Another great article. I like buybacks when prices make no sense. At current prices for energy stocks, which I do (generally)think are still a good buy, I would much prefer debt be gone and dividends. If shit happens and prices drop significantly then buy your shares withbthe money previously owed to pay debt. Great detail; thanks for the read.
Rafi's recent podcast mentioned problem with this methodology. FCF is a big part of his approach, but not the only part, and I agree.
For example, MEG has really long reserve life, 0 exploration risk, known costs, known foreseeable capex. Thats gonna worth more than shale oil companies with same FCF.
I'd caution for companies with under 10 year of reserve life. Sooner or later they will have to do M&A or do drill baby drill. This will impact dividend if they are going for that route.
But of course if the investment horizon is only short term, none of this will matter.
As regard to buyback vs dividend, to individual investors, both are interchangeable with synthetic dividend. I do not consider selling for the purpose of synthetic dividend a selling. It is just reversing DRIP done at the company level --- same ownership percentage can be maintained by doing synthetic dividend.
True, synthetic dividend can be used to keep same percentage ownership but often leads to odd lots and requries needless effort. Dividends treat all shareholders equally but buybacks do not. Any time you treat some shareholders differently than some others you create inequities among them. The point is not to keep the same ownership level but to keep the same long term dividend stream intact and not find it altered by cash that might have been included in the dividend stream going to shareholders who are cashing out and leaving you to re-adjust your portfolio. If one of the adverse events listed (or others) tanks the stock after a buyback, shareholders who got a dividend are way better off than those who kept their shares during a buyback. This is not complex.
I tend to agree with your buy back comments. We need to remember that most fund managers want capital gains more than income. You should consider sending this article to Eric Nuttall, Josh Young ( Bison Investments ) and Rafi Tahmazian ( Canoe Financial ) and see if they agree or reply. Johnny
Managed money will always prefer buybacks since they tend to increase the share price (if they have any value at all) and inflate the assets under management on which the managers base their fees, but dividends often flow through to unit holders of the fund. I am unimpressed with managed money - no fund manager has outperformed my portfolio for many years and I hate paying fees for no benefit.
When a stock is trading at a 20%-30%-40% FCF yield, why would ANYONE prefer a dividend over a buyback?? Most E&Ps are trading at enormous FCF yields which makes buybacks >>>>>>>>>>>>>>>>> dividends all day, every day
If the 20% to 40% FCF persists it is clear buybacks can add value, but if the high FCF is temporary, dividends are preferred. In 2014, MEG stock traded about $40 a share, cash flow was about $800 million and planned capex about $250 million. By 2016 the stock was $5 a share and cash flow was negative. The assumption that FCF will remain high is dangerous. At 20% to 40% FCF, MEG could pay a dividend of 20% to 40% and investors could decide to reinvest or keep the cash. With respect Ron, that is my preference and the large scale academic studies of buybacks found they did not generally create value. So I guess I qualify as "ANYONE" since I prefer dividends except in exceptional circumstances and when energy bulls are crying for buybacks but the general market is pricing the stock low enough for cash flow per share to be 20% to 40% I see that as a danger signal, not an opportunity. What is that energy bulls know that the professional money managers, hedge funds etc. don't know?
Michael, I agree with you on most of your writings, but your repeated thesis regarding share buybacks is simply not correct. Effect of a share buyback is not the same as share consolidation, as with buybacks equity stakes of the remainig shareholders enlarge, while in case of share consolidation equity stakes percentage wise and in regards to the underlying value remain unchanged, just splitted into a lower numberof shares held.
And as others have said, dividends are pure waste of money, as they just add a, unnecessary layer of taxes on already highly taxed businesess.
No disrespect, but you are wrong. McKinsey did large scale studies of buybacks and found they destroyed value rather than adding value. Read my MEG article published today and see the reality laid out in simple terms.
another HUGE oversight is the TAX BENEFITS of company buybacks over dividends
tax rates for high income earners can be upwards of 40-50%
Dividends are taxed lower in some countries, but it's still around 20% in the US.
Buybacks are not (currently) taxed again, so that means that $1 of buying power = $1 of stock repurchases
$1 dividends becomes 80 cents (or less) for many investors
If I'm going to buy more of the stock anyways, I'd rather have the company buyback shares at a 1:1 ration then pay the government for the "privilege" of buying it myself
You say don't time the market, but isn't keep cash on the sidelines waiting for the market to crash timing the market. Are you in favor of variable dividends ? Personally I view buybacks as a tool and preferably a tool used as part of an overall capital return strategy that also includes dividends. For every company that has used buybacks poorly I can name one that shrunk the shares outstanding in front of an inflection. Proper capital allocation is key.
You can rationalize anything. Proper capital allocation would be to drill when returns exceed the implied return on the stock and at a typical 4 x EBITDA ratio the return on a buyback is about 25% while the return on drilling is often over 100%. Dividends are the mechanism to share value, buybacks are the mechanism to redistribute value treating shareholders who sell into the buyback differently than those who keep their shares. I don't want management screwing up my dividend stream.
