BAC-WT - Bank of America Warrants

[Eye4Valu]

Someone should ask WEB his thoughts on this at the meeting.

[xazp]

One reason people use TBV is because it's a yardstick that doesn't change (much).  Capital calculations DO change drastically because the rules are constantly changing. 

 

As a "for example" the accounting mistake didn't seem to impact B1 calculations at all, impacted fully-phased in B3 calculations by $4Bn, but impacted current capital rules (a combination of B1 and B3) by about $700M.  Some capital ratios did not change at all, while some were modified by 20bps.  This is why the news release has tables of numbers, because the impact really depends on which capital calculations you are looking at.

 

This is also why BAC gets a partial pass on these mistakes.  The rules were basically hot off the printing press for B3 when they made the mistake.  I'd say 80% of the problem here is spending a few months trying to get a $2 trillion balance sheet under the scrutiny of new rules; 20% is BAC's fault.  But, people don't seem to recognize the problem is because the capital rules changed, and BAC made a mistake with the new calculations.

 

I'm frustrated with BAC too, but, most people on this thread date to 2011 which means you have been paid very well for your patience.  I view BAC as a company where investors have to simply understand that for years and years, you're going to be hit with small and large set-backs.  This is why you once bought BAC for 1/2 of TBV, and currently buy BAC for a discount to BV.  It's part of the game.  The market isn't going to let you buy a well-run, cockroach-free, profitable company for 1/2 TBV.  So you take the frustration with the low prices or skip the frustration and take a better-run company. 

 

IMO the hits to BAC -- still substantial -- are lessening over time.  By my judgement we're about 90% through the crap, so I'm expecting another few-billion dollar set-back in the next year or two, and then I think it calms down.  I say this so that when BAC says "by the way, OOPS" in the next year, I just roll with the punches.  I expect it. 

 

 

 

The reason why I believe TBV doesn't matter, is that the company won't be liquidated.

 

It will be operated for decades going forward, if not centuries, and the only value here in the stock is the distributable earnings generated by the businesses.  That anticipated distribution drops by $4b with this error.  Thus, the value of the stock drops by $4b too.

 

I just go ahead and call that a $4b reduction to our perception of intrinsic value (as best as we can estimate it).

[xazp]

Wanted to discuss FICC here.

 

After hours, JPM said they view markets revenue as dropping 20% y/y.  http://finance.yahoo.com/news/jpmorgan-sees-markets-revenue-declining-214224203.html

 

JPM says this is a cyclical trend - as interest rates start moving, so will trading.  And, over time in general, there will be more bonds on the market as economies grow. 

 

Citigroup seems to say part of this is secular - they're all competing for a shrinking pie. 

 

There's also a middle ground which says, shrinking pie, but the competitors are shrinking too - the third tier guys, the European banks -- they'll be forced out of the market, so the remaining participants will grow market share even with a shrinking pie. 

 

My question for the board: is market/trading revenue in a secular decline, and if so, does it weigh on "normalized" earnings for BAC, C, JPM? 

[kevin4u2]

The range for legal liability is simply a guess AND it will NEVER be ZERO until the company has zero lawsuits filed against them.  If you expected it to drop to zero after the additional reserves in Q1 you don't understand what it means. 

 

It does not mean they have additional legal liabilities today.  Current legal reserves could... be accurate, be underestimated or be overestimated... who knows. 

 

I mean if you really want to be conservative why don't you personally tell yourself that it is $0-20 billion.  Then you can feel good about yourself when it comes in under that amount because you've already reserved that amount mentally. 

 

Another possible option is to accept reality, which is BAC and nobody else knows what the ULTIMATE reserves will be, this is just a possible range and then you don't have to be so upset. 

 

The nice thing about BAC is that most of us have made at least a double over the past couple years and this was accomplished in the face of a string of negatives developments and very little positive developments, proving the margin of safety was quite large.  Today the investment is quite different, new assumptions need to be made and each need to come to their own decision. 

 

In light of the gains, is it worth going on a rampage over a $0.30/share loss (2% return on TBV) that may not even materialize.  I think this is partially what Scotthall was getting at.  Cheers!

 

To start with, I'm not sure where you keep getting this $0.65 number from

 

They raised the range of legal liability by $4.9 billion.  That's 30 cents per share after-tax that we thought we would be seeing, but now we're pretty sure we'll never see it.

