Tag Archives: Dividends

looking at corporate cash balances

October 15, 2012 By in Academic Theories, Dividend Discount Model, Recent Market Action, Stock ideas, Strategy Tags: , , , , , , , 2 Comments

AAPL as a model global company

Many publicly-traded US companies have huge cash balances relative to their stock market value.  AAPL is a good example.

The company had just short of $120 billion in cash plus marketable securities on its balance sheet as of June 25th.  That’s about 20% of the stock’s total value at last Friday’s close.  Let’s say 80% of that cash is held overseas in countries that levy little or no tax on corporate earnings.

Like many global companies, AAPL’s tax rate–25.3% during the first nine months of its current fiscal year–is substantially below the 35% statutory rate in the US.  (Yes, the US rate is much higher than in the rest of the world.  Yes, a good part of the reason for AAPL’s lower rate is that it earns money abroad that it declares to be permanently invested overseas and therefore doesn’t repatriate to the US.)

analytic issues

Today’s dominant stock market view is that cash is cash, no matter where it’s located, and that earnings are earnings, no matter how lightly they’re taxed.

In contrast, when I began working on Wall Street in 1978, attitudes about recognizing earnings in low-tax areas and about holding cash balances there were far different from what they are today.

Specifically, in those days, investors in the US mentally subtracted from cash balances the home country tax that would be due if the money were to be repatriated and used for shareholder dividends or domestic capital expenditure.

In the UK, brokerage house analysts went further than that.  They did that work for you. Their written recommendations commonly contained, in addition to actually reported earnings, the same numbers “normalized” as if the firm had repatriated all foreign earnings and paid a full tax rate.  Brokers gave their estimates the same dual treatment.

two views:  what’s the difference?

cash

This is pretty straightforward.  For profits on business concluded by a US company in, say, Hong Kong, the corporate tax rate is zero.  If the firm wants to distribute this money as dividends, it first has to be sent to the US, where it is subject to the 35% Federal corporate tax–and possibly to state tax as well.  If this possibility is all an investor is concerned about–cash in his hands rather than in the company’s (a view the dividend discount model explicitly endorses/encourages), then foreign cash balances are worth substantially less than domestic ones.

Figuring out how much less is more difficult,  That’s because a company gets a credit against tax due to Uncle Sam for any tax paid to the foreign country.  To make a stab in the dark, AAPL’s cash pile is probably worth $20 billion less to our totally dividend oriented investor than its balance sheet carrying value.

On the other hand, if you have faith in company management to maximize the value of the corporation, you’re probably willing to believe that holding the cash balances abroad is the best use of the money.  Maybe the funds are being earmarked for reinvestment there, either through purchase of capital equipment or maybe an acquisition.

So you’re less worried about the fact that the money is in a foreign bank.  You’d also think it would be crazy to repatriate the cash, lose a large chunk to taxes, and the ship the funds back out of the US to pay for foreign expansion.

earnings per share

AAPL’s corporate tax rate for the first nine months of 2012 is 25.3%.  If its pretax total were subject to tax at 35%, eps for AAPL would be about 15% lower.

Another way of saying the same thing is that if we adjusted the AAPL PE multiple to reflect a full US corporate tax rate, it would be about two PE points higher.

why write about this?

As I mentioned above, conventional wisdom is that these distinctions don’t matter.  But this is an expression of investor preferences or “taste,” as academics might put it.  And these are subject to change.  After all, these preferences were substantially different a few decades ago.

My reason for writing is that I think preferences are starting to change again.

Maybe it’s the more subdued state of world economic growth.   Maybe it’s the aging of the Baby Boom and that cohort’s increasing interest in dividends.  Maybe I’m just wrong.  But I think that investors are beginning to become more aware of differences in taxation of profits and of the geographical location of corporate cash.

Consequences?

If so, companies sporting low corporate tax rates– predominantly ones with emerging markets exposure, in my view–may be subject to a lot more backing and filling than is commonly thought as the market discounts the possibility that they’re more expensive than they seem.

