I really wish undervalued companies wouldn’t pay any dividends.


It’s like them investing in a 0% IRR project – they give the money away and get nothing in return

No, you’re “rewarding” shareholders with a share of the profits

The person who bought the share the day before the Record date doesn’t need rewarding

But what about the retirees and funds that need the income?

Lots of funds roll up the income but if any need income, they can sell ~2% of their shares – I’ll illustrate shortly why they’re better off this way

Besides, Capital Gains tax is lower than Dividend tax in most places anyway

And any decent shareholder should want them to invest their profits wisely. Getting a 0% return isn’t achieving that objective

That’s not the theory I learned at Uni

Forget theory, it’s simple maths – look at Apple

In 2012, Apple had 26.2bn shares outstanding and earned $1.59 per share

The price was 20 so the PE multiple was 12.5

Over the last 9 years Apple has spent $445bn repurchasing their shares

= 87% of their $512bn in net income

Which has reduced the share count by nearly 40% over this period

So while net income has increased at a CAGR of 9%

EPS has increased at a CAGR of 15% (even with share options)

meaning EPS is 57% higher than this year’s net income divided by 2012 shares

But I thought Apple pays a dividend

They do and spent $91bn of their $512bn of net income doing so = 20% of what they spent on buybacks

But that means they spent more than they earned on buybacks and dividends combined?

They did and funded the shortfall using debt

But they bought back shares at an average PE multiple of 15 which is equivalent to investing at a 6.7% return

That doesn’t sound very high

Well remember their cost of debt is only 2% so if you borrow at 2% and invest at 6.7%, you add value

AND the combo means

ROE has increased from 43% to 74%

Huh, what have share buybacks got to do with ROE?

Well, when you issue shares, you increase equity so when you buy back shares, you reduce equity

If net income stays the same, the lower denominator means buybacks increase ROE

And nothing gets equity investors excited more than faster EPS growth and higher ROE’s

So we reward them with a higher PE multiple which is now 26x, not 12.5x

If Apple still traded at 12.5x their EPS-sans-buybacks ($3.56)
The share price would be $45

Add the ~$17 of extra dividends you might have received ($445bn / 26bn shares)

And compare to the current share price of $148

Still want dividends?

Very theoretical, I know, but it illustrates the point

And a rising share price keeps the Rating agencies’ heart rates low = lower cost of debt

Now if that’s the impact from buying back shares at 6.7% yield,

go run the numbers on per-share value creation at a 15% – 20% FCF yield which is what some small and mid-caps are trading at

Then share this with the management of your small and mid-cap holdings

And let’s go create some value together.