Buybacks at $46B a Month Dwarf Everything in U.S. Market (2015)
bloomberg.com
bloomberg.com
On the other hand, when the rate of taxation on capital gains is lower than the rate of taxation on corporate dividends, it's advantageous to pay out surplus cash in the form of capital gains by executing a share buyback. This also provides a tax-planning benefit to shareholders: Everybody is forced to realize a dividend (and pay tax on it) but some shareholders will prefer to realize more or less capital gains in a given year.
In Canada we have rules which sometimes reclassify capital gains as "deemed dividends" to prevent this sort of maneuver. A far better solution would be to simply fix the tax system so that economically equivalent actions get taxed identically in the first place.
(I give you credit for knowing the difference, but not every reader will know the difference, so I'm trying to help them, not nitpick you.)
This is false (conditionally). Most valuations look something like: earnings x growth + cash. If you have cash that you cannot reinvest at the same ROI that you have been growing at, you can increase shareholder value by removing the cash element, since it's dead weight. A buy back is a way to invest that cash at the same ROI that your company is growing at. A dividend would require the investors to re-invest that cash and get the same ROI that the company is growing at.
This is why it make sense for large, fast growing companies to buy back their shares and for large, slow-growing companies to issue dividends.
A dividend lets the investors choose if they want to buy more shares (from the same sellers who would sell in a buyback) or mix their current shares with the cash.
The key is the asymmetry of information. The market price should reflect all public information. However the company has non-public information, which puts them in the best position to judge if money is best invested inside the company or out. Share buybacks are a legal form of insider-trading.
Reducing shares increases the price (while keeping market cap the same). Share splits increases the shares outstanding and decreases the price. So... yes, shares outstanding does matter.
You're wrong. When the company issues the dividend, the share price falls for precisely the amount issued. So if everybody used that money to buy the shares again, the share price should return (roughly) to the value before the dividend was paid. The number of shares outstanding wouldn't change.
Say you own 1 share. It's trading for $20. Tomorrow the company pays $2 dividend. Then your share is worth $18 and you have $2 cash as well.
Alternatively, if you're buying the share, you're willing to pay $20 for it today but only $18 tomorrow, because you know that you won't be getting a $2 dividend if you buy it.
If you take future dividend payments into account, you also need to discount them. If you think that (discounted future dividends) > (stock price), that's a signal for you to buy. If enough investors reason this way, the price will rise until (discounted future dividends) ~~ (stock price).
Before dividend:
P = D_0 + δ D_1 + δ^2 D_2 + δ^3 D_3 + ...
P = δ D_1 + δ^2 D_2 + δ^3 D_3 + ...There is a value in a future dividend. On the ex-dividend date, the share becomes less valuable because the new holder will not receive a dividend in X days. This X is usually very small, so a share that goes from paying you $5 in two weeks to not paying you has clearly lost value close to $5.
If your argument was true, that a stock's price predictably fell the day after the dividend, investors could simply short the stock and get a guaranteed profit, which is not possible in an efficient market.
False. If I receive cash today I can reinvest it and start earning a return. If I receive cash in a month I have forgone one months reinvestment return.
> investors could simply short the stock and get a guaranteed profit, which is not possible in an efficient market.
False. Well if you are short a stock over ex dividend date then you need to pay the owner of the stock (whomever you borrowed from) 1) the dividend which he has forgone 2) a financing spread equal to a benchmark (e.g. FED Funds + 300 bp's) for the duration you are short.
No offense but you really haven't thought this through very hard.
Also markets are not efficient despite what you read in academia.
The ex-dividend rate is an implementation flaw that makes the stock price discontinuous at the dividend date. If dividends were pro-rata it would not be.
I never said markets were perfectly efficient.
You didn't think through your answer very hard did you? ;)
They do. But you don't usually see this, because the prices are "adjusted", to make price history continuous, same as with stock splits.
