Corporations raiding their own cookie jars

[wakeflood]

I first thought this post was really only directed at the folks who have significant interest in their 401k’s or other equity-based investments. But it really applies to anyone who is concerned with where the economy is headed.

There’s been another hot run up of stock values over the last year or two and it’s based on…well, depends on who you ask. But clearly there’s been a LOT of stock buybacks and dividend payouts from cash rich big cap companies. This largesse for the stockholder (and senior mgmnt!) generally comes at the expense of investing that cash in the company’s future – products, services, hiring, etc.

Basically, you’re raiding your own cookie jar and puffing up the short term at the expense of the longer.

Here’s some analysis I thought interesting and a quote from it:

“The bottom-line is that market pressures — investors’ insatiable desire for ever-larger dividends and buybacks — are forcing large U.S. companies, which are vital to our economy, to pay out more cash than ever before, raising questions about where their future earnings — and, ultimately, the U.S.’s overall economic growth — will come from. Equally troubling, this mania for buyouts is taking place when the market is at record highs, in part to try and juice earnings to sustain these valuations. Not to be a doomsayer, but is hard to see how all of this ends well.”

http://fivethirtyeight.com/features/corporate-america-is-enriching-shareholders-at-the-expense-of-the-economy/

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[skeeter]

I’ve been actively investing for 15 years. By “actively investing” I mean I have set aside a substantial portion of my earnings and purchased investments with a goal of maximizing my wealth over the long term.

I *like* dividends. I specifically seek out stocks that pay a dividend. Dividends allow my savings to produce earnings – something I can see increasing my wealth. I can then use those dividends to purchase additional investments. One day in the future when I no longer have a salary, I will use those dividends to provide for my lifestyle. Although my earned income is taxed at a marginal rate of 28 percent, my “qualified” dividend income is taxed at a 15 percent marginal rate. So I get to keep 85% of the dividend in my pocket.

I’m indifferent about share buybacks. It doesn’t bother me at all, but I’d be just as happy to get an increased dividend. It is a little silly that buybacks happen when the stock market is at a historically high valuation and lower when at a lower valuation. That’s the exact opposite of what a savvy investor would do. But oh well – it does work in increasing investor returns.

What I don’t want to see is a company wasting money on purchases because they don’t want to give away their cash to shareholders. Look at Microsoft’s purchase of Aquantive in 2007 I believe. I think they paid $4 billion for Aquantive in 2007. A couple years later they wrote off the ENTIRE amount as worthless. I would much, much, much rather Microsoft give the money to the shareholders in either dividends or buybacks rather than buying a worthless company simply to make some point about acquiring strategic assets to supposedly grow the company.

My message to Microsoft (or Coke, or IBM) would be this: I’m the shareholder. If I give you my money then I expect you to return my earnings to me in the form of dividends. I ONLY give you permission to keep the earnings if you are quite certain that you can use that money to grow the business in a way that increases my wealth in the medium to long-term.

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[skeeter]

Note that I didn’t address your concern about where future economic growth will occur if we return all/most profits as dividends instead of investing in new property, plant and equipment. Of course Skeeter has an answer for that but you’ll have to wait a bit…

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[wakeflood]

All of which is predicated on the notion that you will be cashing out in a period of positive standing of your investments, Skeets. Everything points to a reinforcement of the boom/bust cycle.

You’re timing is wrong – i.e. you retire at the wrong time and your wonderful plan leaves a valuation at a fraction of some other “on paper” value from the peak.

Just because MS bought something that failed doesn’t mean the strategy of investing is wrong. It means they made a poor choice. Some of this stuff is always a coin flip and sometimes companies buy other companies just to reduce competition.

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[skeeter]

“All of which is predicated on the notion that you will be cashing out in a period of positive standing of your investments, Skeets. Everything points to a reinforcement of the boom/bust cycle.

You’re timing is wrong – i.e. you retire at the wrong time and your wonderful plan leaves a valuation at a fraction of some other “on paper” value from the peak.”

You are correct Wake. I am gambling. But I do have 100 years of history on my side. The longest market downturn has been what? 10 years? 15? Under no scenario would I be exposed to 100% equity investments during my retirement years. I’ll follow the model that has worked well for a long, long time. I’ll start switching from equities to other low-volatility investments at about age 50. When the market is low I hold. When the market is average/high I sell. With social security payments I can outlast a 10 or even 15 year down cycle.

