to invest always in non-taxable accounts? or you only invest non-dividend paying stock in tax able accounts?

 

because i have both tax able account and non taxable. my non tax able account is a lot smaller than my tax able.

 

hy

 

Tax situations differ for every person, buy you put yourself at a big disadvantage if you buy something that has a high tax rate for you, but a low rax rate for most investors.

 

Sometimes not buying a certain asset class might be the best move: if you indeed need to pay a 45% dividend tax as an Australian on a foreign stock you are basically screwed by the government, and owning a dividend paying foreign stock is just not an option. But you might be able to work around the issue. Buying derivatives (such as options, or CFDs) could be a solution: their pricing does include the expected dividend, but since you don't receive  the dividend you don't need to pay the tax and the party writing the option is most likely not paying any dividend taxes. Or maybe you could setup an offshore holding company. If you face high taxes you either have to find a way around it, or just not buy it in the first place.

[ERICOPOLY]

hielko, i hear ya and agree

 

i guess the point is, eventually high dividend tax will hit you at some point. i understand you take tax  into account as part of any investment (I wish i didn't have to, but oh well).

 

but at some point it will hit you as you invest long enough. UNLESS you completely avoid paying tax in ALL your investment which is possible but might not be the most optimal. (maybe this assumption is not correct, maybe there is a way by setting up a holding company etc to completely avoid tax, completely, which i know nothing about)

 

i guess it boil down to given you will get hit with the tax at some point, what do you prefer buybacks vs dividend etc.  some poster here prefer buyback (given the high tax) but some dont.

 

hy

 

EDIT: if someone knows about the personal holding company  and at what size of asset does it make sense to setup one up or any info about it, it would be greatly appreciated if you can share it with us.

 

hielko,

 

i am curious, i don't see how you can avoid this. unless you actively avoid dividend paying stocks in your taxable accounts.

 

unless you have a way to invest always in non-taxable accounts? or you only invest non-dividend paying stock in tax able accounts?

 

because i have both tax able account and non taxable. my non tax able account is a lot smaller than my tax able.

 

hy

 

Tax situations differ for every person, buy you put yourself at a big disadvantage if you buy something that has a high tax rate for you, but a low rax rate for most investors.

 

Sometimes not buying a certain asset class might be the best move: if you indeed need to pay a 45% dividend tax as an Australian on a foreign stock you are basically screwed by the government, and owning a dividend paying foreign stock is just not an option. But you might be able to work around the issue. Buying derivatives (such as options, or CFDs) could be a solution: their pricing does include the expected dividend, but since you don't receive  the dividend you don't need to pay the tax and the party writing the option is most likely not paying any dividend taxes. Or maybe you could setup an offshore holding company. If you face high taxes you either have to find a way around it, or just not buy it in the first place.

 

You aren't going to get anywhere with that unless you go with something like an insurance company which holds the passive investments.

 

You can't simply set up a foreign corporation for yourself where you do your passive investing. 

 

http://www.borelassociates.com/topics/Using-Offshore-Holding-Companies.pdf

 

Basic Anti-Deferral Regimes For a taxpayer to benefit from deferral, the foreign entity that holds the income producing property or activity must be a foreign corporation. If a U.S. taxpayer invests through a foreign entity that is treated as a partnership, branch or disregarded entity for Federal income tax purposes, it will remain subject to tax on its allocable share of the entity’s income, regardless of whether the partnership is formed under domestic or foreign law. Accordingly, the general rules applicable to the taxation of foreign corporations owned by U.S. persons must first be considered. 

There are two main anti-deferral regimes under which the U.S. imposes tax on the income of a foreign corporation with U.S. shareholders. These regimes operate by applying special tax rules to shareholders of foreign entities that qualify as either CFC’s or passive foreign investment companies (PFIC’s). Both sets of rules are aimed predominantly at taxing a U.S. shareholder on the foreign corporation’s passive and “mobile” income (i.e., income that may easily be shifted to low-tax jurisdictions). If the rules apply, the U.S. shareholder may either: (1) be taxed currently on the foreign corporation’s income, despite the fact that no income was repatriated to the shareholder through a distribution; or (2) face a somewhat punitive interest charge (in addition to the shareholder’s ordinary income tax liability) on an ultimate distribution to the U.S. shareholder or disposition of the entity’s stock.

[Myth465]

Ericopoly is describing a real situation.

 

Dividends for me are taxed as ordinary income as an American living in Australia. Capital gains which are long term, are taxed at half ordinary income.

Due to this I will never hold dividend paying stocks in taxable accounts. Its just not worth it.

They are all in my IRA.

 

I prefer buybacks given this. Americans abroad are subject to the worst of the US tax system and their current home tax system. Its a bit of a pain, but can be overcome with planning.