Take a look at MSFT (Microsoft) stock price on Yahoo! Finance. "Close" is what actually happened, and "Adj Close" is what you see on the graph.
Date close Adj Close*
16 Feb 2016 51.09 51.09
16 Feb 2016 0.36 Dividend
12 Feb 2016 50.50 50.14
* Close price adjusted for dividends and splits.
> investors could simply short the stock and get a guaranteed profit
No, to short a stock you need to borrow it first. If you borrow a stock, you owe the dividends that were due in the meantime.
When shorting, you only pass the dividends through. The company sends you the dividend, you send it to the original owner, you could still profit from the drop in share price.
Edit: e.g. EWM (an ETF, I think)
https://uk.finance.yahoo.com/q/hp?s=EWM&d=3&e=4&f=2016&g=d&a...
No, shorting doesn't work that way, obviously. "Shorting" means you sell he stock, so the new owner gets the dividend, not you. That's one reason shorting equities is very risky long-term.
The point I'm making, which I admit is an obvious one, is that without profits a dividend will erode a company's value. Simple flow of money. Unless there's a surplus flow of money in, you can't have an outward flow. Therefore, the effect of a dividend on a company's market cap depends on how much profit they have in comparison.
It is basically the opposite of issuing shares and diluting existing shareholders.
Say the only thing my company owns is a bank account with $100 in it. There are 5 shares outstanding worth $20 each. The company buys back one share for $20, so now there are 4 shares outstanding in a company that owns $80.
The ownership percentage is hidden inside the equity.
So the interesting question is why are they doing this now given the medium/long term ROI a company with cash looks generate. It could mean they stopped seeing obvious medium/long term investments. Maybe a small bubble is 5-10 years away.
1) https://ycharts.com/indicators/sp_500_eps (note: slowly rising, if you ignore seasonality)
2) https://ycharts.com/indicators/reports/sp_500_earnings (note: dropping fast)
TLDR earnings are going down, but earnings/shares are going up. So what is going on ? Earnings for the US economy as a whole are dropping (pretty fast even). But the metric investors use to value shares, earnings per share is going up.
That means U.S. companies are buying back shares at a faster rate than their earnings are dropping. Why ? Exactly to generate this outcome : normal valuation metrics for shares (net-present-value of future earnings per share) go up as a result of this operation. When cutting a million corners the share price of any (large cap) stock should be roughly NPV(8%, future_cashflow).
The next question to ask is ... given that this uses a LOT of debt that is currently at very low interest rates, what happens if interest payments inevitably go up (either as a result of inflation, or of the FED raising rates) ? The problem with low interest rates is that, at the moment, 1% rate rise would quadruple interest payments for the government, and double interest payments for AA corporations.
I'm pretty sure they don't do this as a loan from the untaxed or under-taxed overseas entity back to the taxed parent would create a tax event.
AAPL has more cash than it knows what to do with, but it's a huge borrower in the corporate market so that it can fund its dividend payments.
I don't see this equivalence. I guess It's rather like settling debt since after a buy-back there will be fewer future dividends to pay. But nothing changes for continuing shareholders, does it?
Dividends and buybacks are simply a way to get money from the company to the shareholder. The total number of outstanding shares is of no import---as you can see in stock splits.
Example:
Assume 10M shares at $1 each. With a 10 cent dividend ($1M total), an investor with 100k shares (1% of the company) receives $10k. The market cap drops to $9M (since cash holdings decreased) and the stock price drops to $0.90. They then buy ~11k (10k/.9) shares and have 111k shares, or 1.1%.
Now instead assume the company does a buyback of 1M shares. Now there are 9M shares, each still priced at $1 (cash holdings decreased). The investor has 1.11% of the company.
Lots of assumptions here (no fluctuation in price due to market reaction, cash is not discounted in market cap, etc) but the numbers check out in a perfect world.