I buy stocks and hold them for very long periods, and hold cash all the time. That is the opposite of timing the market. I have no desire to book trading gains, just to build a portfolio of solid companies and enjoy a growing dividend stream for many years. Traders as a group lose money.
I’ll just add, a secondary offering will cost $5-10% and almost always negative, buying back shares at less than 1% is the opposite, it must almost always be positive
You make a good case, although if you own the stock, you already think it’s undervalued.
If you look at buybacks compared to a company expanding they don’t have the lawyer fees, the bid over current price and a large set payout of money of buying another company, uncertainties and many other costs.
Buying back can be done on a daily basic @the market price, close immediate of a known resource. It’s closer to throwing the change in your pocket into a jar every day, it adds up.
I own many stocks I don't think are undervalued, actually most since the market is pretty good at price discovery. But I choose ones that build growing streams of dividends through sensible investment and buybacks don't increase the dividend stream, just re-allocate who gets it. McKinsey has done large scale studies of buybacks and found as a general rule companies that buy back shares do not deliver better value.
I don't agree market is good at price discovery. If it would be, prices would not be so volatile, often without a company/industry specific changes. If price for instance today is X, tomorrow X+10％ and in a few days it would be X-10％, not all three (and even more, rather different prices) could be "correct".
Michael, wow that was a whopper of an article. Good points on external risks and the joint probability...34%. eye opening. BIR is a recent long position for me thanks to your analysis highlighting.
I'm a fan of MEG and hope that after they reach their debt floor sometime next year, they will blend buy backs with div with their 100% return of FCF. By that time hopeful the will have moved needle on outstanding shares and dollars spent in div will go further
Why not just pay dividends? If they want fewer shares (and less liquidity) they can consolidate the shares treating everyone the same. Buybacks don't, they separate shareholders and artificially alter prices but not always higher. I have seen many companies with active NCIB's go bankrupt over the past 50 years including Pengrowth, Bellatrix, Lightstream and Bonavista.
Another great article. I like buybacks when prices make no sense. At current prices for energy stocks, which I do (generally)think are still a good buy, I would much prefer debt be gone and dividends. If shit happens and prices drop significantly then buy your shares withbthe money previously owed to pay debt. Great detail; thanks for the read.
My 2cents worth of comment:
Rafi's recent podcast mentioned problem with this methodology. FCF is a big part of his approach, but not the only part, and I agree.
For example, MEG has really long reserve life, 0 exploration risk, known costs, known foreseeable capex. Thats gonna worth more than shale oil companies with same FCF.
I'd caution for companies with under 10 year of reserve life. Sooner or later they will have to do M&A or do drill baby drill. This will impact dividend if they are going for that route.
But of course if the investment horizon is only short term, none of this will matter.
As regard to buyback vs dividend, to individual investors, both are interchangeable with synthetic dividend. I do not consider selling for the purpose of synthetic dividend a selling. It is just reversing DRIP done at the company level --- same ownership percentage can be maintained by doing synthetic dividend.
True, synthetic dividend can be used to keep same percentage ownership but often leads to odd lots and requries needless effort. Dividends treat all shareholders equally but buybacks do not. Any time you treat some shareholders differently than some others you create inequities among them. The point is not to keep the same ownership level but to keep the same long term dividend stream intact and not find it altered by cash that might have been included in the dividend stream going to shareholders who are cashing out and leaving you to re-adjust your portfolio. If one of the adverse events listed (or others) tanks the stock after a buyback, shareholders who got a dividend are way better off than those who kept their shares during a buyback. This is not complex.
I tend to agree with your buy back comments. We need to remember that most fund managers want capital gains more than income. You should consider sending this article to Eric Nuttall, Josh Young ( Bison Investments ) and Rafi Tahmazian ( Canoe Financial ) and see if they agree or reply. Johnny
Managed money will always prefer buybacks since they tend to increase the share price (if they have any value at all) and inflate the assets under management on which the managers base their fees, but dividends often flow through to unit holders of the fund. I am unimpressed with managed money - no fund manager has outperformed my portfolio for many years and I hate paying fees for no benefit.
When a stock is trading at a 20%-30%-40% FCF yield, why would ANYONE prefer a dividend over a buyback?? Most E&Ps are trading at enormous FCF yields which makes buybacks >>>>>>>>>>>>>>>>> dividends all day, every day
If the 20% to 40% FCF persists it is clear buybacks can add value, but if the high FCF is temporary, dividends are preferred. In 2014, MEG stock traded about $40 a share, cash flow was about $800 million and planned capex about $250 million. By 2016 the stock was $5 a share and cash flow was negative. The assumption that FCF will remain high is dangerous. At 20% to 40% FCF, MEG could pay a dividend of 20% to 40% and investors could decide to reinvest or keep the cash. With respect Ron, that is my preference and the large scale academic studies of buybacks found they did not generally create value. So I guess I qualify as "ANYONE" since I prefer dividends except in exceptional circumstances and when energy bulls are crying for buybacks but the general market is pricing the stock low enough for cash flow per share to be 20% to 40% I see that as a danger signal, not an opportunity. What is that energy bulls know that the professional money managers, hedge funds etc. don't know?
