Prince & Pauper Among Stocks
The best run companies do not pay a single dividend
Ezra
Publish date: Sat, 20 Jun 2015, 11:51 AM
Ezra
0 18
The gems are to be found even on the streets. Yet, we chase all those that glitter ahead of us forgetting the ones worth chasing are the unpolished diamonds that walk among us. The same is true of stocks. Men are creatures of habit. As such we generalize and smear all those stocks coming from China but happily fete the ones from Malaysia although both of them may share the same fundamentals and in some cases even when it's abundantly clear the Chinese stocks are better than the local ones.
The title in question came into being after I have received response from Pingdan and recently Henry HO, suggesting that companies especially those who operate in China but listed on KLSE should perhaps increase their dividend payout in order to convince the investors they have the money and prop up their share price.
This is an article I made in response which I believe will be useful in looking at how we view a fundamentally run company (whether having business in China, Malaysia or anywhere for that matter) should better manage its cash reserves and increase its enterprise value - above the immediate clamour for dividends.
Investors, in general, would be happy if their investments were to give them a stable quarterly or annual dividend payout especially if they're as generous as some companies. However, a reasonably well managed company will not squander all their cash on dividend payments especially ones that are on a growth trajectory. The ones that overpay in order to please the shareholders or prop the share price above their fair value is an example of poor financial stewardship. They either have something to hide or are headed for trouble.
The company's first and foremost business is to attend to the business of growing the company. The rest will take care of itself. The stock market usually rewards a well run company with its stocks growing in demand. This translates into a higher price for its stock thus unlocking immediate value to shareholders.
Naturally, shareholders are more than happy to see their stocks appreciate in value. That having dividends is just a bonus. In some cases, they don't mind not being paid the dividends as the latter is secondary and I mean a distant second as they're already making hefty gains on their principal investment.
Interestingly, the best run companies do not pay a single dividend. You know why? The saying cash is king comes to mind. With all that cash in the bank, a company has plenty of options in running its operation, expanding it or even making new acquisitions.
Companies in this mould include Apple under Steve Jobs who had not paid a single dividend to shareholders ever since his return to the company which was 3 months away from bankruptcy in 1995 then till his demise in October 2011, Berkshire Hathaway under Warren Buffet hasn't paid a single dividend for the last 47 years despite generating a mountain of cash from its insurance and industrial operations and Dell Inc. under its founder Michael Dell who doesn't believe in quarterly dividend payouts as they're a hurdle to intelligent financial management.
If you own these stocks and you need a little cash to live on, you do what the founding or principal stakeholders do: sell a few shares, paying only capital gain taxes.
Steve said in not so many words and said it well when asked in 2010 why Apple has never paid a dividend and rarely bought back its own stock, he said dividends do not increase the value of the company for shareholders. “Our goal is to increase enterprise value,” he said. “Which would you rather have us be? A company with our stock price, and $40 billion in the bank? Or a company with our stock price and no cash in the bank?”
The answer to such a question was clear to Jobs and continues to be the same position held by Buffet and Dell.
[Side note: Following the untimely demise of Jobs, Apple under Tim Cook subsequently declared a 35 billion dollar dividend payout and 10 billion dollar share buyback in 2012. Share buyback is a great thing to have as the company can always recoup its cash layout from the market. But dividend payout that yielded $2.65 per share or 0.44% of stock price each quarter was ill conceived. It meant depleting one third of the company's cash reserve. Such a huge cash layout could have been better spent on improving the living and safety standards of its underpaid workforce in China. Yes, Apple does have an edge when it comes to influencing Foxconn's labor practice.]
Founders like Steve Jobs – but unlike managers like Tim Cook – understand the pain of growing a business and will do everything to build the cash reserve so as to ensure their company's long term security and funding flexibility is protected well into the future.
So, the next time somebody were to ask you a question about a huge dividend payout when discussing Chinese companies that are cash rich, think again.
As an investor, you don't want to buy into a company that spends its money on dividends merely to please its investors - just like what happened at CSL previously which was too busy making the existing shareholders happy with generous dividend payouts but had clean forgotten about its primary business of ensuring its long term survival which was placed in jeopardy when it failed to adequately insure its factory.
When a company ignores its business fundamentals, then all is lost. It matters not how much dividend is paid out.
Rather, a better course for investors is to opt for great companies that have a clear focus on its long-term business survival and growth and use every penny of their cash reserve to increase its enterprise value.
Companies of this mould are a rare breed in the stock market. They understand the greater value of cash in business more than the ones spending on an unproductive exercise such as having (or increasing) dividend payout that does nothing to add value to an enterprise.
When companies improve their enterprise value, the stock value will naturally grow by leaps and bounds.
And that is a good position to have for fundamentally strong and fast growing companies like Xinghe Holdings Berhad (which by the way, has a reasonable albeit small dividend policy that does not lessen its enterprise value).
Ezra, 20 June 2015
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Discussions
1 person likes this. Showing 25 of 25 comments
This article must make TTB of Icap happy. But if he suddenly dies tomorrow, will he get the money stacking in Icap?
Money not spend is not yours!
This is what we are risking our money buying stocks and investing for and hope to get good returns from it. But some people just don't get it.
2015-06-20 17:09
The perception of risk and reward differ from one person to another residing in country with different tax regime, there are three factors that determine your returns; current yield, earning growth rate and revaluation or change of price/earning multiple.
Current yield depends on dividend payment (net of tax) and entry price. US Federal Tax on corporation profit on worldwide scope and also tax on the same profit declared as dividend to shareholder (double taxation). President George W. Bush in 2003 managed to sign a new tax law to tax qualified dividends at the same rate as long term capital gains.