Guinness

Return on equity (III): a tax-efficient split up

August 17, 2012 By in Dividends, double taxation, from growth to value: the life cycle, return on equity Tags: , , , , , , , , Leave a comment

double taxation of dividends
In the US, and most often, elsewhere, dividend payments to shareholders must be made from income on which domestic taxes have already been paid. Recipients pay income tax again on any dividend income they receive.
(In contrast, the IRS regards interest payments on bonds as an expense. So these payments are made from pre-tax income, and serve to lower the firm’s tax bill. No wonder some companies leverage themselves too much.)
For a mature, low growth, business that throws off cash and doesn’t have many good ways to reinvest the money, stock buy backs and dividend payments are the two common methods of returning these funds to shareholders. Personally, I think stock buy backs are almost always a scam. At the very least, they’re not a very dependable source of funds for income oriented investors. And double taxation means that a sizable chunk of the money available for distribution–just over a third, in the US–is lost to the taxman.
There has to be a better way!
For many firms, there is. It’s called a Real Estate Investment Trust ( REIT), and it’s becoming an increasingly popular corporate solution to the mature business problem.
Briefly, a REIT is a special form of corporation, somewhat akin to a mutual fund. It accepts restrictions on the kinds of activity it can take part in, and agrees to distribute virtually all the income it generates to shareholders. In return, it is exempt from corporate income tax.
Details on Monday.

dividend-paying stocks in the US (II)

July 18, 2012 By in Constructing a Portfolio, Current Market Thoughts, Dividends, Portfolio management, Strategy Tags: , , , , , , , , , Leave a comment

the income investor’s decision–maximize current income or maximize total return

Suppose an investor can choose between two stocks:

–stock #1 has a current dividend yield of 5%, but no prospects of either earnings or dividend growth

–stock #2 has a current dividend yield of 3%, and will likely grow both earnings and dividends by 10% per year.

Let’s assume that we’re in a world where we can make long-term predictions like this with a very high degree of confidence, and that neither stock has any special risks associated with it.  Yes, these are unrealistic assumptions, but I want to make a point about the expected income stream.

Which do you choose?  In this case, investor preferences are the key.

the income stock

Someone who wants to maximize current income would probably choose the stock with the higher yield.

Why?

Figure out how long it will take for stock #2 to grow its dividend until it matches the current yield of #1.  The answer is seven years.  How long will it take for the holder of #2 to receive the same amount of current income as he would by holding #1?  Eleven years.  Eleven years to breakeven by choosing stock #2 is too long to wait, in my view.

the total return stock

Suppose our investor makes his choice today and that each stock is trading at $100 a share.

Over the next seven years, stock #1 will pay out $35 in dividends and #2 will pay out $28.40.  The difference is $6.60.  However, the earnings for company #1 will be the same as they are today, while those of #2 will have doubled.  By year 11, when the cumulative dividend payments of the two will be equal, the earnings of #2 will be almost 3x the starting level.

For the total return of #2 to exceed that of #1, all that’s necessary is that the huge increase in its earnings generate a rise of 6% in its stock price over that of #1.  In the US stock market, if events play out according to our assumptions, that’s as close to a sure thing as ever happens.

That’s not an iron-clad guarantee, however.  Just as important, it’s also not clear when any relative price gains will happen. That’s not such a good thing if you need the money by a certain date.

the point being…

…if you’re interested solely in income, it takes an awfully long time for a fast grower to overcome the influence of the starting point of its higher-yielding rival.

don’t forget about portfolios!

There’s no law that says that anyone has to make the all-or-nothing choice I’ve outlined above.  You could consider buying some of each and hedging your bets.  Of course, any diversification will mean lower current income for a period of time.

back to the real world: today’s dilemma

Stock #1 is a close as you can get in the equity world to a long-term bond.

At some point, not this week, and maybe not for two years, the Fed will determine that the current economic emergency is over and will begin to raise short-term interest rates from today’s zero.  It will have two targets.  One is to make rates positive in real terms (i.e., higher than the inflation rate, which is currently about 2%).  The second, which it wrote about a couple of months ago, is to get them to around 4.5%.  That’s right, 4.5%! 

The effect on the 30-year Treasury, which is currently yielding 2.60%, will be big–and negative.  As yields rise, bond prices adjust by going down.

During past periods of rising rates in the US, stock prices have generally gone sideways or up.  That’s because the signal for the Fed to begin to raise rates is that domestic economic growth is high–and accelerating, which implies accelerating profit growth for publicly traded companies.

