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Why Redwheel’s Nick Clay favours dividends over share buybacks: a contrarian view

by uma
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Nick Clay, Head of Global Equity Income at Redwheel, explains why his team dismiss buybacks in favour of simply dividends, despite US (and some European) companies increasingly favouring the latter method of “return to shareholders”:

  • In text-book form, buybacks are attractive at the right time to remaining shareholders – in a large size and in one go. But if conducted above a company’s intrinsic value, then value flows to the sellers. The majority of buybacks happen at the top of markets and disappear at the lows, meaning beneficiaries are the sellers, not investors. Buybacks also disappear at the bottom, replaced with share issuance – further diluting existing holders.
  • Some claim the favourable tax system makes buybacks more sensible to return value to investors. But many buybacks are simply used to offset the dilution of share-based compensation. Because of the tax advantage of being paid in capital gain rather than income, share schemes are sometimes the preferred method of paying senior management.
  • Buybacks don’t align management and investors to share price appreciation – many options are issued far below the prevailing price together with the tendency of equities to rise over time. Many schemes are unrelated to the company’s success, meaning such alignment is tenuous at best.
  • Distribution of the buyback is unequal and skewed to the few – those with the geared option schemes linked to the shares. The effect of the buyback is truly different across those with an interest in the ownership of the company.
  • The majority of buybacks are conducted above intrinsic value to fund share option schemes. Existing holders are effectively transferring value directly to the senior management team, in a “tax efficient” manner for the recipients.
  • Finally, data shows that a large proportion of buybacks are either funded from a significant percentage of company cash flow (leaving little for investment) or, worst of all, are debt funded – a trend which has increased since 2006. This is not taking advantage of cheap debt to invest in projects that could generate returns greater than the cost of the debt, and thus increase future cash flow – but simply borrowing monies to give to individuals in senior management.

Nick Clay, Head of Global Equity Income at Redwheel, summarises:

“Buybacks can be a useful tool for returning value to shareholders under certain circumstances. It is also rare to find a company that actions buybacks in a text-book fashion. And given that investing is a continuous endeavour, statistically fishing for such rare beasts is stacking the odds against you. This is why we focus solely upon dividends.

“An active approach means one can invest in companies who will pay dividends in good and bad times, who grow them in a real sense over time, and thus can be relied upon to be able to compound over time to become the main driver of one’s total return. Dividends represent an equal distribution to all investors, be they longer-term investors or employees or pension funds. Everyone receives the same per share distribution. Dividends as a means of returning value to shareholders is statistically advantageous for investors, truly aligned to their long-term objectives in a manner of equality.

Why Redwheel’s Nick Clay favours dividends over share buybacks: a contrarian view

Nick Clay, Head of Global Equity Income at Redwheel, explains why his team dismiss buybacks in favour of simply dividends, despite US (and some European) companies increasingly favouring the latter method of “return to shareholders”:

 

  • In text-book form, buybacks are attractive at the right time to remaining shareholders – in a large size and in one go. But if conducted above a company’s intrinsic value, then value flows to the sellers. The majority of buybacks happen at the top of markets and disappear at the lows, meaning beneficiaries are the sellers, not investors. Buybacks also disappear at the bottom, replaced with share issuance – further diluting existing holders.
  • Some claim the favourable tax system makes buybacks more sensible to return value to investors. But many buybacks are simply used to offset the dilution of share-based compensation. Because of the tax advantage of being paid in capital gain rather than income, share schemes are sometimes the preferred method of paying senior management.
  • Buybacks don’t align management and investors to share price appreciation – many options are issued far below the prevailing price together with the tendency of equities to rise over time. Many schemes are unrelated to the company’s success, meaning such alignment is tenuous at best.
  • Distribution of the buyback is unequal and skewed to the few – those with the geared option schemes linked to the shares. The effect of the buyback is truly different across those with an interest in the ownership of the company.
  • The majority of buybacks are conducted above intrinsic value to fund share option schemes. Existing holders are effectively transferring value directly to the senior management team, in a “tax efficient” manner for the recipients.
  • Finally, data shows that a large proportion of buybacks are either funded from a significant percentage of company cash flow (leaving little for investment) or, worst of all, are debt funded – a trend which has increased since 2006. This is not taking advantage of cheap debt to invest in projects that could generate returns greater than the cost of the debt, and thus increase future cash flow – but simply borrowing monies to give to individuals in senior management.