[ERICOPOLY]

Ericopoly is describing a real situation.

 

Dividends for me are taxed as ordinary income as an American living in Australia. Capital gains which are long term, are taxed at half ordinary income.

Due to this I will never hold dividend paying stocks in taxable accounts. Its just not worth it.

They are all in my IRA.

 

I prefer buybacks given this. Americans abroad are subject to the worst of the US tax system and their current home tax system. Its a bit of a pain, but can be overcome with planning.

 

It's real alright.

 

And people who theorize about whether dividends should be paid or buybacks should be paid... blah blah blah

 

They shouldn't care!  They don't even own overvalued stocks in the first place (being "value" investors), and if they did, then it's their own frigging fault for not having sold out!  Talk about a case of living in an ivory tower... sheesh!

 

[Myth465]

Trust me you dont care as much and have a theoretical argument at 15%.

It starts to hurt when you give Uncle Sam his 15%, and Uncle AUS the remaining 25%, and keep whats left.

 

Sucks when you could have had a buyback, and sold at LTC gain of 15% to Uncle Sam and the remaining 5% to Uncle AUS. It forces one to get very creative.

 

Eric raises a valid point which no one answers. If it pisses you off that Management is buying back overvalued shares, why are you holding those shares. Why not sell when overvalued? Why arent you mad at yourself for your crappy capital allocation to overvalued stock?

[ERICOPOLY]

Sucks when you could have had a buyback, and sold at LTC gain of 15% to Uncle Sam and the remaining 5% to Uncle AUS. It forces one to get very creative.

 

Forgive me for pointing this out, but your tax rate on the share-repurchase "dividend" is less than what you are stating, because the tax is not paid on the cost basis.

 

So of course the tax might very well be zero on the pass-through sneaky dividend-laundering buyback.

 

Lastly, the very guy that first promoted this thing through value investing circles is Mr. Warren Buffett himself.  He has a scheme where 99% of his net worth is in Berkshire, 100% of his Berkshire common stock holdings are held within insurance companies, and the tax rate on those dividends is only 14.5%.  Oh, and did I forget to mention that his tax rate on capital gains is 35%???  Geez, no wonder he's got everyone singing the dividends over buybacks song.  He's got everyone painting his white fence for him.

[giofranchi]

You only get a dollar back through dividends if you don't pay taxes.

 

Supposing the dividend rate is 33% (like mine), the stock has to be 50% overvalued before the dividend is the better option on a relative basis.

 

Some people pay 45% on their dividends (an Australian holding a foreign stock).  That would be a situation where the buyback is always better unless the stock is overvalued by more than 81%.

 

Just run the math.

 

Well Eric, I think you are right. But only if you don’t look at cash as a strategic asset… There are not many people out there I trust to invest my free cash flow in my stead… And those whom I trust do not buy back shares at these prices… So, if someone instead is buying back shares at these prices, I don’t trust his judgment and I would much rather have the money to invest myself… Even if this means starting with 67% of the original money (assuming a tax rate of 33%). Do stupid things with $1, or do smart things with $0.67… which would you prefer? :)

 

Gio

 

I would prefer starting with the $1 rather than with the systematic destruction of 33% of value.

 

Especially since it's the democratic way.  People like you who don't want the stock buyback can just sell an offsetting amount of shares -- quite possibly tax-free if your cost basis is at or above where you are selling the stock.

 

So everybody wins.

 

Eric,

this how I see it:

1) If you see good opportunities, do not distribute any dividend and seize them.

2) If you don’t see or expect in the future good opportunities, and your stock is undervalued, do not distribute any dividend and buyback your own stock.

3) If you don’t see or expect in the future good opportunities, and your stock is overvalued, do distribute a dividend.

In 3), if you keep the capital inside the company, you are almost surely going to do something stupid… your shareholders, on the other hand, might find a better use for those funds. Ok, they will pay taxes, but when you do something stupid, you might end up destroying value very quickly!

I understand your idea of a “democratic way”… But I don’t necessarily endorse nor want democracy, if and when it behaves stupidly! ;)

 

Gio

 

[ERICOPOLY]

I understand your idea of a “democratic way”… But I don’t necessarily endorse nor want democracy, if and when it behaves stupidly! ;)

 

Gio

 

Gio,

I think this is a matter of personal responsibility.  If the stock is overvalued and you do not sell out your shares, then you are the one behaving stupidly.

 

Are you not making an implicit "buy" decision every single day that you hold your shares?  I mean, you can go back to cash at any time... so by continuing to "hold", you are in fact making the same capital allocation decision as if you were buying new shares.

 

So it's you, you, you!  You can't ever duck and blame management.

[gary17]

If it's a fundamentally good business, and the initial cost was very low, why sell, even if slightly over valued?  I really think it needs to be evaluated on a case by case basis -  if it's in a regular account it might incur significant capital gain... 

