Apple $AAPL reported earnings after the bell today. If they would have reported poor earnings or as expected earnings, the entire market would have tanked. They didn’t.
Apple beat estimates and the stock was up less than $1 on the news but is now trending lower after hours.
The big news wasn’t beating their earnings estimates, nor was it their increase in the dividend. The big news is Apple is buying back $90B of its own stock. For years, I have looked at the cash Apple generates and holds on its balance sheet and said it’s really a hedge fund with a computer company attached but I digress.
I guess Apple could have donated the money to cure world hunger, but instead will reduce the float of their publicly traded stock.
Lots of people absolutely detest buybacks. Most don’t understand them. I had a huge misunderstanding about them until it was clearly explained to me by a finance professor. That was after getting an MBA.
Here is the deal on buybacks and dividends. The cost to the company from a theoretical corporate finance perspective is they are the same. If the company buys its own stock or gives shareholders the money, it’s equivalent.
In many cases, it’s more efficient to go out and borrow money and buy back the stock if you think you can earn a greater return from the purchase than not doing the purchase.
Merton Miller was the leader in finance theory and was a friend of mine. I wish he still was around the educate people about it.
Why do I find stock buybacks distasteful? Purely theoretical perspective. I like decentralized decision-making over centralized decision-making in most cases.
If I want to be a long-term holder of the stock, a buyback might or might not put money in my pocket. Theoretically, there is less supply of stock, but over time management exercises options increasing float, and the stock doesn’t necessarily go up just because a company buys it back. It is also a decision made by a central authority in the person of the CEO and CFO of the company that executes the buyback. They decide for me.
Of course, as a shareholder, I outsource lots of decisions to the management team about the business. But, in this case, there is a definite return, with a definite time horizon. Many decisions made by the business to remain a going concern have an indefinite time horizon and don’t have defined returns.
However, if I received a dividend I get to hold the stock and put cash in my pocket. I get to make the decision of what to do with the cash. If I want to buy more stock, I’ll buy it. If I want to buy a different stock, I will do it. If I want to spend it on anything I want, I can do it. The counter-argument is I can always sell the stock.
The problem with dividends is the constraints put on the company by the federal and state governments around the US. They tax the crap out of them.
Hence, most investors and funds that hold investments jump through legions of hoops to avoid taxation. They don’t want dividends because they will incur tax.
Democrats have proposed taxing buybacks. That’s a really really dumb idea. But, instead, they ought to be thinking about making the dividend tax 0%. That makes the buyback vs dividend conversation equivalent and strategic.
In a perfect world, there wouldn’t be corporate taxes since corporations just aggregate taxes. Dividends are double, and sometimes triple taxed.
Saying that doesn’t get you any talking points on television and it doesn’t get the anti-wealth pitchfork carrying crowd inspired.
Great post! You hinted at a further point: it's not a binary, i.e., buyback or dividend. Policies that discourage one or the other cause the distortions you mention, but they also incent management to allocate capital to other uses. It's really hard for humans to sit on cash. These other uses may be decidedly less economical than returning capital to shareholders.
The correct corporate tax rate is 0%