The point is that with a Dividend investors can choose whether to reinvest, whereas with a buyback everyone essentially reinvests.
The whole point of giving out dividends as a company is saying to an investor "here, you can invest this cash better than we can". If you're not giving out dividends you think you have better investment foresight than your investors, which may often be true.
What you as a company then do then with the cash, whether you're investing it in R&D, personnel, etc.. or buy stock doesn't change the mathematics of things for the investor, even if the stock you buy happens to be your own stock.
In my example with the buyback, if the investor sold 0.11% of the company after the buyback, the result would look just like what would happen if they did not reinvest the dividend. 1% of the company and $10k cash.
The obvious way to demonstrate this is you sell 10 shares for a higher price than 10 billion shares.
The US should tax buybacks and interest as it does dividends. That would put a stop to this.
And buybacks effectively get taxed as capital gains (because they result in higher share prices), but not until the shareholders sell their shares, and of course then it's at the capital gains rate.
So what you're really getting at is that dividends and capital gains should be taxed at the same rate.
And if you really want to promote dividends, let reinvested dividends defer taxes like buybacks do until the shares purchased with the dividends are sold, even if they're reinvested in a different company. Then you'll see investors demanding dividends because the tax advantage of buybacks would be gone and dividends would have the advantage of allowing investors to choose what to invest the new money in.
In large part, they are: https://en.wikipedia.org/wiki/Qualified_dividend
Which might be zero, depending on where the shareholders sit.
Unfortunately due to the law of large numbers, for them to grow at even a 15-20%, would require billions and billions of dollars in revenue increases. Seems like the most prudent course of action for them and their investors. Albeit you could also argue that using that cash to buy other companies might be worthwhile.
BOOM! Especially HW and SW I.P. companies given Apple's market and legal strategy. Yet, it's the road not taken.
[1]http://www.efinancialnews.com/story/2012-01-24/large-mergers...
[2]http://www2.warwick.ac.uk/fac/soc/wbs/subjects/accountinggro...
[3]http://www.evancarmichael.com/library/stephen-warrilow/Merge...
Since that is not the case, you can presume there is not money out there not yet tapped. Which, considering economic trends in recent decades towards wealth concentration in the same capitalist class who has nothing to spend money on except making more money nowadays, that should be no surprise.
When the consumers are getting poorer, their demand is dropping, not increasing, so there is no reason to ever try increasing supply. Just use monetary loopholes to profit more instead.
* : all relative to risk. There are of course things you could take large risks on and see incredible returns if you succeed, but you cannot predict or even guarantee success on them (gene therapy, new silicon fab tech, nuclear energy, new solar panel tech, better battery tech, AI, and way, way more). When the board is awash in cash from a perpetual money machine, and you could easily just do stock buybacks to make shareholders happy, you go with the no risk easy route to appease shareholders than taking the risk.
For example, I use to work for a company as a wage earner. I left, moving my 401k into a self-directed IRA. Since the market has been bad lately, I remained in cash. I want to put that money somewhere else: property.
I would love to buy a building downtown (which is theoretically possible). I would convert the top floor, about 5k sq/ft, into a co-work office that charges $10/day. The first floor I would rent out to someone, like a grocer. Sadly, the system works against this dream.
First, I can't use the building directly if I purchased it with the IRA. I, as the IRA holder, cannot utilize any properties within the account directly. There goes the co-work. I can't put sweat equity in because that is an illegal contribution. There goes fixing the building without loosing money on labor. I can't directly take the checks and deposit them in the IRA. The law requires that all checks go directly to IRA holding company (who will take a percentage). Finally, I have to get a special IRA account that holds property. Trick is that there is almost no one that does that since they don't make a lot of money. The few that do, take a big chunk.
So I, as a lowly wage earner, can't tap my largest asset directly. I can only use my money to feed the pockets of others via stocks and bonds.
As the Simpson's sung, "It's the American way!"