Is my plan full or risk? Yes. Is it also full of amazing potential for a comfortable retirement? Yes. It worked for my grandparents. It worked for my parents. I’m rolling the dice and hoping it works for me too.

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[skeeter]

BTW Wake – there are exceptions to my general investing philosophy. One of my absolute favorite investments has been/is Precision Castparts (PCP.) Fantastic management team. They pay a tiny dividend. Last year they had EPS of $12.13 per share. They only paid a dividend of 12 cents. What did they do with the rest? Strategic acquisitions and savvy investments in their own business. I fully support their decision to keep my money and invest it because they have proven themselves to make smart long-term decisions. (Look at their five year chart and confirm that for yourself!)

http://finance.yahoo.com/echarts?s=PCP+Interactive#symbol=PCP;range=5y

So I don’t mean to imply that “my way” of investing is the only correct way to invest. There are a variety of investment options and investors should do their own due diligence and find the best options for their hopes and goals. You’re a very bright guy and I’d be happy to hear your investment philosophy as well.

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[wakeflood]

Skeets, we don’t need to rehash our particular investing philosophies again here, I wanted to provide some macro-level thoughts that were reinforced by some data I read.

I get that you as an investor, want every return that you can rationalize on that investment – allowing for some reasonable re-investment by the company in their future growth. Of course. I suspect that our difference is merely one of scale.

It appears to me that lots of $ isn’t circulating into building better mousetraps but rather building sr. management portfolios. What WILL be driving earnings in 5 yrs? 10? I suspect we’re needlessly, and artificially blowing up another speculative bubble in stock value and that will create a commensurate bust. When? Your guess is at least as good as mine. But the piper will be paid. And LOTS of folks are in the last decade or less of their work life and will be needing to sell these equities to someone younger…what will they be willing to pay for companies whose growth potential is meager?

This is my fear. Just as I absolutely KNEW both the tech and housing bubbles were insane and would burst, I see a similar dividend/buyback bubble. Someone in the position of having time before their retirement might well be served by taking ALOT of those equity earnings off the table and banking them on something less volatile. Which is a hard thing for most folks to A)realize they should do, or B)know when they should execute it.

I don’t worry about your particular situation, Skeets. You’re smart and you enjoy this stuff and keep up on it. I worry for the millions who get screwed each time the bubble bursts.

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[wakeflood]

Remember that Wall St. punishes companies harshly that don’t make their number – and sometimes even when they DO.

What happens when these dividends recede to historically average levels? What happens when they can’t buy back stock because they’re cash poor or the value has been artificially raised to unsustainable levels?

You know damn well what happens. The Shorters come out of the woodwork like Ringwraiths. Nobody likes Ringwraiths. ;-)

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[wakeflood]

Correction: Only Sauron and (presumably) other Ringwraiths… ;-)

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[skeeter]

Part of what makes this market so interesting, and abnormal, is the interest rate. Historically, a certificate of deposit or a T-Bill would beat inflation by about 2%. So anyone with money, either $1,000 or $1,000,000 could invest in arguably perfectly safe investments and be richer each year even after inflation. That ended in what? 2005? 2008? I don’t remember. Savings rates are now under 1% and inflation is about 3%. So a saver who selects a safe investment will actually be *poorer* every year. So many investors, myself included, are basically forced into riskier investments such as equities. I wonder if that is what is pushing stock prices so high? Investors don’t have a choice. If we return to more historical interest rates I suspect we’ll see a lot of money coming out of the stock market and prices will drop. I just don’t know when that will happen.

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[wakeflood]

Well you are right that rates will move up, as Yellen has been confirming for months. What’s interesting is that long term rates have NOT been rising like the short term ones with her announcements. This suggests that inflation isn’t a significant fear in the foreseeable future. Which could change and likely WILL if equities start to stumble and/or consumer confidence starts to get shaky again – which it has started to show signs of again recently.

I get that safe havens aren’t as plentiful or inviting these last few years of recovery but there’s something to be said for running in place for a while versus getting hammered by 20%-35% too.

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[skeeter]

Okay Wake. I need you to tell me when this 20-35 percent correction is gonna be. It’ll make the difference between retired Skeeter driving an old VW or a Porsche Boxter.

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[wakeflood]

HA! I recommend you ask any cat prognosticator or the dusty Ouija board. Anybody but Jim Cramer..or me. ;-)

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[JoB]

Robert Reich says this year

i think Warren Buffet does too

traditionally.. october?

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