Author Topic: Discussion: Unless you're retired dividends are an inefficent, drag on portfolio  (Read 16263 times)

beltim

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My entire point is that stock buybacks can actually destroy shareholder value.  Most often they destroy shareholder value relative to paying a dividend, but the frequently result in not just relative but absolute losses to investors.  In this case, stock buybacks are worse than doing nothing they are management actively losing money for investors.

I'm not following this train of thought.
How do stock buybacks destroy shareholder value?


See the link I posted, as well as at least the first link that skyrefuge posted.  Basically, when directly compared to a dividend, there's no difference at any particular point in time.  But because dividend policies in the US are relatively consistent (management is loathe to reduce dividends unless it's their last option), while stock buybacks are highly cyclical (companies buy back far more stock when the market is high, and a lot less when the market is low), the net effect to investors is that dividends are a far superior return of capital than stock buybacks.

If stock buybacks were as consistent or more consistent than dividends, this wouldn't be the case.  But I don't know of any companies that buy back stock more consistently than pay dividends.

Wouldn't it be a positive aspect that management does not have to stick to a dividend policy?

Some companies may feel the need to keep paying a dividend even if they would be better off keeping some money or be reluctant to increase their dividends for fear that they will need to keep the same level over time.

With buybacks, companies can better time their cash flows to make sure that they are in accordance with the company's long-term strategic vision.

I do agree that it makes things less predictable for investors.

In theory, yes.  Just like in theory, individual investors should be able to spot when equity markets are undervalued (and buy more!) and overvalued (and reduce equity exposure).  But in practice, just like individual investors, management is terrible at timing the market, even when "the market" is just the stock of the company they run.

skyrefuge

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I really thought you got my point when you said this (although you keep bringing up active investing even though stock buybacks destroy shareholder value for index investors too).

I think I only brought up active investing once in my last two posts, and as I described there, that's because "value destruction" is difficult to discern in the passive world. It either doesn't happen, or it happens everywhere. When you reinvest an index's dividends in that index, the money is reinvested proportionally to the components of the index, even though it was not generated proportionally. If my dividends are generated largely by "undervalued" companies, and then reinvested in "overvalued" companies, I'm destroying value. But who cares? I'm matching the index, which is my goal. If the index's largest component goes from correctly-valued to overvalued, money must shift from correctly-valued components to that overvalued one. If that component again becomes correctly-valued, value is destroyed. But who cares? I'm matching the index, which is my goal.

In short, "intrinsic value" is a concept that the passive index investor blissfully ignores, and since intrinsic value is the only way that value destruction can be detected, the passive investor will never see it. The active investor presumably has an actual intrinsic value in mind, and can thus take action around a buyback. There is no action for a passive investor to take. How is he to know if a share price going from $20 to $10 after a buyback is the result of an overvalued stock returning to its correct value (thus making the buyback a value-destroyer), or going from undervalued to even-more-undervalued (thus making the buyback a value-creator that hasn't paid off yet)? Sure, the passive investor would enjoy it if managers only did buybacks that were value-creators for ongoing shareholders, since that would presumably result in a higher total return on the index, but he'd enjoy it if managers got their workers to be more productive too.

But then you said this:

"Mostly meaningless"? Just because there are investors and companies for whom a buyback may be less-optimal than a dividend, that hardly makes buybacks meaningless. They're still returns of capital to the investor pool, in exactly the same magnitude as a dividend would be.

My entire point is that stock buybacks can actually destroy shareholder value.  Most often they destroy shareholder value relative to paying a dividend, but the frequently result in not just relative but absolute losses to investors.  In this case, stock buybacks are worse than doing nothing they are management actively losing money for investors.

Sorry, when I said "investor pool", I meant that to refer to both the former investors and the ongoing investors. As my Legg Mason bro illustrates on p.6, value is conserved when you consider the entire system. So I was just disputing the notion that the transfer of billions of dollars from corporations to investors could in any way be considered "meaningless".

beltim

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I really thought you got my point when you said this (although you keep bringing up active investing even though stock buybacks destroy shareholder value for index investors too).

I think I only brought up active investing once in my last two posts, and as I described there, that's because "value destruction" is difficult to discern in the passive world. It either doesn't happen, or it happens everywhere. When you reinvest an index's dividends in that index, the money is reinvested proportionally to the components of the index, even though it was not generated proportionally. If my dividends are generated largely by "undervalued" companies, and then reinvested in "overvalued" companies, I'm destroying value. But who cares? I'm matching the index, which is my goal. If the index's largest component goes from correctly-valued to overvalued, money must shift from correctly-valued components to that overvalued one. If that component again becomes correctly-valued, value is destroyed. But who cares? I'm matching the index, which is my goal.

If my investments are destroying shareholder value, that's functionally indistinguishable from burning $100 bills lots of them.  That's something that index investors should care about.  That's something that all investors should care about.

brooklynguy

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If my investments are destroying shareholder value, that's functionally indistinguishable from burning $100 bills lots of them.  That's something that index investors should care about.  That's something that all investors should care about.

If Admiral General Aladeen clubs baby seals and puppies to death for sport in his spare time, that's also something index investors should care about.  That's something all people should care about.

But neither that nor the burning of hundred dollar bills by one of their indirectly held portfolio companies is something passive index investors should care about as it pertains to their investment strategy.  Passive index investors will keep robotically investing in the cash-burning company in proportion to its percentage constitution of the index, and let the active investors vote with their wallets (which will of course result in that company becoming a smaller percentage of the composition of the index).

beltim

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If my investments are destroying shareholder value, that's functionally indistinguishable from burning $100 bills lots of them.  That's something that index investors should care about.  That's something that all investors should care about.

If Admiral General Aladeen clubs baby seals and puppies to death for sport in his spare time, that's also something index investors should care about.  That's something all people should care about.

But neither that nor the burning of hundred dollar bills by one of their indirectly held portfolio companies is something passive index investors should care about as it pertains to their investment strategy.  Passive index investors will keep robotically investing in the cash-burning company in proportion to its percentage constitution of the index, and let the active investors vote with their wallets (which will of course result in that company becoming a smaller percentage of the composition of the index).

Sure.  But index investors shouldn't then advocate for Aladeen to club baby seals instead of, you know, creating shareholder value.  Similarly, index investors shouldn't encourage irregular stock buybacks, which we know destroy shareholder value.

brooklynguy

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Sure.  But index investors shouldn't then advocate for Aladeen to club baby seals instead of, you know, creating shareholder value.  Similarly, index investors shouldn't encourage irregular stock buybacks, which we know destroy shareholder value.

Yep, I agree.