As a national program, it's better if your pension is delayed, rather than your investment completely failing and you becoming homeless and sick at 62.
Preferential tax treatment for retirement savings accounts was created with the the specific intention of encouraging people to save for retirement, in order to minimize the extent of poverty among senior citizens. It is a feature, not a bug, that these accounts make it difficult to speculate, because the speculation decisions of amateurs and even most professionals are provably, demonstrably worse in aggregate returns than buy-and-hold passive investment in the overall economy.
If you want to speculate on real estate, you are free to do so. You just have to pay taxes on the money used to do so, so that the government can afford to rescue you from poverty if you fail.
> Since the market has been bad lately, I remained in cash.
For the record, buying at the top of the market and cashing out in downturns is the maximally wrong investment strategy. A random number generator would in general outperform this strategy, because at least some of the time it would do anything but that.
Except that IRAs do let people invest their retirement savings in risky speculative investments like buy-to-let properties - they just have to give the IRA holding company a cut of they money in fees and pay someone else to deal with the repairs and maintenance, both of which have the effect of making their returns worse.
That's a highly competitive market filled with deep pockets and thin margins.
Companies are doing buybacks because the Fed is basically siphoning all the wealth to big business and the Government via 0 per cent interest rates.
In the past companies had to offer their stock in exchange of savings. Today The central banks basically finance big corp and Government just printing money(and diluting the currency).
So instead of using your savings, the central banks create new money and give it to their friends at 0 per cent interest rates(lower than inflation, aka: free money).
Their friends take that loan and buy their own shares. That way prices remain up without plunging enough time for the CEO of the company to look like a superstar and nobody complying when she retires with a billion dollars in golden parachutes.
Wow, you managed to put almost every misinformed finance meme into a single paragraph.
While U.S. tax law is currently making it unattractive for Apple to spend its foreign earnings on buybacks, that pile of overseas capital (now above $200 billion) is effectively guaranteeing bonds that raise cheap capital Apple can use to buyback its shares at an extreme discount.
Steps:
1. Loan "US" cash, guaranteed by foreign cash (doesn't need profits repatriated)
2. Use loaned cash to buyback shares
Optimization:
1. Loan "US" cash, guaranteed by foreign cash
2. Buyback using loaned cash
3. Have your foreign subsidiary buy the loan from whoever you loaned from
4. Use the interest payments to transform US income into foreign (non-taxable) income
(it's not quite unlimited, there's a number of problems with this)
[1] http://appleinsider.com/articles/15/10/27/apple-inc-snatches...
Benefits are obvious: you don't have to answer the shareholders for every quarter. You are free to innovate without thinking about short term profits only.
Of course there are drawbacks as well, such as access to Capital. But when you sit on a large amount of cash, this is less relevant.
Owners (rather than todays "owners") get their share of profits, rich people pay their share in taxes, good triumphs over evil, and so on.
[1] http://taxfoundation.org/article/2016-tax-brackets
[2] http://www.forbes.com/sites/robertwood/2015/03/25/u-s-capita...
[3] http://taxfoundation.org/blog/how-high-are-capital-gains-tax...
If the strongest businesses are based in the US, the US can force investors to play by the rules they want. It's just another part of the equation.
I'm sure that Zuckerberg et al have brilliant tax accountants, but this is one thing that has never made sense to me. Volunteering to pay an extra 13% simply for the privilege of living in Northern California seems insane to me. Any of these guys could move a few hours down the road to Tahoe or Reno and save themselves billions of dollars in state taxes, even if they left the company headquarters in CA.
I'd also like to see Pricenomics do a study measuring the market cap impact of California's high corporate income tax rates on major publicly traded Silicon Valley companies. I'm guessing investors would be sickened by the results.
If he wants to give $1 billion in cash away, there are alot better uses than to give it to state government bureaucrats. For example, he could have moved to Nevada, saved the $1 billion, and taken 50,000 homeless people off the streets for a year for that much money (which, by the way is ~10% of the entire homeless population in the United States - imagine the positive social impact of doing such a thing).
