Autozone, Bernie Madoff, Big Ang, Character Group, dividend coverage, dividend yield, enhanced EPS/NAV, gold, income/dividend bubble, investment companies, JAKKS Pacific, Liquidations, Livermore Investments, M&A, share buyback, tender offer, trading sardines, wind-down
Continued from here. OK, so dividends kinda suck…but what’s the alternative? Well, let’s tackle that from the corporate perspective first:
– Obviously, share buybacks (and/or tenders & capital returns) are generally a far more tax-efficient means of distribution to shareholders. They enhance earnings, or significantly increase NAV/book value. [Just look at the amazing run on Autozone (AZO:US) – yes, they’ve had great execution, but much of its performance is down to aggressive/sustained stock buybacks]. It also permits management to be far smarter & more opportunistic in their distributions, and their response to share price volatility.
– Just as important, it frees management of the potentially absurd strait-jacket of maintaining an inappropriate dividend – which, in extremis, leads to management idiotically borrowing just to fund a (tax-inefficient) dividend. On occasion, this is exactly the point where management tips over from ‘gently deceiving‘ shareholders into downright criminal/accounting fraud…
– Trouble is, I’ve a major problem with how most companies (particularly in the US) go about share buybacks. I wrote about this in detail here – with far too many companies, there’s no concept of/attempt at determining a fair intrinsic value, and then opportunistically buying at a discount to this value. Instead, share buybacks seem to be all about management confidence (meaning the idiots will only buy high…), and simply smoothing & manufacturing a higher EPS.
– The secular decline in interest rates has really exacerbated this EPS magic… Do the math, the v worst examples come from companies with net cash. The interest forgone on cash used for share buybacks is so miniscule now, it means that buying at almost any share price will improve EPS. Fortunately, this has been offset to a fair extent by the last few years of economic woe – which has left most management teams frozen with indecision. I guess they need their share prices to break to new highs before they’ll actually re-start/accelerate their buybacks..?!
Now what about the personal investor perspective?
– To repeat, ad nauseum: Whether you’re trying to maximize compounding, or to extract a regular cash return, a portfolio of low/zero dividend stocks is the most tax-efficient approach. In fact, if you can find some decent funds (attractive exposure, performance and/or discounts?), and/or you prefer to delegate some of the heavy lifting, UK-listed investment trusts/companies are an excellent choice! Motivated by their tax/accounting regime, they usually adopt a zero/low dividend yield policy. In contrast, US funds (open or closed-end) can be a goddamned tax nightmare for US residents, let alone for non-residents..!
– Also focus on stocks where management is conducting sustained share buybacks, ONLY IF they’re opportunistic & actually focused on enhancing shareholder value. This can be problematic to determine, as they all say that’s what they’re bloody doing..! Generally, use what I’ve already highlighted as a guide: a) watch what they do, rather than what they say, and b) managers that act like smart/honest/well-informed owner-operators are far more likely to execute share buybacks in a responsible manner!
– One team that stands out for me right now is Character Group (CCT:LN). They’re in a tough business (toys), and their trading updates never seem to promise good news, but it’s amazing to see such a small company exploit share buybacks so effectively. To illustrate: In 2007 & 2011, revenues were an almost identical GBP 95 mio. Net income actually dropped by 16% in the period to GBP 6.8 mio, but somehow diluted EPS increased 46% to GBP 25.45p. Why? Because almost half the (net) outstanding share count was retired in the same period (to 23.8 mio shares)! Now CCT trades on a GBP 28.5 mio market cap., a curiously low valuation when you consider the multiples sported by Mattel (MAT:US) & Hasbro (HAS:US). The ongoing takeover war between JAKKS Pacific (JAKK:US) and Oaktree Capital (OAK:US) should serve as another timely reminder of the underlying intrinsic value in the sector.
– On the fund side, Livermore Investments (LIV:LN)** is another great example. Livermore’s one of my Baker’s Dozen for 2012. The original discount to NAV here was pretty mystifying… I guess i) the stock was completely off the radar for most investors, and ii) anybody who did notice it was put off by a ‘threatening‘ 66% (at the time) inside ownership. What perhaps was missed was a v shareholder-friendly (and aggressive) share buyback programme. Good Lord, these guys keep buying great gobs of shares at a colossal discount to NAV… In 2011, they bought back 10% of their shares, and so far this year they’ve hoovered up another 22%! The cumulative impact over the years is far larger but, just to give you an idea, 2012 share buybacks have enhanced NAV by 14% YTD.
– Of course, following the above strategy means you’re going to have to sell some shares now & again if you need cash. First, please don’t tell me this is difficult, or expensive – four, even two, sales a year should be perfectly adequate for this purpose! [Monthly?! You’re kidding…if you can’t manage your finances on anything longer than a 1 mth horizon, you haven’t much business being an investor]. And second, this brings us to perhaps the v best benefit of this strategy: Selling!
– For some reason, dividend/income investing seems to go hand-in-hand with buy-and-hold investing. I can’t think of a worse combination – perhaps Big Ang doing her make-up in a fun-house mirror..? Company management love this type of sucker – just focus on that lovely/steady dividend…why not ignore the actual financial performance & metrics of the company? That’s like Bernie Madoff offered you a nice reassuring investor letter OR his actual trading & bank records – and you chose the investor letter..!
