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Companies with low growth have a few options (assuming strong cash flow). 1. Distribute cash back to shareholders via buybacks or dividends 2. Increase R&D sp

Companies with low growth have a few options (assuming strong cash flow). 1. Distribute cash back to shareholders via buybacks or dividends 2. Increase R&D spending on new initiatives 3. Acquisitions Buybacks are at least much more tax effective than issuing dividends. Large acquisitions tend to fail and I imagine it could be hard for an established company to regain the "growth mindset" of a startup. Should a company load up on debt or pursue buybacks way above intrinsic value? Probably not. But, if a company is paying a 4% dividend, and can borrow at 3.5%, buying back stock reduces the dividend payout, and the company avoids lowering the dividend per share (something that is considered sacrilegious in America).

AnthonyMouse 8y ago
> But, if a company is paying a 4% dividend, and can borrow at 3.5%, buying back stock reduces the dividend payout, and the company avoids lowering the dividend per share (something that is considered sacrilegious in America). It's also essentially an arbitrage opportunity at 0.5% gain. The company is borrowing money, buying its own shares, and then using less than 100% of the dividend it would have paid on those shares to pay the interest on the debt, and having the rest left over. That revenue stream goes away as interest rates rise -- you can't arbitrage 4% ROI against 4.5% borrowing costs -- but it takes time before that has to happen. If the company borrowed by issuing ten year bonds, they're effectively still paying the original (e.g. 3.5%) interest rate until the bonds mature. At that point they either have to re-borrow the money (which only makes sense if interest rates are still low) or re-issue the shares. But even if they re-issue the shares at that point, they're still better off than having not done it, because they still have the ten years worth of arbitrage profits. This makes even more sense for the companies that have a pile of cash sitting around making <1% returns, because then the arbitrage profits are even higher (and continue to exist even if interest rates rise more), and they don't even have to pay anything back at the end.
tboyd47 8y ago
Why does a company have to grow, if it's doing what it does well, workers are happy, and customers are happy, and growth is not occurring naturally? Could it be that the expectation for all companies, everywhere to grow at a constant rate is not reasonable?
- candiodari 8y ago
  Well, if you have that attitude, you won't be CEO for long. Shareholders want return, and get to replace the CEO. So for public companies this doesn't work.
- pmart123 8y ago
  I get your rationale, but you have to remember that this hypothetical company would probably generate a fair amount of cash. The question then becomes, what do they do with that cash? Say a company has a steady state $10B revenue, $2B profit and requires $1B of reinvestment capital with a market cap of $20B. After 5 years, the market cap becomes $25B all things being equal due to an additional $5B of cash on the books. Eventually, the company's value would start to be primarily cash. In a low interest rate environment, it could be hard for this company to make money on this cash, and investors are probably more interested in the company executing its mainlines of business versus turning into a hedge fund to manage of huge cash position. A stock buyback is one way this company could "grow" in revenue and earnings per share, but not have to try and grow top line revenue.
  - tboyd47 8y ago
    I guess I don't understand the mindset in which having extra cash is some sort of problem to solve. Apple, Microsoft, Cisco, Oracle, Qualcomm, etc. all have large stockpiles of cash and no one thinks of them as hedge funds, right?
    - nostrademons 8y ago
      Cash is pretty much the only guaranteed losing long-term investment out there, other than gambling & used cars. The Fed has a target inflation rate of 2% - that means that if they do their job correctly, every year your cash stash will be worth 2% less. If they do it incorrectly it can lose value even more quickly. Big tech companies hoard cash because much of their business model depends upon being able to buy up potential competitors before the competitor can take over their market, and they need liquidity to do it because things move very fast in tech and delaying even a couple weeks can mean the price goes up $100M. That's why you see purchases like Instagram for $1B, YouTube for $1.5B, DoubleClick for $3B, or WhatsApp for $19B. And they often make rates of return far, far in excess of the purchase price of these - YouTube is estimated as being worth $75B now. They're not holding cash for the sake of holding cash, they're holding cash as a punctuated-equilibrium investment strategy where they spend a lot when the right opportunity comes along and sit back and wait for the right opportunity to come along the rest of the time.
bogomipz 8y ago
>"Buybacks are at least much more tax effective than issuing dividends." Why are buybacks much more tax effective? Is this due to the way the accounting is done on them?
- pmart123 8y ago
  Assuming an investor owns the stock in a taxable account, dividends are taxed at ordinary income whereas if the stock appreciates due to stock buybacks, it could be taxable as a long-term gain (if held for more than a year). https://mebfaber.com/2016/05/02/much-dividends-costing/ https://mebfaber.com/2016/05/02/much-dividends-costing/ >>> In a taxable account dividends could have cost you anywhere from 0.3% to over 3.0% in returns PER YEAR since 1974.
  - bogomipz 8y ago
    Interesting I always think of the "income vs capital gains" as a consideration for individual tax payers. I didn't realize it also pertained to corporate purchases of their own stock.
    - triviatise 8y ago
      It does pertain to individual tax payers. Tax payers can either pay ordinary income on dividends or capital gains tax on the sale of share with increased value. Even better is that as long as the shareholder holds, they have increased value, but can defer taxes.
- kgwgk 8y ago
  Simplifying things quite a lot, say that you have a share in a stable company priced at $1000. During the year the company makes $50 per share in profits and the price gradually goes up to $1050. The company can pay a dividend: you get $50 and pay taxes on them (and your share is now worth $1000). The company could also use the money to buy its own shares: you still have a share worth $1050 and no tax is due (yet).
thisisit 8y ago
> Companies with low growth have a few options This is true. It is always better to return money to shareholders if there aren't any avenues of future growth. But, on the flip side there are companies which are knowingly using their portfolios to create similar situations. A good example is Broadcom. They have cutback on R&D spending. Using huge amount of debt to grow via acquisitions and share buyback.

