Buying back shares vs dividend

[SwedishValue]

Flawed thinking, my bad, thank you. Didn't consider the creation of a deferred tax liability.

[siddharth18]

...put to rest this myth that dividend are always better than buybacks when valuations are steep. 

 

 

Cui bono? If you are Warren Buffett holding Coca Cola in 1998 and the stock is selling at a stratospheric valuation, it doesn't benefit the long term shareholder (Buffett in this case) if KO initiates a buyback at that valuation.

 

My understanding is:

 

All the intrinsic value that is lost (lost because you spend $1 to buy back stock worth less than $1) from buyback executed at steep levels is completely and proportionately transferred from the company coffers (long term shareholders) to the sellers of KO stock.

 

Since all companies are run under the mandate of maximizing long-term shareholder value, isn't overpriced buyback always ill-fated?

 

Said another way: Buybacks executed at prices higher than intrinsic value benefit short term sellers at the detriment of long term share holders, right?

 

 

With the benefit of hindsight of course - but if Coca-Cola could have issued new shares in 1998 to raise cash and then turned around and used that amount to buyback the stock in 2000-2001, it would have benefited long term shareholders at the expense of short term shareholders - which is exactly a company ought to be doing.

[ERICOPOLY]

...put to rest this myth that dividend are always better than buybacks when valuations are steep. 

 

 

Cui bono? If you are Warren Buffett holding Coca Cola in 1998 and the stock is selling at a stratospheric valuation, it doesn't benefit the long term shareholder (Buffett in this case) if KO initiates a buyback at that valuation.

 

My understanding is:

 

All the intrinsic value that is lost (lost because you spend $1 to buy back stock worth less than $1) from buyback executed at steep levels is completely and proportionately transferred from the company coffers (long term shareholders) to the sellers of KO stock.

 

Since all companies are run under the mandate of maximizing long-term shareholder value, isn't overpriced buyback always ill-fated?

 

Said another way: Buybacks executed at prices higher than intrinsic value benefit short term sellers at the detriment of long term share holders, right?

 

 

With the benefit of hindsight of course - but if Coca-Cola could have issued new shares in 1998 to raise cash and then turned around and used that amount to buyback the stock in 2000-2001, it would have benefited long term shareholders at the expense of short term shareholders - which is exactly a company ought to be doing.

 

A couple of thoughts:

 

Buffett regrets not selling Coca Cola during the bubble.  You only hurt yourself by not selling during bubbles.  Management of KO was not the source of his woes -- it was Buffett himself and he admits this. 

 

"I merely clucked when I should have walked".

- Warren Buffett

 

Berkshire pays 14.5% tax on KO dividends.  It does't surprise me that he favors them.  Only 14.5% of intrinsic value is lost to the tax man.  I'd love to hear his thoughts on buybacks vs dividends if his dividend tax rate were 99%.  Somewhere in between 14.5% and 99% lies reality for the rest of us who hold in taxable accounts.

 

An Australian citizen holding KO shares pays dividend tax at 45% rate.

 

Let's raise Buffett's dividend tax to 45% and see what comes rolling off his tongue?

 

 

After $1 in dividend is paid:

Buffett  keeps 85.5 cents

Australian keeps 55 cents

 

 

Hmm....  55 vs 85.5.  And which guy did you say favors dividends?  Oh right, yes...

 

 

[ERICOPOLY]

Forgot to add...

 

Buffett's dividend tax rate at Berkshire is less than half of his capital gains tax rate. And he has many stocks carrying very low cost basis.

 

So naturally he'd favor capital gains tax  ::)

 

Places like Australia tax dividends on KO at twice the rate of capital gains.  Probably Canada too (not sure).

 

Buffett's situation is completely reversed.  He's paying less than 1/2 on dividends vs capital gains.  And he LOVES dividends.  Wow  :-*

[ERICOPOLY]

So anyways, the entire topic needs to be viewed under the framework of after-tax intrinsic value.

 

Shares might be fully valued, but you capture 100% of intrinsic value when you repurchase shares.

 

45% of intrinsic value is lost to the tax man if you dividend tax rate is 45%.

 

I'm not sure there is much else to discuss -- people are driven by incentives.