So the growing profits of stock #2 give it a chance to avoid going along with Treasuries.  Stock #1 has no such defense.  The only thing it has going for it is a current yield that’s 2x that of the long bond.

I don’t think this is a worry for right now.  But pure income seekers who hold high-yielding stocks are probably in the same boat as holders of government bonds.  So they face the same portfolio rotation issues that bond investors will, when rates eventually begin to rise–or, more likely, somewhat sooner than that, when markets begin to anticipate rate rises.

I think this makes the practical decision between #1-like stocks and the #2s much more complicated now than it would normally be.

 

 

 

 

 

 

dividend-paying stocks in the US (I)

July 17, 2012 By in Current Market Thoughts, Dividends, Stock ideas Tags: , , , , , , , , Leave a comment

then…

I remember a brokerage house strategist(from Lehman?) making a sales call in 1984 on the money management firm I was working for.  The main point of his presentation was his belief that there was tremendous predictive value in the level of the dividend yield on the S&P 500 index.  According to the strategist, the dividend yield on the S&P rarely fell below 3%.  It never stayed that low.  Therefore, the dividend yield on the index falling below 3% was the strongest possible sell signal that stocks could give.

As it so happened, the yield had just dipped below the fateful 3% line.  So the strategist’s strongly held conviction was that clients should reduce exposure to the stock market, and should rotate any holdings that remained into a very defensive posture.

Three years later, the index had doubled–and the strategist was out of a job.

Where did he go wrong?

Admittedly, hindsight makes it easier to see, but he missed just about all the important economic influences in play during the period.    Specifically:

–the decade of the 1980s saw great structural economic change in the US, including the emergence of women in the workforce, the widespread move of families to the suburbs, the rise of specialty retailing as competition for department stores, and the change from the mainframe to the PC.  Companies were also expanding rapidly abroad.

The result of all this was that most firms were reinvesting all their cash flow into growing their businesses.  They didn’t want to raise dividends.  In some cases, it would have been a condition of getting new bank loans that they not do so.

–the emergence of discount brokers, along with the move to self-directed 401ks and IRAs, made equity investing accessible to young Baby Boomers who were much more interested in making capital gains than earning income.  We didn’t want income.

–interest rates were in the early days of a quarter-century decline.  This secular movement made capital gains easier to achieve, and current income worth less. (Of course, during the accelerating inflation period of the late 1970s, investors of all stripes actively shunned dividend stocks.)

…and now

Other than for a short period in early 2009, when the dividend yield on the S&P reached 4%–and, by the way, gave a strong “buy” signal in doing so–the yield on the index hasn’t spent any significant time above 3% since 1984.

The dividend yield on the S&P is currently about 2.1%.

Economic conditions also changed substantially since that day in 1984.  In particular,

–the dramatic positive effect on the US of the entrance of women into the labor force has passed, as have the boosts caused by changes in retail and the development of the suburbs.  As a result the trend growth rate of the economy has slowed (from 3%+ to maybe 2.5%); consequently, reinvestment demand for corporate cash has waned.

–many of the iconic firms of the Eighties and Nineties have matured (MSFT is the poster child for this phenomenon) and are generating tons of excess cash.

–the Baby Boom is starting to retire and is less interested in investing for capital gains than to receive steady income.

–at the moment, short-term interest rates are at the emergency low rate of essentially zero vs. what the Fed thinks should normally be around 4.5%.  This is to help the economy heal itself of the wounds caused by twelve years of policy blunders in Washington, widespread regulatory failure and fraud perpetrated by major domestic financial companies.  So income investors can’t achieve their goals by buying government bonds or money market funds.

dividend stocks as underperformers

Stocks whose attraction is solely, or mostly, their ability to pay steady or rising dividends to shareholders have been chronic market underperformers throughout the thirty + years I’ve been involved in the stock market.

But changes in investor preferences, combined with the lack of higher-yielding fixed income alternatives and the increasing propensity of publicly traded companies to pay dividends, have caused a mini-renaissance in dividend stocks over the past couple of years.  Yes, dividend stocks have still been underperformers during the market bounceback that began in March 2009.  But not so much recently.  And, as they usually are, dividend stocks had been substantial outperformers during the market decline of 2007-2008.  So the fact that they lagged in the early part of the current cycle is understandable.

where we are today

According to the most recent Factset Dividend Quarterly:

–400 of the S&P 500 constituents are now paying dividends, the highest percentage since before the Internet bubble burst

–growth in dividend payments is outpacing growth in S&P 500 earnings

–the S&P payout ratio (the percentage of after-tax earnings devoted to dividends) remains at 28.0%, about 10% below what has been typical over the past ten years

–the valuation of dividend-paying stocks vs. their non-dividend counterparts appears to be stretched.