Nick Clay, Head of Global Equity Income at Redwheel, summarises:

“Buybacks can be a useful tool for returning value to shareholders under certain circumstances. It is also rare to find a company that actions buybacks in a text-book fashion. And given that investing is a continuous endeavour, statistically fishing for such rare beasts is stacking the odds against you. This is why we focus solely upon dividends.

“An active approach means one can invest in companies who will pay dividends in good and bad times, who grow them in a real sense over time, and thus can be relied upon to be able to compound over time to become the main driver of one’s total return. Dividends represent an equal distribution to all investors, be they longer-term investors or employees or pension funds. Everyone receives the same per share distribution. Dividends as a means of returning value to shareholders is statistically advantageous for investors, truly aligned to their long-term objectives in a manner of equality.”

Why Redwheel’s Nick Clay favours dividends over share buybacks: a contrarian view

Nick Clay, Head of Global Equity Income at Redwheel, explains why his team dismiss buybacks in favour of simply dividends, despite US (and some European) companies increasingly favouring the latter method of “return to shareholders”:

 

  • In text-book form, buybacks are attractive at the right time to remaining shareholders – in a large size and in one go. But if conducted above a company’s intrinsic value, then value flows to the sellers. The majority of buybacks happen at the top of markets and disappear at the lows, meaning beneficiaries are the sellers, not investors. Buybacks also disappear at the bottom, replaced with share issuance – further diluting existing holders.
  • Some claim the favourable tax system makes buybacks more sensible to return value to investors. But many buybacks are simply used to offset the dilution of share-based compensation. Because of the tax advantage of being paid in capital gain rather than income, share schemes are sometimes the preferred method of paying senior management.
  • Buybacks don’t align management and investors to share price appreciation – many options are issued far below the prevailing price together with the tendency of equities to rise over time. Many schemes are unrelated to the company’s success, meaning such alignment is tenuous at best.
  • Distribution of the buyback is unequal and skewed to the few – those with the geared option schemes linked to the shares. The effect of the buyback is truly different across those with an interest in the ownership of the company.
  • The majority of buybacks are conducted above intrinsic value to fund share option schemes. Existing holders are effectively transferring value directly to the senior management team, in a “tax efficient” manner for the recipients.
  • Finally, data shows that a large proportion of buybacks are either funded from a significant percentage of company cash flow (leaving little for investment) or, worst of all, are debt funded – a trend which has increased since 2006. This is not taking advantage of cheap debt to invest in projects that could generate returns greater than the cost of the debt, and thus increase future cash flow – but simply borrowing monies to give to individuals in senior management.

Nick Clay, Head of Global Equity Income at Redwheel, summarises:

“Buybacks can be a useful tool for returning value to shareholders under certain circumstances. It is also rare to find a company that actions buybacks in a text-book fashion. And given that investing is a continuous endeavour, statistically fishing for such rare beasts is stacking the odds against you. This is why we focus solely upon dividends.

“An active approach means one can invest in companies who will pay dividends in good and bad times, who grow them in a real sense over time, and thus can be relied upon to be able to compound over time to become the main driver of one’s total return. Dividends represent an equal distribution to all investors, be they longer-term investors or employees or pension funds. Everyone receives the same per share distribution. Dividends as a means of returning value to shareholders is statistically advantageous for investors, truly aligned to their long-term objectives in a manner of equality.”

 

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