r/valueinvesting
Could Switching From Buybacks to Dividends Improve Value?
The author argues Adobe and PayPal could improve value and reduce terminal value uncertainty by switching from buybacks to dividends.
- Switching to dividends shortens shareholder duration and reduces the weight of uncertain terminal value.
- Current strong fundamentals may lack the long-term resiliency required to justify current valuations.
I think i can make a compelling case that companies like Adobe and PayPal would benefit from implementing a dividend policy.
The problem with these companies has to do with uncertainty about the terminal value. Current underlying fundamentals look strong, but are those fundamentals resilient? And valuation is a question about long long term resiliency...
By switching to dividends, they would effectively shorten the duration for shareholders, and the weight applied to the terminal value would decrease.
\I wrote a short article looking at this thought experiment.\
Buybacks are preferred as they return capital while allowing taxes to be deferred and compound wealth longer
Valuation based on buybacks is contingent on the company remaining resilient into perpetuity...which is technically impossible.
The tax thing is also strange because it only defers the payment. It doesn't actually reduce your liability. It's great for management of timing your tax bill, but that's about it.
The tax rate on dividends is much higher than LTCG. Also the dividend is contingent on the company remaining resilient into perpetuity and maintaining/growing the dividend
Here’s my question - what are the chances that in the market your shares are the best value?
It's basically the management making the bet that them plowing that cash into their own stock will "buy" a rate of return greater than the average investor will get by investing that cash themself, factoring in tax implications as well.
I tend not to like constant steams of buybacks at elevated multiples. If the market is willing to give you $100 for every $1 of cash flow, please dilute shares and buy something really promising with that cash. Henry Singleton is the perfect example of this.
they should not be concerned with what the average investor does, their duty is to their shareholders, who are by definition capital allocators they have a fiduciary responsibility for. but yes i'm sure they'd say that they expect the long-term valuation to be good (although i don't see how that's defensible when you're literally buying every quarter, of every year)
yeah singleton and everyone in The Outsiders is just a great framing point
For companies that are struggling that is a non-starter.
Dividends are considered to be “sticky”. If these companies can’t commit to raising the dividend regularly, and eventually could risk having to CUT….its a bad sign.
Great point.
I wonder if the investor class should get more comfortable with the idea of variable dividends.
I feel like you are missing a crucial point as to why buybacks occur. Put yourself in the shoes of a CEO that wants more compensation. You can either pay dividends to all you share holders, or you can juice your stock price by implementing buy backs. Both things will net you more money in your account assuming you have had some real number of shares put in your account as compensation, but the dividends will have immediate tax implications where as the stock price going up will have no tax ramifications until you sell. Add that incentive to the fact that your compensation is probably tied to the stock price improving over your tenure and you can start to see why CEOs prefer buybacks.
Also, lots of executives might have options - which don't benefit from dividends.
Indeed. I have been saying that since a year now. That Switching from buybacks to Dividends will put a floor under the stock price bcz people will buy it when yield becomes too high
BRK, BN really time their buybacks.
GOOG has done well recently, buying back shares at low prices and diluting at a high price but I think they were still doing buybacks at the peak of 2021
yeah i would say GOOGL is guilty of always buying back shares and should pay a div, but they did time the recent equity raise really nicely. i have a feeling, NVDA not raising tons of equity + going on an acquiring spree during this cycle will be looked upon as an unforgivable mistake
BRK fair enough lol. haven't followed BN but ill have to take a look then
I think so if company doesn’t have clear path for growth. Cut expenses which is easy to do with software firms, start paying a dividend.
It's kind of a catch-22. When the stock is getting pummeled is precisely when investor confidence about the future is the lowest, and when switching to dividends has the most positive impact.
My point is if you are going to do buybacks, at least do them when the price is not high.
That's why I sold out of TMO. They've spent the last 6 years trading sideways, no dividend, basically zero ROI for shareholders
Dividends would be a much better use of capital at the moment, and eliminates the risk of the business falling out and having nothing to show for it at the end
Yeah exactly. Share buybacks when the share price is below intrinsic value, dividends when share price is at or above intrinsic value. Both dividends and buybacks only done if reinvestment of capital wouldn't generate a high ROI for the business.