The point is that federal taxes are inescapable, while state taxes are not. It makes no financial sense for someone with nine or ten figure tax liabilities to be living in high tax states.
[1] http://www.forbes.com/sites/robertwood/2013/12/20/mark-zucke...
They'd have to move the company HQ to Reno/Tahoe to avoid the taxes.
[1] http://www.reuters.com/article/us-usa-campaign-romney-ira-id...
No place is wonderful enough to pay billions of dollars in extra taxes just to live there. If you are a top engineer making $500K/yr, you're only paying ~$65K/yr in CA taxes, and you wouldn't make anywhere close to $500K in other cities. So the decision to live in CA makes perfect financial sense in that scenario. But in the case of a billionaire founder, it simply doesn't make any sense to sell shares while living as a California resident. You're essentially volunteering to pay a ~65% increase in total capital gains taxes over what they would be in a tax-free state.
If Mark has to stay 183 nights in NV (or stay in NV more nights than anywhere else), that might be more of a personal burden and inconvenience than paying CA tax. And if it harms his ability to lead his company, it might ultimately be more expensive as well...
I mean, I accept that it will have a negative marginal effect, and I accept that people will shift their behavior to avoid the tax, but I don't accept that they will start stuffing their money in the mattress because they only get to keep some of the profits of their investments.
Also, there's an additional hidden loss. I earn $30k last year, with a tax break of $3k, this year I earn nothing because I take the year off to have a baby, I lost $3k in tax break. When I work next year I don't get a $6k tax break. I can't ever make that back. Just because it's hidden, doesn't mean it's not there.
And that's far more expensive than it is to someone taking extreme risks with capital that they can lose/earn $100k in a year.
Also, you already tax your gamblers in the US...
I'm usually calling out for a progressive tax system, however, the parent is right. Investment doesn't work the way you describe. You are asking people to risk capital in order to gain some reward. A particular investment may not pan out for years and then give a windfall. I'm going to go out on a limb and say this: typically, the longer term payoff kind of things benefit society more.
As someone who has very little capital, I too get unhappy when I see regressive tax regimes. The increase in inequality is one of the great problems of our age. That said, we must take care not to throw out the baby with the bathwater. Our current standard of living would not be possible without investment.
Your example about taking time off for the baby is an interesting one. Perhaps the tax system needs to take account of people taking sabbaticals and such.
[1] http://www.aboveavalon.com/notes/2015/11/2/apple-is-buying-b...
So by doing share repurchases with borrowed money, shareholders and executives can reap the benefits of offshore cash without subjecting it to the enormous tax burden they would by directly repatriating the money. As long as corporate profits are still piling up abroad, this trend of corporate buybacks will likely continue.
You have that backwards. Companies are generating vast amounts of cash and don't see investments that they want to make (hiring and expanding into new products, acquisitions, etc), which leads to the large cash piles. Some investors then pressure the company to return part of this cash to shareholders (see Carl Icahn / Apple for a recent and high profile example), and that can be done directly via dividends, somewhat indirectly via buybacks, or both. Companies do not spend 'rainy day' money on buybacks - companies in need of additional funds sell more shares or take on more debt, not use cash to buy shares.
But it's still possible to own, sell, or give away the shares privately.
It just means any dealings are by private agreement, and not open to public trade or analyst scrutiny.
This also means the value is more likely to be estimated by relying on business fundamentals and perhaps some aggressive haggling, and not on public market sentiment.
Lets assume that the last remaining shareholder of Apple made the choice to sell his share to the company for $1 (not a very logical choice). The company still needs shareholders to operate and so the board would need to issue new shares. At that point the could simply grant them to themselves and take control of the company.
There are other corporate structures that don't require shareholders for things like trusts, non-profits, member controlled companies and cooperatives.