Unlike some big growth companies, Apple stock actually pays dividends, although the yield on this is now down to about 1%. Apple has wisely focused more on stock buybacks.
There remains a big debate out there about whether companies should favor dividends or share buybacks. The fact that so many people favor dividends in the face of the overwhelming evidence that we have that buybacks are far more effective in helping investors, tells us that these folks really haven’t thought about this very much.
This is far from a comparable proposition, nor is it a matter of a bird in the hand being worth two in the bush, as these two birds end up getting placed in our hands instead. Two birds in the hand is surely worth more than one bird in the hand, and stock buybacks simply hand over more birds.
If our understanding of how stocks and stock markets is lacking, we might want to think of this as taking the money on the table now or waiting on either a similar amount if the stock price remains stable, or risking losing what we could have had if its price declines, wiping out our gain.
If we do view these strategies as proportionate, that might even be a good argument. If we look at buybacks in isolation, where the buyback puts the stock price up by the amount of the buyback, increasing the value of the stock proportionately, it’s easy to see how some might see this as a comparable situation with getting paid the money directly.
Apple spends about 5% of the value of their market cap lately on these things, where 4/5 of this money is spent on the buybacks, and about 1/5 gets paid out to shareholders. If this only caused the price of their shares to go up by 4%, we’re no better off and our money is at risk whether we want it to be or not. Not everyone wants to let this ride and quite a few people will just pocket the money, especially with the bull market in stocks lasting so long, the big year that both the market and Apple had in 2019, and all the uncertainty out there.
Some may also point out that, given that the price pressure that these buybacks create are artificial, we might see some sort of reversion to the mean here, or some sort of selloff, with both creating momentum on the sell side. When you spend all that money to put the price of your stock up and it instead goes down, that can be pretty disheartening, and can have you banging your glass to call for the dividend to be increased more instead.
We are hearing these glasses being banged on the table more now, although we may rightly wonder why they believe this is a good idea. as we’re not told why. We’re not even sure that they have any idea why they prefer this, apart from just liking dividends, but they don’t even tease us with arguments or evidence that may even appear to be sound.
Mum’s the word here, not unlike worshippers who do not feel the need to think about their faith, as everything is simply taken on faith. Faith has no place in investing though, so we’re going to have to look behind the curtain to see how these two strategies actually do stack up.
We’ll leave aside the tax consequences here, as people may well wish to have distributions, even though they could accomplish the same thing by simply taking them through liquidating their stock. Some may not though and may object to this, and while it’s better to allow investors to choose their own tax strategies whenever possible, we’re instead looking at what creates more value from the stock itself for investors.
It seems that you first have to know that dividends are preferable, but not everyone knows this and that’s where the game ends, if you don’t just accept this fact without thinking about it at all. The moment you think about this a little, this wrests the manner away from faith and in itself tarnishes the beliefs that their followers hold so dear.
We Need to Observe How These Things Stack Up in Practice to Decide
It is not that dividends are a bad thing, as we do get paid from them, but that isn’t enough, as we need to look at alternatives where we may get paid even more in the end. The biggest argument in favor of not paying dividends is that the money could be better used to grow the company, and buybacks aren’t leaned on as much, where the growth people do all the taking and the buyback folks just nod along in the background, much like people do while standing beside the President during a press conference.
We won’t be going into the growth argument either, even though a very strong case can be made for this, especially if the company makes good choices on how to spend this money on growing the business. We’re here to compare buybacks to dividends, because this is where most of the talk is centered, with a legion of people on the other side who simply think buybacks are a bad idea and a worse one than growth spending as well.
Buybacks have therefore been the whipping boy of the dividend hounds, and even proponents of spending the money on something else but dividends tend to back away from the buyback argument often times. There is no reason to though, and in fact, buybacks create significantly more value than either dividends or growth spending.
Since we are keeping score with the stock’s price, it only makes sense that an approach that directly seeks to influence this is at least playing on its home field. Improving a company’s profitability does indirectly translate to stock prices often times, but at differing rates. In some cases, there may even be a negative correlation over a certain period of time, where profits and stock prices can move in opposite directions.
