Graduate Level Investing - Share Repurchases vs. Dividend Payouts
Today's post is more of a "graduate level" topic, as it goes a bit deeper into pricing and valuation of stocks. This article compares and contrasts dividend payouts and share repurchases. Read on to understand how to apply this to your investment strategy.
If you are a student of the markets, you know that dividends have been literally around for centuries. You will also notice that recently there are more and more "share repurchases" that are taking place in the stock market. That has begged the question of "which is better"? The answer is — quite simply—that there is no difference (from a financial standpoint).
Both share repurchases and dividend payouts have the IDENTICAL effect (from a VALUATION standpoint). Let's walk through it:
- Valuation is expressed in terms of the "Price to Book" (P/B) ratio.
- (P) Price refers to the market capitalization of the stock (i.e., the total value of all shares outstanding).
- (B) Book refers to the valuation of assets of the company.
In the case of either a repurchase or a dividend payout, the market capitalization of the stock will reduce by the amount of the dividends paid or the shares repurchased. Since we are paying out/repurchasing the same amount, the numerator (the P) of the P/B ratio will change the same. (BTW, at a later point in time, I will take on the issue of dividend payout and its impact on the valuation, as this is one of the least well understood topics out there—as can be seen by the emotional connection to dividend-paying stocks!).
Similarly, the book value of the company is reduced by an equal amount in either case—cash is either paid for the dividends or for the shares repurchased. So, the denominator (the B) of the P/B ratio is equally affected in either case.
Since we get identical changes in the numerator and identical changes in the denominator, we get the same impact to the P/B ratioin either case.
So, if the effect on valuation is the same in either case, why are companies moving from the dividend-payout approach to the repurchase approach?While I cannot give you an academically proven/validated answer, I can offer my opinion:
- Because it is new and novel and draws attention. AND attention tends to influence people's perceptions. AND it influences their behaviors.
In other words, in my opinion, it's an attempt to get more folks to buy the stock. This is EXACTLY why I prefer a quantitative, algorithmic, process-centric, data-driven approach to investing!
The attached article goes into much more detail on this topic. Hopefully, after you have a chance to review the article, you will better understand this topic AND be able to incorporate this new knowledge into your investment strategy.
- Do you have a well-defined Investment Policy Strategy that is used to drive your investments?
- If not, would you like to partner with someone who is used to helping people get through these struggles and (then, with confidence) implement portfolio strategies in a systematic manner?
If so, feel free to send us an email or give us a call.We'd love to have the opportunity to help you find a bit more peace of mind when it comes to investing.
Enjoy the read and remember, it's NOT about the money. It's about how the money supports your goals!
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F5 Financial
F5 Financial provides fee-only financial planning services to Naperville, Plainfield, Bolingbrook, Aurora, Oswego, Geneva, St. Charles, Wheaton, Glen Ellyn, Lisle, Chicago and the surrounding communities. Curt Stowers is a fee-only financial planner. He is a Certified Financial Planner (has passed the CFP® examination). Contact or visit Curt at his Naperville location.
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