 

Then add the 35 cents from the accounting error.

 

30+35=

[Uccmal]

The stock from top to bottom has taken a hit of 2.60 per share.  Thats 2.60 * 10.5'b = 27 Billion.

 

So, we have a potential hit to the company of 5 b for the error, which isn't actually a loss of money.  The money is still there, either way. 

 

Then we have the DOJ settlement of say 10 b - I am assuming they have paid some of this in the other recent settlement.  Of course I dont know for sure. 

 

If the JPM pattern stays intact then the DOJ should be the last major regulatory settlement.  Obviously lawsuits will continue, probably for the foreseeable future but the big, Public Players, with government backing, will be out of the way with the DOJ settlement.  That leaves small private suits that are getting long in the tooth. 

 

This is very frustrating, and I understand where Eric is coming from, but it is nowhere near the level of punishment we took with FFh in 2004,05 & 06.  The returns I got from my Leaps from FFh came in big in a matter of days when the 2006 lawsuit against the cabal was filed.  I suspect we will see a mirror image of this with BAC.  The next phase of huge gains will come over a period of a few weeks.  And then, the massive retrenchment they have completed will have the effect of outperforming the s&p for years forward. 

 

In the meantime, it is a massively safer company, than it was at $5 or $10 per share.  I repositioned my Leaps at much lower strike prices this past week, taking realized losses on the higher strike positions. 

 

 

[shalab]

Someone should ask WEB his thoughts on this at the meeting.

 

Guess the question was answered:

 

Buffett; He isn't concerned by B of A's mistake on the Fed's stress test. It doesn't change his opinion

 

[ERICOPOLY]

In light of the gains, is it worth going on a rampage over a $0.30/share loss (2% return on TBV) that may not even materialize.  I think this is partially what Scotthall was getting at.  Cheers!

 

30 cents a share is a six-figure hit to my net worth.

 

It's not like they raised the price of beer 10% at the pub.

[tombgrt]

A luxury problem to have.

[ERICOPOLY]

I agree... it's a luxury problem.  I was rather trying to express how I haven't lost my sense of the value of 100k.  I'm not at the point yet where I shrug it off.

[ERICOPOLY]

The money is still there, either way. 

 

It's true that the money is still there.

 

The problem is that it will permanently remain that way.

 

It went from status of "acceptable to return to shareholders" to "absolutely never will be returned".

 

And so it's like you have this money but it will never come back to us unless the company is liquidated.  And it will never be liquidated.  So it's value is zero (discount it out to infinity).

 

[Uccmal]

The money is still there, either way. 

 

It's true that the money is still there.

 

The problem is that it will permanently remain that way.

 

It went from status of "acceptable to return to shareholders" to "absolutely never will be returned".

 

And so it's like you have this money but it will never come back to us unless the company is liquidated.  And it will never be liquidated.  So it's value is zero (discount it out to infinity).

 

 

I dont necessarily see it the same way.  That money will be utilized some way or other.  Being a TBTF bank has/is going to have its advantages in borrowing costs, and other advantages that will come to light as time goes on.  However, it probably has no relationship to our time frame. 

 

If there aren't advantages to being a TBTF then they will liquidate over time.  BAC into 6 banks worth $50/ share in total, or more. 

 

 

 

[xazp]

http://www.bloomberg.com/news/2014-05-03/bofa-s-accounting-blunder-brings-no-bother-to-buffett.html

 

Someone should ask WEB his thoughts on this at the meeting.

[ERICOPOLY]

The money is still there, either way. 

 

It's true that the money is still there.

 

The problem is that it will permanently remain that way.

 

It went from status of "acceptable to return to shareholders" to "absolutely never will be returned".

 

And so it's like you have this money but it will never come back to us unless the company is liquidated.  And it will never be liquidated.  So it's value is zero (discount it out to infinity).

 

 

I dont necessarily see it the same way.  That money will be utilized some way or other.  Being a TBTF bank has/is going to have its advantages in borrowing costs, and other advantages that will come to light as time goes on.  However, it probably has no relationship to our time frame. 

 

If there aren't advantages to being a TBTF then they will liquidate over time.  BAC into 6 banks worth $50/ share in total, or more.

 

I didn't mean that kind of liquidation.  I meant the kind where they stop making loans and just return all assets to shareholders as cash when it is completely run down.