Michael, I agree with you on most of your writings, but your repeated thesis regarding share buybacks is simply not correct. Effect of a share buyback is not the same as share consolidation, as with buybacks equity stakes of the remainig shareholders enlarge, while in case of share consolidation equity stakes percentage wise and in regards to the underlying value remain unchanged, just splitted into a lower numberof shares held.
And as others have said, dividends are pure waste of money, as they just add a, unnecessary layer of taxes on already highly taxed businesess.
No disrespect, but you are wrong. McKinsey did large scale studies of buybacks and found they destroyed value rather than adding value. Read my MEG article published today and see the reality laid out in simple terms.
another HUGE oversight is the TAX BENEFITS of company buybacks over dividends
tax rates for high income earners can be upwards of 40-50%
Dividends are taxed lower in some countries, but it's still around 20% in the US.
Buybacks are not (currently) taxed again, so that means that $1 of buying power = $1 of stock repurchases
$1 dividends becomes 80 cents (or less) for many investors
If I'm going to buy more of the stock anyways, I'd rather have the company buyback shares at a 1:1 ration then pay the government for the "privilege" of buying it myself
If you intend to buy more you should hope for lower prices.
I'd rather not try to time the market, i'd prefer the company issue a systematic buyback program that dollar cost averages into its purchases
Your failure to acknowledge the tax advantages of buybacks over dividends is very telling.
Silence is golden
this is inaccurate on so many levels
So many false assumptions that management teams are trying to "time" the market
When you buyback shares for YEARS it doesnt matter what the price is.
Really? Large scale McKinsey studies of buybacks found no benefit.
No one has ever cited any McKinsey report. You are the first to ever mention this obscure report that could be 50 years outdated
You say don't time the market, but isn't keep cash on the sidelines waiting for the market to crash timing the market. Are you in favor of variable dividends ? Personally I view buybacks as a tool and preferably a tool used as part of an overall capital return strategy that also includes dividends. For every company that has used buybacks poorly I can name one that shrunk the shares outstanding in front of an inflection. Proper capital allocation is key.
You can rationalize anything. Proper capital allocation would be to drill when returns exceed the implied return on the stock and at a typical 4 x EBITDA ratio the return on a buyback is about 25% while the return on drilling is often over 100%. Dividends are the mechanism to share value, buybacks are the mechanism to redistribute value treating shareholders who sell into the buyback differently than those who keep their shares. I don't want management screwing up my dividend stream.
I buy stocks and hold them for very long periods, and hold cash all the time. That is the opposite of timing the market. I have no desire to book trading gains, just to build a portfolio of solid companies and enjoy a growing dividend stream for many years. Traders as a group lose money.
I’ll just add, a secondary offering will cost $5-10% and almost always negative, buying back shares at less than 1% is the opposite, it must almost always be positive
You make a good case, although if you own the stock, you already think it’s undervalued.
If you look at buybacks compared to a company expanding they don’t have the lawyer fees, the bid over current price and a large set payout of money of buying another company, uncertainties and many other costs.
Buying back can be done on a daily basic @the market price, close immediate of a known resource. It’s closer to throwing the change in your pocket into a jar every day, it adds up.
I own many stocks I don't think are undervalued, actually most since the market is pretty good at price discovery. But I choose ones that build growing streams of dividends through sensible investment and buybacks don't increase the dividend stream, just re-allocate who gets it. McKinsey has done large scale studies of buybacks and found as a general rule companies that buy back shares do not deliver better value.
I don't agree market is good at price discovery. If it would be, prices would not be so volatile, often without a company/industry specific changes. If price for instance today is X, tomorrow X+10％ and in a few days it would be X-10％, not all three (and even more, rather different prices) could be "correct".
Michael, wow that was a whopper of an article. Good points on external risks and the joint probability...34%. eye opening. BIR is a recent long position for me thanks to your analysis highlighting.
I'm a fan of MEG and hope that after they reach their debt floor sometime next year, they will blend buy backs with div with their 100% return of FCF. By that time hopeful the will have moved needle on outstanding shares and dollars spent in div will go further
Why not just pay dividends? If they want fewer shares (and less liquidity) they can consolidate the shares treating everyone the same. Buybacks don't, they separate shareholders and artificially alter prices but not always higher. I have seen many companies with active NCIB's go bankrupt over the past 50 years including Pengrowth, Bellatrix, Lightstream and Bonavista.