– Puhleease, buy-and-hold should be taken out to the wood-shed. [Hmm, maybe not, retail investors would have to fall back then on their other winning strategy: Buy at the top, sell at the bottom…]. It’s a shame – Buffett’s obviously an investing genius, but his legacy often seems reduced to: a) people figuring any price is cheap to buy a franchise/brand-name stock, and then b) people figuring there’s never a good time/price to sell such a good stock…
– Of course, selling’s just as important as buying! I’m not advocating you churn & burn, but every day you’ve got to look at your stocks & be prepared to sell at the right price. Or sell when the underlying financial fundamentals begin to deteriorate, or no longer support the current share price (and I don’t mean when the dividend’s cut – that’s sure to be far too late…). Having to always think about the next share to top slice or sell to raise cash is a great way to develop that habit for your entire portfolio. And I’m sure it will quickly serve as a reminder that the market doesn’t give a damn about your preferred schedule & price(s) – you have to be v opportunistic in your selling. I’m always bemused how many business writers imply being reactive is somehow second-rate (so they can sell you oh-so-useful ‘strategy‘ books!), but much of life & the market is inevitably reactive – embrace it!
While we’re at it, I guess we should address one last dividend myth – the idea dividends represent the only ultimate source of shareholder value/return:
– This is really just the bar of gold (counter-) argument in disguise: A bar of gold has no yield – so what’s its intrinsic value, who knows how high/low it might trade, maybe it’s even ultimately worthless?! It’s just a trading sardine… And a stock with no yield’s just the same. If no shareholder can ever get any cash out of the company, you have to wonder – so what’s its intrinsic value, who knows how high/low it might trade, maybe it’s even ultimately worthless..?!
– First, the comparison is faintly ludicrous. Annual supply & demand are a tiny percentage of the outstanding/enduring cumulative supply of gold that now exists. Therefore, gold’s intrinsic value is obviously v low, and is also basically irrelevant. So, if you want to argue it’s a trading sardine, that’s fine with me. Argue it’s worth zero, or maybe $10 thousand bucks, that’s fine too – I really don’t know, or care, and that’s why I don’t buy gold. To argue the same of a zero-dividend company that has real (& growing) cash earnings makes no sense. Sure, it can perhaps trade at almost any market price… So what’s new? Once you’re aware the company has a v relevant & (reasonably) easy to determine intrinsic value per share you can, of course, simply take advantage of that fact when/if the market offers a significantly higher or lower share price.
– Second, a dividend’s the only legitimate arbiter of value? I think we’ve already covered how dangerous that idea can be… In fact, it’s generally one of the worst (and certainly the most lagging) measures of value one could choose to focus on. And management loves that – the dividend paints over all ills to create an illusion of stability… But if all corporate dividends ceased to exist tomorrow, do you really think the market would lose all sense of value? Or do you really think the overall market capitalization should be suddenly marked down dramatically..?
– Third, we need to realize we’re discussing a rather arid academic idea here: What is a company actually worth if it doesn’t return cash? Five minutes in the real world is all that’s needed to answer that, and to disabuse you of any misconceptions. No, it‘s not all about dividends! As per above, there are other more-efficient ways to return cash, share buybacks being the most obvious. Returns of capital may begin to make sense at some point also – the logical extreme here may be a wind-up/liquidation process to realize value.
– Of course, with a majority of businesses these days, a significant portion of their value may be intangible – so a takeover, or a sale, will offer a better exit. I don’t have figures to hand, but remember an extraordinary % of listed companies are ultimately sold, acquired or MBO’d. And one final point: Let’s assume none of those happen, and the company keeps going from strength to strength – surely it has to start paying dividends?! Well, look at the market caps of some of the largest & most successful businesses & investment companies out there who don’t pay dividends. It certainly doesn’t seem like they’ve crashed into a re-investment wall, or been penalized on valuation..!?
OK, we’re done! Now if you’re still into this whole steady dividend/income lark, just come a little closer… I want to whisper in your shell-like: I’ve an absolutely lahverly 24% annual return on an excellent investment opportunity! Yes, paid as a 2% dividend on the button every month! Yes, yes, I know you read about a return of 24% a month last week on the web – but don’t touch it mate, you’ll be Donald Ducked, they’re all scams! Most of those cowboys will just lie & steal & sell your their bloody grandma. But my investment’s zero-risk, guvnor, I swear it – on my sainted grand-mother’s life, God love her!
In fact, it’s so low-risk, why don’t you borrow some wonga to increase your investment – you’ll make twice as bloody much! I can help with that too – aah, you’re welcome – I’ve a business ‘acquaintance‘ who specializes in that sort of thing. Give me your details, and he’ll call around to you – yes, it’s all personal service with him. Kneecaps Nobbie is his name – don’t worry, he’s a rather large gentlemen, but he’s a diamond geezer…
** Note: I v recently tweeted/commented I’ve halved my stake in Livermore Investments (LIV:LN). No particular change in my fundamental perspective, but the share price was +91% in a mere 6 months! The sale also returns me to a 3.1% portfolio stake, close to my original intended stake (as reached in March). Today, we see Everest depart as a shareholder, but LIV continues to hoover up far larger amounts of shares. All other things being equal, the adjusted NAV is now up to $0.649, or GBP 41.4p, due to share buybacks YTD – so the LIV share price (at 26.25p) still trades on a v attractive 37% discount to NAV.