 

The way things are now, $4b of extra buybacks would have retired 2% of the shares at $17 per share.  That would have been a boost to EPS, the market puts a multiple on EPS, and that's how we would have seen the value.

 

Anyways...  I just see this as hurting the share price by roughly 2% permanently due to having a higher outstanding share count.  It's just as bad as dilution because it keeps the share count at today's level, versus where it would have been trending as that $4b was spent on share retirement.

 

So perhaps if we agree that it was a non-cash event that didn't affect the TBV, we can think of it as affecting per-share earnings via a form of dilution versus the path we were otherwise heading down.

 

 

[ERICOPOLY]

That money will be utilized some way or other. 

 

 

I mean, it reduces their regulatory capital by $4b.

 

So they can't increase their lending either now that they are retaining it.  By retaining it, it doesn't increase their lending power at all as far as I understand things.

 

They have a $1.4 trillion of risk-weighted assets, and they have to maintain a certain ratio fully-phased in Tier 1 B3 of capital relative to that.

 

What this did is reduce the amount of their capital by $4b under the B3 rules.  So not only can they not return it to shareholders, but they can't lend against it either.

 

So what did you have in mind that they can do with it?  I'm obviously not a competent bank analyst and I just argue things the way I understand them.  But if I somehow don't understand what they can do with this $4b now that it won't be paid out, I'm open to learning something new.

 

 

[dutchman]

Nygren on bac (not that anyone should care):

 

Fortune: Bank of America is your largest holding. Does the suspension of its buyback and dividend increase change your views at all?

Nygren: No, the events have not changed our thesis. Most of the big banks today are either at or very close to the Basel III capital requirements. Unless loan growth -- which has been pretty much nonexistent since the bottom of the recession -- returns (which would be a good thing), [bofA] management thinks that within a couple years, it should be able to return almost all its income to shareholders. Say they pay out a third of that in dividends, that would potentially be a $0.75 dividend, something like a 4.5% yield, on a stock that today sells at a pretty significant discount to book value. The bears would say yes, but it doesn't grow. Well, the two-thirds of the earnings that aren't getting paid out in dividends could be used for share repurchase. They could be buying 9% of their stock, per year. So you get a company that without top-line growth could have a 10% EPS growth rate, and a 4.5% dividend yield. The market would never allow it to stay at this price if that was expected of them, and we think that is the likely outcome in several years for Bank of America. It will probably be selling at a much higher price than it is now.

 

[tombgrt]

I agree... it's a luxury problem.  I was rather trying to express how I haven't lost my sense of the value of 100k.  I'm not at the point yet where I shrug it off.

 

I'm glad to hear that Eric. I wish you all the joy that money can (and can't) buy! ;)

[Rabbitisrich]

 

I mean, it reduces their regulatory capital by $4b.

 

So they can't increase their lending either now that they are retaining it.  By retaining it, it doesn't increase their lending power at all as far as I understand things.

 

That worry applies if management fixes their RWA target, and then builds to ratio target. But if they lend the extra capital, even a 1 to 1 increase in Tier 1 CE and RWA improves their position. Something like a well secured home mortgage would add $1 RWA to every $2 of retained Tier 1 CE. In the near term, because BAC is in a hurry to reach the target ratios, they will probably make the most aggressive moves, which means building liquidity. Going forward, they will be able to make more economic decisions.

 

[Rabbitisrich]

Nygren on bac (not that anyone should care):

 

Fortune: Bank of America is your largest holding. Does the suspension of its buyback and dividend increase change your views at all?

Nygren: No, the events have not changed our thesis. Most of the big banks today are either at or very close to the Basel III capital requirements. Unless loan growth -- which has been pretty much nonexistent since the bottom of the recession -- returns (which would be a good thing), [bofA] management thinks that within a couple years, it should be able to return almost all its income to shareholders. Say they pay out a third of that in dividends, that would potentially be a $0.75 dividend, something like a 4.5% yield, on a stock that today sells at a pretty significant discount to book value. The bears would say yes, but it doesn't grow. Well, the two-thirds of the earnings that aren't getting paid out in dividends could be used for share repurchase. They could be buying 9% of their stock, per year. So you get a company that without top-line growth could have a 10% EPS growth rate, and a 4.5% dividend yield. The market would never allow it to stay at this price if that was expected of them, and we think that is the likely outcome in several years for Bank of America. It will probably be selling at a much higher price than it is now.

