Should Repurchases be counted in FCF/yield per share?

[ERICOPOLY]

Given my earlier example I'm still inclined to say that buybacks at various prices affect the per-share value. Do you agree? Or do you want to blow up another one of my paradigms?

 

For the following comments lets assume it's in a tax-deferred account (no dividend tax):

 

I'm going to write about how much value is created if instead dividends were paid and reinvested in the stock through a DRIP.  Of course, if you get paid a dividend when the price of stock is very low... you wind up with more buying power for additional shares.  And when you get paid a dividend when the price of stock is very high... you wind up with less buying power for relatively fewer additional shares.  So an observer would notice that the total effect on the portfolio is that more additional shares are purchased if dividends were paid when the stock was low versus when it was high priced.  Thus, more value was created.

 

So is management no less shrewd to return capital via dividend when stock price is low?  Again, assuming no taxes.

 

The moral of this post is that it simply matters that capital is returned, by either method, as vigorously as possible when the stock price is low.  Neither method creates more value than the other.  But when taxes come into play, it's better to return capital via share repurchase.

 

But what about when stock price is high and stays high for a decade?  Should management not return any capital at all by either method?  I think they should return capital by the method that results in the least amount of tax.  The guy can destroy just as much value by plowing the dividend into more shares as compared to management buying back shares.  The shareholders needs to be personally responsible -- if he can decide when not to buy more shares, he can also decide to sell the incremental fractional ownership that management keeps on buying on his behalf.

 

The higher the dividend tax rate, the more difficult it is for management to make the "wrong" decision by repurchasing shares.  The shares need to be overvalued by 50% too high above fair value before we even get to the break-even tipping point when the dividend tax rate is 33%.

[JBird]

That's another good explanation and I agree. To be sure, I'm asking, do you think that buybacks change per-share intrinsic value; forget dividends or the aim of returning capital to shareholders.

[ERICOPOLY]

That's another good explanation and I agree. To be sure, I'm asking, do you think that buybacks change per-share intrinsic value; forget dividends or the aim of returning capital to shareholders.

 

Yes.

 

However, it's my after-tax account intrinsic value that matters to me.  So whether or not buyback itself adds intrinsic value isn't the final answer -- what also matters is if it doesn't destroy as much intrinsic value for the account as taxable dividends do.

[JBird]

Well said.

[jay21]

The reason being, I think the DCF model has some necessarily simplifying assumptions, eg, that cash flows are paid straight to investors, or that there is no distinction between the investor and the "firm".

 

If the firm just generated 1M in FCF and did nothing with it, it would form a part of the firm's cash account and be an element of value for the company, however if it was used to repurchase shares, it would certainly create value for shareholders, but the way I see it, that value would be counted in your future projections of per share FCF.

 

Only if the company is repurchasing at prices below fair value. You should think of it as a dividend.

 

Why is the stock valuation of any relevancy?  It's the total amount of cash returned to investors that matters.

 

Proof:  each shareholder can sell an offsetting amount of shares at any price that the company buys it from them.  Like a tender offer for example.  The company can offer to buy out each investor's fractional ownership at a billion times IV.  It won't matter, they'll each get exactly the same amount of cash as they would have received if instead a cash dividend had been paid.  After the transaction, they will each own exactly the same % of the business as beforehand.  Cash is the same as dividend.  Ownership is the same as with the dividend.  The only key here is that they need to do their part and sell some shares to offset the buyback.

 

This whole thing about high priced buybacks destroying value is a hoax -- the shareholders are the ones destroying value by holding their shares instead of selling them.  They're the ones making the bad capital allocation decisions, but ain't it convenient to blame management?  Management is at least helping them with tax efficiency.

 

Skimming the thread and I both disagree and agree.

 

Yes, shareholders are making a mistake holding overvalued shares.

 

But, mgmt is also making a mistake buying overpriced shares.  If their options were limited to buy shares or dividend, your point would be more valid.  But there are many other options.

[JBird]

The shareholder merely needs to make 28 cents worth of sales, each and every quarter.

 

I don't follow here.

 

Well, the shareholder is no longer getting a 28 cent per quarter cash dividend any longer (it was cut to zero).  Let's say the shareholder has 100,000 shares.  In the old days, he would get $28,000 of cash dividend each quarter.  Under my regime, the company will be using that very same $28,000 (28 cent per share per quarter) to repurchase shares.

 

Now (under my regime), he just sells shares each quarter amounting to $28,000 cash proceeds.  He might not even owe any tax on this (depends on his cost basis).  Potentially he sold for a capital loss and can actually take the $28,000 distribution completely tax free, as well as reducing his capital gains tax bill from other sales.

 

Compared to the world where he's automatically paying tax on $28,000 of dividend, that's a huge leap forward for mankind.

 

Eric, I'm still in agreement regarding dividends vs. buybacks.

 

There's one consistent statement of pushback I receive regarding capital-gain-income over dividends: "If you sell shares at any kind of loss, you're just taking principle." In other words, in a falling market the strategy doesn't work.

 

I would love to hear your thoughts on that.

 

My take is that you can only take as much income from a stock as the company earned in profit attributable to you. If it earns $5 in profit attributable to your holdings (look-through earnings) then you can take $5 from the stock as a dividend or by selling $5 worth of shares. If it doesn't earn, you can't take. Therefore, the stock price being up or down from your cost basis is really not a factor regarding your income withdrawals from the stock.

[scorpioncapital]

" Therefore, the stock price being up or down from your cost basis is really not a factor regarding your income withdrawals from the stock."

 

Not sure I can agree with this conclusion. If a stock is extremely overvalued, selling shares is going to yield far greater return than a dividend that won't adjust that much to this overvaluation of the share price. If it's undervalued, a dividend may be slower than an opportunistic buyback program. Problem is most companies are brainless zombies and don't understand opportunistic if it hit them in the side of the head. Or worse, they see opportunity all the time when there really is none.