Last Updated on April 26, 2022 by Rational thinking
Last week I wrote an article about how you can create your own “dividend” by selling shares. Many investors have an irrational dividend bias: Benjamin Graham wrote in the Intelligent Investor that a rising dividend has the potential of attracting “ignorant coupon clippers” – not business owners. I believe too many shareholders in ExxonMobil (XOM) are in the “coupon clipper” category.
As of writing, ExxonMobil is trading at 43 dollars and has a dividend yield of 8% (I take for granted that the dividend will be cut pretty soon – I certainly hope so). At such a low price it would make a lot more sense to do buybacks than pay a dividend:
- I believe XOM is trading below intrinsic value (at this price even below book value).
- As a shareholder, I get paid an 8% dividend less 15% withholding tax, which effectively is “only” 6.8%.
- If XOM scrapped the dividend and instead bought back 8% of the shares, I could later sell 8% of my shares (to reflect my increased ownership of the company – or I could sell less or no shares at all). A buyback is a tax-free return of capital – it’s up to the shareholder to sell (or not).
- Furthermore, my cost price is 59 USD, resulting in a loss of 16 USD per share if I decide to sell any shares. If I don’t have any previous gains to offset the capital loss in XOM, I can sell shares in other stocks at a profit (or perhaps carry the loss forward). This way I can “engineer” my own taxes instead of being forced to pay taxes via dividends.
- Clearly, buybacks are much more flexible and fair for all shareholders, given it makes sense to buy back shares value-wise. If a stock is trading below intrinsic value buybacks make sense, and a dividend makes sense above intrinsic value (as long as the company has no use of the capital or can’t reinvest it).
- The focus on paying a steadily rising dividend is a distraction. The focus should be on how to allocate capital in the most rational and agnostic way.
I would like to cut and paste from the shareholder letter of Credit Acceptance Corporation:
As long as the share price is at or below intrinsic value, we prefer share repurchases to dividends for several reasons. First, repurchasing shares below intrinsic value increases the value of the remaining shares. Second, distributing capital to shareholders through a share repurchase gives shareholders the option to defer taxes by electing not to sell any of their holdings. A dividend does not allow shareholders to defer taxes in this manner. Finally, repurchasing shares enables shareholders to increase their ownership, receive cash or do both based on their individual circumstances and view of the value of a Credit Acceptance share. (They do both if the proportion of shares they sell is smaller than the ownership stake they gain through the repurchase.) A dividend does not provide similar flexibility.
Disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.