 

Out of context, I can't be sure what he meant to say. But the out of context quote looks like he is double counting. If you have a 4.5% yielding asset, and you invest those proceeds in other 4.5% yielding assets, you wouldn't say that you returned 9%. The bank is using the retained 2/3 of earnings to repurchase a 4.5% payout on the shareholder's behalf. So the payout is actually 100%, or 13.5%. You have to distinguish between the return potential of an asset, and the return potential of yourself depending on what you do with your proceeds.

[ERICOPOLY]

Nygren on bac (not that anyone should care):

 

Fortune: Bank of America is your largest holding. Does the suspension of its buyback and dividend increase change your views at all?

Nygren: No, the events have not changed our thesis. Most of the big banks today are either at or very close to the Basel III capital requirements. Unless loan growth -- which has been pretty much nonexistent since the bottom of the recession -- returns (which would be a good thing), [bofA] management thinks that within a couple years, it should be able to return almost all its income to shareholders. Say they pay out a third of that in dividends, that would potentially be a $0.75 dividend, something like a 4.5% yield, on a stock that today sells at a pretty significant discount to book value. The bears would say yes, but it doesn't grow. Well, the two-thirds of the earnings that aren't getting paid out in dividends could be used for share repurchase. They could be buying 9% of their stock, per year. So you get a company that without top-line growth could have a 10% EPS growth rate, and a 4.5% dividend yield. The market would never allow it to stay at this price if that was expected of them, and we think that is the likely outcome in several years for Bank of America. It will probably be selling at a much higher price than it is now.

 

Out of context, I can't be sure what he meant to say. But the out of context quote looks like he is double counting. If you have a 4.5% yielding asset, and you invest those proceeds in other 4.5% yielding assets, you wouldn't say that you returned 9%. The bank is using the retained 2/3 of earnings to repurchase a 4.5% payout on the shareholder's behalf. So the payout is actually 100%, or 13.5%. You have to distinguish between the return potential of an asset, and the return potential of yourself depending on what you do with your proceeds.

 

I agree with you -- if you were to merely sell an offsetting amount of shares as what they are buying back, then it will be that 13.5% yield.

 

I think a lot of people see buybacks as something magical -- when it's really just a reinvested dividend.  That magical feeling causes them to make the easy mistake and look for things that aren't there.  It's funny, because it's pretty darned straightforward when it's billed as "returning cash to shareholders".  Cash is cash.  It isn't morphed into being worth more than it's face value when the company buys shares instead of paying a dividend.

 

 

[Uccmal]

The money is still there, either way. 

 

It's true that the money is still there.

 

The problem is that it will permanently remain that way.

 

It went from status of "acceptable to return to shareholders" to "absolutely never will be returned".

 

And so it's like you have this money but it will never come back to us unless the company is liquidated.  And it will never be liquidated.  So it's value is zero (discount it out to infinity).

 

 

I dont necessarily see it the same way.  That money will be utilized some way or other.  Being a TBTF bank has/is going to have its advantages in borrowing costs, and other advantages that will come to light as time goes on.  However, it probably has no relationship to our time frame. 

 

If there aren't advantages to being a TBTF then they will liquidate over time.  BAC into 6 banks worth $50/ share in total, or more.

 

I didn't mean that kind of liquidation.  I meant the kind where they stop making loans and just return all assets to shareholders as cash when it is completely run down.

 

The way things are now, $4b of extra buybacks would have retired 2% of the shares at $17 per share.  That would have been a boost to EPS, the market puts a multiple on EPS, and that's how we would have seen the value.

 

Anyways...  I just see this as hurting the share price by roughly 2% permanently due to having a higher outstanding share count.  It's just as bad as dilution because it keeps the share count at today's level, versus where it would have been trending as that $4b was spent on share retirement.

 

So perhaps if we agree that it was a non-cash event that didn't affect the TBV, we can think of it as affecting per-share earnings via a form of dilution versus the path we were otherwise heading down.

 

There has to be some advantage of being a TBTF bank.  They have to be able to have a ROA comparable to a non TBTF bank of large size.  Therefore the regulators have to give them breaks on borrowing to make up this ground.  Or you downsize BAC, JPM, Gs, etc. into their component parts: GWIM ; ML; Consumer loans, CRES, etc. as the case may be.  And voila, you have 5 or 6 non TBTf entities making 1.5 ROA.  Also, I just realized we are talking about 4 b when there is 200 b in regulatory capital depending on the metric, and 2 trillion that could soon generate 30 b per year return of capital. 