 

I would say Bank of Ireland right now is over valued relative to its European peers, but probably fairly or slightly under valued relative to its future earnings potential.  Same goes for many wonderful US businesses - 

[giofranchi]

Gio,

I think this is a matter of personal responsibility.  If the stock is overvalued and you do not sell out your shares, then you are the one behaving stupidly.

 

Are you not making an implicit "buy" decision every single day that you hold your shares?  I mean, you can go back to cash at any time... so by continuing to "hold", you are in fact making the same capital allocation decision as if you were buying new shares.

 

So it's you, you, you!  You can't ever duck and blame management.

 

This is a really strange way to look at it… It is as if, instead of thinking how to use the new free cash my businesses generate, I would be constantly looking for someone who might be willing to buy those businesses from me… Yes, I might consider to sell a business… but only if it becomes extremely overvalued! This certainly doesn’t mean that I am going to put all the free cash generated by that business back into it! This is clear, isn’t it? I have never done so, and I will never do it… yet, I don’t sell my businesses!

Exactly like it is for my businesses, also for a stock that I bought at BV and that can compound at high rates for many years into the future, I am willing to stick with that business through all the ups and downs. (Unless, of course, it becomes extremely overvalued!) This doesn’t mean I will add to my holdings on the ups… right?

 

Gio

 

[ERICOPOLY]

Gio,

I think this is a matter of personal responsibility.  If the stock is overvalued and you do not sell out your shares, then you are the one behaving stupidly.

 

Are you not making an implicit "buy" decision every single day that you hold your shares?  I mean, you can go back to cash at any time... so by continuing to "hold", you are in fact making the same capital allocation decision as if you were buying new shares.

 

So it's you, you, you!  You can't ever duck and blame management.

 

This is a really strange way to look at it… It is as if, instead of thinking how to use the new free cash my businesses generate, I would be constantly looking for someone who might be willing to buy those businesses from me… Yes, I might consider to sell a business… but only if it becomes extremely overvalued! This certainly doesn’t mean that I am going to put all the free cash generated by that business back into it! This is clear, isn’t it? I have never done so, and I will never do it… yet, I don’t sell my businesses!

Exactly like it is for my businesses, also for a stock that I bought at BV and that can compound at high rates for many years into the future, I am willing to stick with that business through all the ups and downs. (Unless, of course, it becomes extremely overvalued!) This doesn’t mean I will add to my holdings on the ups… right?

 

Gio

 

A company repurchasing it's shares has absolutely nothing to do with plowing money back into the business.  It is merely returning capital to shareholders.  Shareholders who do not sell an offsetting amount are responsible for their increase in ownership at those prices.  Like it or not, it's your personal responsibility as a shareholder to sell the offsetting number of shares if you think it is overvalued.  But you might as well dump the entire holding if it's overvalued, no?

 

And yes, you can be fully in cash on any given day provided you hold relatively liquid stocks.  The fact that today you aren't fully in cash is an indication that you are a buyer of those shares at these prices today.  It's just "tough cookies" if your mental psychology blocks you from seeing it that way, but it's the reality nonetheless.  Nobody ever accused an engineer of being logical  ;)

[giofranchi]

Nobody ever accused an engineer of being logical  ;)

 

;D ;D ;D

So, Eric, you don’t see a situation in which you hold a stock, without adding to that position as soon as you have cash available? Maybe, you are right... The problem though is the difference between theory and practice: in practice almost no one behaves like you are suggesting.

So trying to be practical, and engineers are always practical! ;D, I will be content enough and even very pleased, if management buys back shares when they are undervalued, and refrains from buying back shares when they are overvalued… ;)

 

Mr. Buffett buys back under 1.2 x BVPS, and yet doesn’t sell one share of his, even when the stock trades above that price. Does he? And he is not an engineer! ;D ;D ;D

 

Gio

 

[ERICOPOLY]

Nobody ever accused an engineer of being logical  ;)

 

;D ;D ;D

So, Eric, you don’t see a situation in which you hold a stock, without adding to that position as soon as you have cash available? Maybe, you are right... The problem though is the difference between theory and practice: in practice almost no one behaves like you are suggesting.

So trying to be practical, and engineers are always practical! ;D, I will be content enough and even very pleased, if management buys back shares when they are undervalued, and refrains from buying back shares when they are overvalued… ;)

 

Mr. Buffett buys back under 1.2 x BVPS, and yet doesn’t sell one share of his, even when the stock trades above that price. Does he? And he is not an engineer! ;D ;D ;D

 

Gio

 

Humans are capable of writing down pure logic, and formulating purely logic thoughts, but they are not capable of executing investments in a purely logical manner.