Buybacks Vs. Dividends: Focusing On The Long-Term

by: Roger Ehrenberg

The issue of stock buybacks vs. dividend policy has been frequently discussed on this blog. However, today’s NYT article once again stoked the fires of my frustration with conventional wisdom around this topic.

Consider these two paragraphs from the article referenced above:

In other words, the stock market teaches a tech company that it shouldn’t keep its cash, and it shouldn’t give it to shareholders. The cash can be used for big acquisitions, but those can turn into bombs that really hurt a company. The safest thing to do, the chief financial officers have learned, is to buy back stock, even if that turns out to be a bad investment.

This works out well because of another odd reality: Share buybacks are a useful way to increase per-share earnings. With fewer shares outstanding, the same amount of money parcels out to a greater amount per each share. Of course, this makes no difference for the actual earnings, but Wall Street analysts seem to buy into it.

With all due respect to Wall Street analysts, this is simply awful and has been the case as long as I’ve been in the markets (which now totals 25 years). EPS is most assuredly NOT the salient figure for assessing corporate performance. How about cash flow? EVA? Some other metric that measures the operating (vs. accounting) performance of the business? The only party more culpable than Wall Street analysts? The corporates themselves. Most lack the conviction to deal with short-term pain in order to do the right thing for building long-term shareholder value.

Think Jeff Bezos: he was a pariah for many years as he took on debt, showed terrible numbers yet had deep conviction in his long-term strategy. Window-dressing for EPS purposes? You’ve got to be kidding me. But in the end, he has proven to be a winner. The right business model, the right strategy, deep conviction in the mission and almost entirely tone-deaf when it came to Wall Street expectations. Bravo.

Most corporates do a terrible job timing their stock repurchases; this is a fact. Further, the reasoning that they get rid of cash in order to avoid doing stupid acquisitions and mitigating the dilutive impact of option exercises is yet another weak rationalization for their value-destroying behavior. For some reason dividends are perceived as a negative sign by Wall Street, indicating that there aren’t sufficiently important value-creating opportunities for investing firm capital. What a crock.

How about a rapidly growing business that is simply generating too much cash to deploy intelligently? Initiate a stock buyback at a likely inflated price (because the business is going parabolic and being rewarded for doing so in the public markets) or initiate a dividend to reward shareholders and impose discipline upon cash management? I never have understood the disconnect between dividend policy and the perception of a company’s growth prospects. And unless a corporate management simply says “I don’t care what the analyst community writes” or analysts wake up and say, “Prudent dividend policy and attractive growth prospects are not mutually exclusive” the same value-destroying behavior is likely to continue.

This isn’t that hard a problem. This singular issue has kept corporate finance departments, investment banks and consultants busy for decades. The answer is clear. Eschew popular opinion and employ value-creating long-term strategies for all shareholders. If a company’s stock price suffers in the near-term, so be it. This will also have the beneficial effect of causing compensation programs to be re-worked, equity analysts to actually do some work and force corporate managements to develop some conviction around their long-term strategy and plans. Let’s get busy.