[xazp]

I think a lot of people see buybacks as something magical -- when it's really just a reinvested dividend.  >>

 

Well it's a tax-free (or at least deferred) "dividend."  So, for some people, you get 50% more economic impact from a repurchase than an actual reinvested cash dividend - which is meaningful, don't you think?

 

Dividends in the US are considered sacrosanct and never-to-be-cut.  So, a buyback also has the advantage of being adjustable (for example in the context of extra capital generated by DTAs). 

 

 

 

Nygren on bac (not that anyone should care):

 

Fortune: Bank of America is your largest holding. Does the suspension of its buyback and dividend increase change your views at all?

Nygren: No, the events have not changed our thesis. Most of the big banks today are either at or very close to the Basel III capital requirements. Unless loan growth -- which has been pretty much nonexistent since the bottom of the recession -- returns (which would be a good thing), [bofA] management thinks that within a couple years, it should be able to return almost all its income to shareholders. Say they pay out a third of that in dividends, that would potentially be a $0.75 dividend, something like a 4.5% yield, on a stock that today sells at a pretty significant discount to book value. The bears would say yes, but it doesn't grow. Well, the two-thirds of the earnings that aren't getting paid out in dividends could be used for share repurchase. They could be buying 9% of their stock, per year. So you get a company that without top-line growth could have a 10% EPS growth rate, and a 4.5% dividend yield. The market would never allow it to stay at this price if that was expected of them, and we think that is the likely outcome in several years for Bank of America. It will probably be selling at a much higher price than it is now.

 

Out of context, I can't be sure what he meant to say. But the out of context quote looks like he is double counting. If you have a 4.5% yielding asset, and you invest those proceeds in other 4.5% yielding assets, you wouldn't say that you returned 9%. The bank is using the retained 2/3 of earnings to repurchase a 4.5% payout on the shareholder's behalf. So the payout is actually 100%, or 13.5%. You have to distinguish between the return potential of an asset, and the return potential of yourself depending on what you do with your proceeds.

 

I agree with you -- if you were to merely sell an offsetting amount of shares as what they are buying back, then it will be that 13.5% yield.

 

I think a lot of people see buybacks as something magical -- when it's really just a reinvested dividend.  That magical feeling causes them to make the easy mistake and look for things that aren't there.  It's funny, because it's pretty darned straightforward when it's billed as "returning cash to shareholders".  Cash is cash.  It isn't morphed into being worth more than it's face value when the company buys shares instead of paying a dividend.

[ERICOPOLY]

which is meaningful, don't you think?

 

Of course, and yet that's not what I meant.  Time and again I bitch about dividends because they are taxable, and plead and implore the world to agree in all circumstances that buybacks are always better.  At any price.  Because a buyback is merely a tax-advantaged dividend.

 

So that's no contest.

 

I'm talking of course of the "value investor" crowd that waves the magic "intrinsic value wand" that shuts off their thinking and sends them into the land of "free money" and pixie dust.  All of which is fantasy.  A dividend is a dividend.  The rest of the difference is just taxes and absolutely nothing else to it.  So long as you are willing to sell down your (increased) position if you don't like the price.  The company bought shares, you think it's too expensive, you sell an offsetting amount.  No more complicated than that.

 

 

EDIT:  Oh, and because this is Berkshire weekend and all, I should amend the "in all circumstances" comment.  For Buffett, the dividend is always better (almost!) because 99% of his net worth is in Berkshire and his corporate dividend rate is much lower than his corporate capital gains tax rate.  So for him, usually it's better to get the taxable dividend than to get a capital gain through a stock buyback.  I mean, I think the dividend rate goes down to something like 5% for corporations if they own a large percentage of the shares, and it goes to zero if they own more than 80% (I think that's the number).  To that, I should add, his spoken preference is for dividends most of the time.  Go figure!  Nothing like incentives to drive behavior.

[yitech]

which is meaningful, don't you think?

 

Of course, and yet that's not what I meant.  Time and again I bitch about dividends because they are taxable, and plead and implore the world to agree in all circumstances that buybacks are always better.  At any price.  Because a buyback is merely a tax-advantaged dividend.

 

So that's no contest.

