Those who have been expecting Apple (AAPL) to announce a dividend payout or a stock buyback in its Thursday shareholder meeting to enhance shareholder value must have been disappointed. But do dividend payouts and stock buybacks enhance shareholder value?
In the short-term, the answer is yes, as they create a positive buzz. Dividend payouts usually attract institutional funds that are under mandates to invest in dividend stocks. Stock buybacks reduce the number of shares, boosting EPS. In the long run, however, the answer depends on the profitability of the company, which in turn, depends on the funds invested in to enhance the capital and technological capabilities of the company. This is especially the case for companies that rely heavily on innovation---that's the lesson from Cisco (CSCO) and Dell (DELL). By contrast, Apple (AAPL) hasn't announced any buyback, and its stock has fared far better.
Cisco introduced both a dividend payout and stock buybacks, while Dell introduced just buybacks. Here are some of the reasons these strategies didn't work:
1. A large number of shares outstanding ("share Inflation"). In the old good days (late 1990s) when both Dell's and Cisco's stocks grew by leaps and bounds, both companies issued tons of shares. Now, even after several buybacks, Dell has close to 2 billion shares out, and Cisco close to 5.5 billion shares.
2. Lost momentum Both companies, together with the likes of EMC Corporation (EMC), Ciena Corporation (CIEN), and JDS Uniphase (JDSU), were labeled as "momentum" stocks. And as history confirms, once momentum is gone, no buyback program is sufficient to bring life to these stocks (Ciena and JDS Uniphase have fared far worse than Cisco and Dell).
3. Maturity. Both companies are no longer start-up companies with a few hundred employees that could grow their top line exponentially, but large mature corporations with thousands of employees that find it hard to grow.
4. Both companies failed to keep up with innovations, for different reasons. By and large, Dell's innovation strategy is based on the application of a just-in-time system that has been for years used in the automobile industry in the assembling of computers - a non-proprietary innovation that can easily be replicated by the competition with limited potential for follow-up innovations. Dell's model, further, has certain unique features that cannot be replicated overseas. In fact, the company has already failed to expand successfully in other countries, and the Chinese market won't be an exception to the rule. Cisco's innovation strategy is based on strategic acquisitions, the purchase of smaller companies with breakthrough products, a strategy that isn't sustainable, as owners of these smaller companies demand higher and higher premiums to compensate them for the risks they assume - Cisco end up paying top prices for Net Speed and Growth Networks acquired at the peak of the high-tech bubble. Strategic acquisition further end up being dilutive to existing stockholders when paid with the issuing of new stock - that's how Cisco ended up with 5.5 billion shares.
The bottom line: Dividend payouts stock buybacks aren't business strategies. They are accounting strategies. It often reflects the inability of companies to deploy cash into the discovery and exploitation of new business opportunities - not a good sign for long-term investors.
Disclosure: I am long AAPL.
Additional disclosure: Short on CSCO