AnthonyMouse 8y ago

> But, if a company is paying a 4% dividend, and can borrow at 3.5%, buying back stock reduces the dividend payout, and the company avoids lowering the dividend per share (something that is considered sacrilegious in America). It's also essentially an arbitrage opportunity at 0.5% gain. The company is borrowing money, buying its own shares, and then using less than 100% of the dividend it would have paid on those shares to pay the interest on the debt, and having the rest left over. That revenue stream goes away as interest rates rise -- you can't arbitrage 4% ROI against 4.5% borrowing costs -- but it takes time before that has to happen. If the company borrowed by issuing ten year bonds, they're effectively still paying the original (e.g. 3.5%) interest rate until the bonds mature. At that point they either have to re-borrow the money (which only makes sense if interest rates are still low) or re-issue the shares. But even if they re-issue the shares at that point, they're still better off than having not done it, because they still have the ten years worth of arbitrage profits. This makes even more sense for the companies that have a pile of cash sitting around making <1% returns, because then the arbitrage profits are even higher (and continue to exist even if interest rates rise more), and they don't even have to pay anything back at the end.

tboyd47 8y ago

Why does a company have to grow, if it's doing what it does well, workers are happy, and customers are happy, and growth is not occurring naturally? Could it be that the expectation for all companies, everywhere to grow at a constant rate is not reasonable?

candiodari 8y ago
Well, if you have that attitude, you won't be CEO for long. Shareholders want return, and get to replace the CEO. So for public companies this doesn't work.
pmart123 8y ago
I get your rationale, but you have to remember that this hypothetical company would probably generate a fair amount of cash. The question then becomes, what do they do with that cash? Say a company has a steady state $10B revenue, $2B profit and requires $1B of reinvestment capital with a market cap of $20B. After 5 years, the market cap becomes $25B all things being equal due to an additional $5B of cash on the books. Eventually, the company's value would start to be primarily cash. In a low interest rate environment, it could be hard for this company to make money on this cash, and investors are probably more interested in the company executing its mainlines of business versus turning into a hedge fund to manage of huge cash position. A stock buyback is one way this company could "grow" in revenue and earnings per share, but not have to try and grow top line revenue.
- tboyd47 8y ago
  I guess I don't understand the mindset in which having extra cash is some sort of problem to solve. Apple, Microsoft, Cisco, Oracle, Qualcomm, etc. all have large stockpiles of cash and no one thinks of them as hedge funds, right?
  - nostrademons 8y ago
    Cash is pretty much the only guaranteed losing long-term investment out there, other than gambling & used cars. The Fed has a target inflation rate of 2% - that means that if they do their job correctly, every year your cash stash will be worth 2% less. If they do it incorrectly it can lose value even more quickly. Big tech companies hoard cash because much of their business model depends upon being able to buy up potential competitors before the competitor can take over their market, and they need liquidity to do it because things move very fast in tech and delaying even a couple weeks can mean the price goes up $100M. That's why you see purchases like Instagram for $1B, YouTube for $1.5B, DoubleClick for $3B, or WhatsApp for $19B. And they often make rates of return far, far in excess of the purchase price of these - YouTube is estimated as being worth $75B now. They're not holding cash for the sake of holding cash, they're holding cash as a punctuated-equilibrium investment strategy where they spend a lot when the right opportunity comes along and sit back and wait for the right opportunity to come along the rest of the time.

bogomipz 8y ago

>"Buybacks are at least much more tax effective than issuing dividends." Why are buybacks much more tax effective? Is this due to the way the accounting is done on them?

pmart123 8y ago
Assuming an investor owns the stock in a taxable account, dividends are taxed at ordinary income whereas if the stock appreciates due to stock buybacks, it could be taxable as a long-term gain (if held for more than a year). https://mebfaber.com/2016/05/02/much-dividends-costing/ https://mebfaber.com/2016/05/02/much-dividends-costing/ >>> In a taxable account dividends could have cost you anywhere from 0.3% to over 3.0% in returns PER YEAR since 1974.
- bogomipz 8y ago
  Interesting I always think of the "income vs capital gains" as a consideration for individual tax payers. I didn't realize it also pertained to corporate purchases of their own stock.
  - triviatise 8y ago
    It does pertain to individual tax payers. Tax payers can either pay ordinary income on dividends or capital gains tax on the sale of share with increased value. Even better is that as long as the shareholder holds, they have increased value, but can defer taxes.
kgwgk 8y ago
Simplifying things quite a lot, say that you have a share in a stable company priced at $1000. During the year the company makes $50 per share in profits and the price gradually goes up to $1050. The company can pay a dividend: you get $50 and pay taxes on them (and your share is now worth $1000). The company could also use the money to buy its own shares: you still have a share worth $1050 and no tax is due (yet).

thisisit 8y ago

> Companies with low growth have a few options This is true. It is always better to return money to shareholders if there aren't any avenues of future growth. But, on the flip side there are companies which are knowingly using their portfolios to create similar situations. A good example is Broadcom. They have cutback on R&D spending. Using huge amount of debt to grow via acquisitions and share buyback.