 

I'm talking of course of the "value investor" crowd that waves the magic "intrinsic value wand" that shuts off their thinking and sends them into the land of "free money" and pixie dust.  All of which is fantasy.  A dividend is a dividend.  The rest of the difference is just taxes and absolutely nothing else to it.  So long as you are willing to sell down your (increased) position if you don't like the price.  The company bought shares, you think it's too expensive, you sell an offsetting amount.  No more complicated than that.

 

 

EDIT:  Oh, and because this is Berkshire weekend and all, I should amend the "in all circumstances" comment.  For Buffett, the dividend is always better (almost!) because 99% of his net worth is in Berkshire and his corporate dividend rate is much lower than his corporate capital gains tax rate.  So for him, usually it's better to get the taxable dividend than to get a capital gain through a stock buyback.  I mean, I think the dividend rate goes down to something like 5% for corporations if they own a large percentage of the shares, and it goes to zero if they own more than 80% (I think that's the number).  To that, I should add, his spoken preference is for dividends most of the time.  Go figure!  Nothing like incentives to drive behavior.

 

Buybacks are useful when you have shrewd and opportunistic capital allocators like John Malone or Henry Singleton doing the work for you. Dividends are actually after-taxed cash (corporate tax on retained earnings whether via realized profits of stock sale or net profit of the operating businesses) dollars, hence the saying double-taxation (taxed first via corporate tax then income tax), so Buffett doesn't feel better getting dividends than buybacks(taxed once only).  Also, he is donating 95-99% of his share to Bill Gates though, so not a penny of the money will be be taxed for 50 years of capital gains at all. He hasn't sold a single share and probably never will.

[ERICOPOLY]

Buybacks are useful when you have shrewd and opportunistic capital allocators like John Malone or Henry Singleton doing the work for you. Dividends are actually after-taxed cash (corporate tax on retained earnings whether via realized profits of stock sale or net profit of the operating businesses) dollars, hence the saying double-taxation (taxed first via corporate tax then income tax), so Buffett doesn't feel better getting dividends than buybacks(taxed once only).  Also, he is donating 95-99% of his share to Bill Gates though, so not a penny of the money will be be taxed for 50 years of capital gains at all. He hasn't sold a single share and probably never will.

 

It doesn't really matter if you have Harry Singleton or Forrest Gump at the helm when it comes to how they return cash to shareholders.  Returning cash is returning cash.

 

The double-taxation issue happens with buybacks as well.  However, for a taxpayer like you and me it's usually worse to get taxed as a dividend (except for Buffett it is usually worse to be taxed as a capital gain).

 

I'll now explain that:

 

The key difference is the tax rate and how much is actually taxed (100% of the dividend is taxed at the dividend rate, but the cost basis on the shares is exempted from the capital gains tax rate).

 

Let's say we're talking about Berkshire Hathaway.  They will pay a 35% tax rate on a capital gain.  However they may pay only a 10.5% or 5% tax rate on a dividend (the rate goes lower when they own larger stakes in companies)

 

So let's say a favorite holding like Coca Cola stops paying dividends and instead only buys back shares.  In order to get to that same amount of cash, Buffett then needs to sell down an offsetting amount of Coca Cola stock.

 

Let's say the shares have appreciated 5x since he bought them.  He is thus paying tax on 80% of 35%.  He doesn't pay 100% of 35% because of his cost basis exempts 20% from capital gains taxation.  You of course only pay tax on the gain.

 

So that's it my friend.  You have 35% of 80%, or you have 10.5% of 100%.

 

Now you can see why it's almost always better for Buffett to get dividends instead of buybacks.  Most of his holdings are held within Berkshire, since Berkshire is where he holds 99% of his net worth.

 

But let's instead look at the average Joe that doesn't have most of his money in a holding company.  The typical Joe gets his dividend taxed at the same rate as his capital gains.  So he'll pay more tax because he can't exempt a portion of the distribution from taxation when he gets a dividend.  But when there is a buyback, he'll never pay tax on his cost basis.

 

 

Better for me to always get a buyback.  Better for Buffett to almost always get a dividend -- except when the shares are so cheap that he would be wanting to buy more, in which case he doesn't want to be double-taxed even at his low corporate dividend tax rate.

 

PS:  I believe it may be a 14.5% tax rate for most of his equities' dividends -- this is because of the rate that insurance companies pay on dividends.  I'm not sure he qualifies for the lower 10.5% or 5% rates when held within an insurance sub.  Yet, 14.5% is still better than 35% cap gains rate when we're talking about shares that have appreciated substantially.