Buybacks, on the other hand, hit the nail on the head and forcefully and permanently affect the value of a stock. This is more than your run of the mill buying pressure, even though this creates lots of that, it also makes the value of the stock greater on another level, by increasing everyone’s share of the company.
The real payload here isn’t that they are worth more now, they are worth more in the future as well, and this is where most of the valuation with stocks come from. Think of this as owning a bigger piece of the future, just like the company gave you extra shares in a way that did not dilute the stock, even though that’s normally impossible.
No matter what happens to the stock, if your share has increased by 10% from a series of stock buybacks, it will be worth 10% more than it would be otherwise in 2030 or 2040, provided that the company does not issue new equity. You both get a bigger share of things now and a bigger share of the company later as well, as this invests your dividend money instead of just giving it to you.
Investments go up a lot over time, and that’s why you bought the stock in the first place. People do re-invest dividends, and end up both taking a distribution and ending up in the same place, just handing some of their money over to the government basically instead of keeping it all in the stock, but a lot doesn’t get reinvested.
This presumably includes everyone who likes dividends, because favoring them and also wishing to re-invest them is just plain stupid. On the other hand, maybe there are people out there who think that way, but we certainly do not want to go to them for advice.
Buybacks Build Value for Investors Like Nothing Else
Buybacks just don’t allow you to keep all of your stock invested, it makes all of your stock more valuable and allows you to invest your dividend money without taxation or a single transaction. It also forces everyone to do this, and the strength in numbers here is what delivers the biggest wallop.
Stock prices are not fundamentally created by inflows of cash from investors, where more money invested is proportionate to changes in prices. Stock prices are created more by changing perceptions, where the funds in provide the quantitative side and the perception provides the qualitative one. Stock prices are much more influenced by qualitative factors.
Buybacks don’t add to this perception, but they certainly leverage them. Those who look to build positions will normally be quite careful in doing so, lest they influence the stock’s price too much. What if we had a super investor with billions of dollars to spend and they not only did not care about raising the stock’s price, this is actually the primary goal?
Like all leveraging, this can backfire if your stock does not have enough momentum though, but Apple sure does, and serve as an excellent example of how successful stock buybacks can be. The business numbers were off for Apple last year, yet you would never know if by looking at their chart, where the stock price nearly doubled during 2019.
2019 was a stellar year for the market, not anywhere this bright but the brightest one in years, and we have buybacks to thank for that as well. Investors actually took more money out of the market than they put in last year, and this does affect stock prices negatively in itself, but compared to the jacking up of stock prices that buybacks cause, the buybacks won handily.
We may not care that much about the quantitative side, but we do need to care a lot about the qualitative side, which in our case means the tendency for the market to pay more for the stock. Buybacks raise the price directly, and together with a positive outlook, we take things higher.
The 4% of their stock that Apple bought back last year did not just serve to put the price of their stock up by that amount, as we instead see this multiplied, and we do not have to wait years to see the multiplication manifest. 2019 showed us this with Apple quite nicely.
A company is not worth its market capitalization, and there isn’t all that much of a connection with the two, which we can see when we compare the wide range of book value. The market capitalization instead represents the perception of the future value of the company far down the road, even though this always remains at the level of perception, both now and in the future.
Investing itself seeks to multiply, which is a good thing to be sure. If we can multiply the benefits of our withheld dividend money, as well as see this used as a very powerful tool to influence stock prices, both directly and collaterally, that’s a real good thing.
People need to understand stock buybacks a lot more to get this though. If we told them that they could take a dividend or not only let the money ride but see it used to directly and significantly grow the stock price, who would not want something like this? The only thought that should come to mind besides yes is that this seems too good to be true.
Instead of calling for Apple to reduce buybacks and increase their dividends, we need to be thanking them for their wise approach to this, where we are given more of what we hope for, seeing our portfolios grow more in value. You need your stocks to go up more for this to happen, and every little bit helps. Stock buybacks help more than a little and a lot more than dividend distributions do, by any measure, as long as we actually do some measuring.