The raw data on this last point are stunning.  According to Factset, the PE of dividend-paying stocks is now 244 basis points lower than the PE of non-dividend stocks.  If we take monthly readings of this statistic over the past twenty years, the median discount is 1304 basis points.  So it would appear on the surface that the multiple on dividend stocks has expanded by over a thousand basis points vs. non-dividend stocks.  …uh oh.   …run?!?

That number is misleading, though.  In rough terms, the 1160 point spread would probably be cut in half if we factor out the crazy valuations applied to so-called TMT (tech, media, telecom–mostly non-dividend) stocks during the Internet bubble.  We might clip off another 100 bp or so if we adjusted for the fact that many companies have changed stripes away from non-dividend to dividend payer over the period we are considering.

Even so, there has been a substantial upward readjustment of the relative valuation of dividend-paying stocks in the US market over the past couple of years.

Is there anything left to go for?  or is the dividend stock phenomenon all played out?

That’s my topic for tomorrow.

Warren Buffett has been selling INTC–should we? //the INTC dividend

May 16, 2012 By in Dividends, Stock ideas Tags: , , , , , , , , Leave a comment

Buffett’s INTC buy

Institutional money managers are required to disclose their equity portfolio holdings to the SEC each quarter in a filing called a 13F. (The 13F is not to be confused with the 13D, a filing the SEC requires ten days after anyone not an institutional investor acquires a 5% of any class of securities (equity or debt) of a public company).

In its 13F filing for the December 1011 quarter, Berkshire Hathaway indicated that it had bought 11.5 million shares of INTC, worth over a quarter billion dollars, during the period.

In its just-released March 2012 13F, the company says it held only 7.7 million INTC shares at the end of the quarter–meaning it sold a third of its holding in the interim.  As thestreet.com points out, Buffett added roughly the same dollar amount to his holding in IBM.

What’s going on?  Should we follow the Buffett lead?

my thoughts on the recent selling

1.  Mr. Buffett makes no secret of the fact he feels he doesn’t have a deep understanding of technology nor is he comfortable with large tech holdings.  He likes financials like GEICO, instead.  IBM, a steady grower that sells a branded set of services on a recurring subscription basis through a large sales force, is much more his style.

2.  My guess is that, at least implicitly, Buffett has put a dollar size limit on the INTC position because it’s in an industry he’s not an expert in.  He’s trimming to keep the position from getting too big.

3.  Coming at INTC from a slightly different angle, the company is a turnaround story.  To me, at $20 a share, the stock was so cheap that it didn’t matter too much whether the company’s efforts to reinvent the PC ( or at least clone the Macbook Air) and crack the mobile market will be successful.  At $30 a share, in contrast, it seems to me that a buyer/holder is betting that ultrabooks are a hit and that designing bespoke cellphones for carriers will work, as well.

I feel no strong urge to buy at today’s level, but I’m content to wait and see what happens.  Mr. Buffett seems to me to be acting in line with my general analysis.  He wants to continue to make the positive bet–or else he would have sold everything–just not a big one.

4.  Stock picking is like baseball, in that it’s the season’s average that counts, not a given at bat.  Even the most successful professional equity managers are wrong at least 40% of the time (the industry cliché is that 55% right/45% wrong = genius, the reverse proportions = unemployed).  So riding on anyone’s coattails on a single decision is a risky position. Think:  Albert Pujols.

the INTC dividend increase

On May 7th, INTC announced its board of directors had upped the quarterly dividend to $.225 from $.21.

I’m pleasantly surprised.  This is the fourth boost to the payout in less than three years.  My picture has been that 2012 would be a flattish year, before a reacceleration earnings during  2013.  I thought the company might wait until November or December to decide on a dividend increase.  That’s because dividend decisions are never made in anticipation of future profits.  They’re always backward-looking.  They’re made based on what earnings already booked will support.

I take the board action as an indication INTC’s current business is going better than I’d anticipated.