 

When Forrest Gump is at the helm and buys shares back only, at both high and low prices and never pays dividends, everybody wins except for those people (like Buffett) who have most of their money tied up in a situation where dividend tax rates are substantially lower than capital gains tax rates.  You just sell off a portion of your holdings to create your own tax-advantaged "dividend" when you prefer cash instead of more shares.  When prices are cheap, you don't sell anything (reinvesting your "dividend"). 

 

[gary17]

Eric

What do you suppose BAC can deliver back to Shareholders over the next 20 years?

The $4B or whatever they now have to keep -- while cannot be delivered to the shareholders, it does have value in that it makes the bank safer than it otherwise would have been. And that should count for something. 

 

So perhaps the way to think about this is before the recession it was a bank delivering X amount to shareholders for 15 years reliably (in terms of risk) ; but it is now able to deliver Y , which is less than X, but more reliably - for 20 or 25 years. 

 

Gary

 

Buybacks are useful when you have shrewd and opportunistic capital allocators like John Malone or Henry Singleton doing the work for you. Dividends are actually after-taxed cash (corporate tax on retained earnings whether via realized profits of stock sale or net profit of the operating businesses) dollars, hence the saying double-taxation (taxed first via corporate tax then income tax), so Buffett doesn't feel better getting dividends than buybacks(taxed once only).  Also, he is donating 95-99% of his share to Bill Gates though, so not a penny of the money will be be taxed for 50 years of capital gains at all. He hasn't sold a single share and probably never will.

 

It doesn't really matter if you have Harry Singleton or Forrest Gump at the helm when it comes to how they return cash to shareholders.  Returning cash is returning cash.

 

The double-taxation issue happens with buybacks as well.  However, for a taxpayer like you and me it's usually worse to get taxed as a dividend (except for Buffett it is usually worse to be taxed as a capital gain).

 

I'll now explain that:

 

The key difference is the tax rate and how much is actually taxed (100% of the dividend is taxed at the dividend rate, but the cost basis on the shares is exempted from the capital gains tax rate).

 

Let's say we're talking about Berkshire Hathaway.  They will pay a 35% tax rate on a capital gain.  However they may pay only a 10.5% or 5% tax rate on a dividend (the rate goes lower when they own larger stakes in companies)

 

So let's say a favorite holding like Coca Cola stops paying dividends and instead only buys back shares.  In order to get to that same amount of cash, Buffett then needs to sell down an offsetting amount of Coca Cola stock.

 

Let's say the shares have appreciated 5x since he bought them.  He is thus paying tax on 80% of 35%.  He doesn't pay 100% of 35% because of his cost basis exempts 20% from capital gains taxation.  You of course only pay tax on the gain.

 

So that's it my friend.  You have 35% of 80%, or you have 10.5% of 100%.

 

Now you can see why it's almost always better for Buffett to get dividends instead of buybacks.  Most of his holdings are held within Berkshire, since Berkshire is where he holds 99% of his net worth.

 

But let's instead look at the average Joe that doesn't have most of his money in a holding company.  The typical Joe gets his dividend taxed at the same rate as his capital gains.  So he'll pay more tax because he can't exempt a portion of the distribution from taxation when he gets a dividend.  But when there is a buyback, he'll never pay tax on his cost basis.

 

 

Better for me to always get a buyback.  Better for Buffett to almost always get a dividend -- except when the shares are so cheap that he would be wanting to buy more, in which case he doesn't want to be double-taxed even at his low corporate dividend tax rate.

 

PS:  I believe it may be a 14.5% tax rate for most of his equities' dividends -- this is because of the rate that insurance companies pay on dividends.  I'm not sure he qualifies for the lower 10.5% or 5% rates when held within an insurance sub.  Yet, 14.5% is still better than 35% cap gains rate when we're talking about shares that have appreciated substantially.

 

When Forrest Gump is at the helm and buys shares back only, at both high and low prices and never pays dividends, everybody wins except for those people (like Buffett) who have most of their money tied up in a situation where dividend tax rates are substantially lower than capital gains tax rates.  You just sell off a portion of your holdings to create your own tax-advantaged "dividend" when you prefer cash instead of more shares.  When prices are cheap, you don't sell anything (reinvesting your "dividend").