Malaysia has changed from a dividend imputation system to a single tier system in 2008. In other word, the tax suffered at company level will be final. There is no tax on capital gain on buying and selling shares.
If business can continue to reinvest their excess cash and generate return on invested capital (from equities and borrowings) over and above of its weighted average cost of capital (positive EVA). This will add value and share price will move in tandem with revaluation of P/E multiple.
A US shareholder in this case will prefer hold and pay capital tax later if business has the ability to produce positive EVA. On the other hand, if it has no avenue to invest its excess cash and earning is flat or on downward spiral, shareholders will prefer dividend payment or business to hold more treasury shares. It will be foolish for the business to continue holding the excess cash and destroying shareholder value. Its enterprise value will also be lowered by the excess cash holding. Excess cash is the lesser of cash and cash equivalent or the current assets – 2 x current liabilities.
Businesses which have proven capability to generate sustainable earning growth with a right mixed of debt/equity structure and the ability to generate positive free cash flow will be able to maintain a steady dividend payout policy. Normally, as a rule of thumb, businesses which are light in assets have a better chance of achieving this. Those need high capex to generate growth, their earning will be impacted by inflationary pressure.
2015-06-20 17:21
:) Chinaboleh. Naturally, a company with a higher NTA makes a potential target for takeovers which would also benefit the shareholders. Thus, spending huge sums of money on a dividend payout is not only financially imprudent but will recklessly diminish its NTA appeal - as what Time Cook has done to Apple following his predecessor's demise.
2015-06-21 13:43
Thanks for your alternative take on the subject Alphabeta. It's great we can discuss this at length.
Although capital gains tax is not imposed under an independent tax code of its own in Malaysia, the aggregate net gains in a share trade are nonetheless taxed albeit indirectly under a general all purpose income tax that is levied on the taxpayer each year.
As far as dividend payout is concerned, there's always a flipside view of the coin that has not gained currency in the mainstream media for the simple reason the interests of the wall street and main street are not necessarily aligned.
The only reason mainstream media has not taken Tim Cook to task for departing from his predecessor's policy of not paying dividends - for all 16 years of Jobs' tenure at Apple - is because they're being polite and more so they do not wish to upset the financial markets namely the institutional investors that love reaping the cash through a dividend payout although the latter does not actually improve enterprise value.
But it's time we called a spade a spade. Financially prudent companies listed on stock exchange seek to improve enterprise value by generating a greater turnout in net assets including cash and do not recklessly deplete them on an unproductive exercise such as dividend payout which exist solely to please shareholders who're unable to profit otherwise from capital gains in the stock market.
It's like what Michael Dell has opined over the years dividend expenditure is a hurdle to intelligent financial management. This is the opinion shared (for very good reasons) by Steve Jobs until his untimely demise and Warren Buffet.
2015-06-21 14:39
On the contrary gungho92, this article is meant to counter the irrational bias in the marketplace against a stock simply because of its national origin. The fact they're Chinese, Malaysian or American is secondary.
It's a clarion call to evaluate stocks on fundamentals and not prejudge and blackball them just because they're not locally based. At the end of the day, each stock (China or not) must be judged on its individual merits.
For a greater insight I suggest reading this http://klse.i3investor.com/blogs/Xingheanalysis/78527.jsp
2015-06-21 14:40
“The best run companies do not pay a single dividend”
I have doubt on the above statement unless you can show an academic research showing the statistical significance of your statement, some kind of research showing economic value added or market value added or something, more than those dividend paying companies, and not just cite one or two examples such as Apple in its old days, or Berkshire Hathaway. Otherwise intuitively I guess of otherwise.
John Burr Williams, in his The Theory of Investment Value mentioned that the intrinsic value of a company was equal to the present value of its future dividends discounted by an appropriate rate.
The US equity market provided a compounded annual total return of 10.4% from 1900 to 2000, 5.0% in dividend yield, and 4.8% from earnings growth and just 0.6% due to change in the PE ratio (John Bogle of Vanguard). One can see that dividend yield made up the highest portion in the total return.
Hence the best run company in my mind, must be one which is able to earn a high return on its capital (ROC) consistently. This provides economic value added to shareholders. Part of the return can be distributed to shareholders, and part of it used to reinvest and earn a marginal ROC higher than its cost, and more dividend distributed to shareholders subsequently.
Take one example in Bursa. If you have bought Pintaras Jaya shares 5 or 6 years ago, you would have recouped all your capitals, just by receiving the dividends.
Many corporate managers when saw so much cash in the company, simply went on acquisition sprees on businesses outside their expertise, or spend lavishly or misappropriate all the cash. As a result, acquisition earned return way below the costs, or even losses, and result in huge shareholder value destroying, and money disappeared mysteriously.
Hence it is not a matter if a company pays dividend or not, rather clever capital allocation by the managers.
2015-06-21 15:24
Why cash rich Frontkn, LCTH and PM Corp no need to pay dividend yet punters chase?
2015-06-21 17:33
There are quality stocks who provide both good dividend and capital returns over many years...even decades!
2015-06-21 19:12
An interesting read on this topic... http://fortune.com/2015/04/27/dividend-stocks-shelter-in-bear-market/
2015-06-21 20:08
KCChongnz. Well said. Thanks.
Why_leh. Go to their AGM and demand an answer. To "stand them down" "just ask the right question".
2015-06-22 04:12
good company must pay dividend once they reach stable stage after growing rapidly in the beginning... i won't call these China company "good company" though..
2015-06-22 08:22
Malaysia is a non-efficient market, loopholes in law and incompetent management.
2015-06-22 09:21
aiyo!Apple with such huge cash reserves should distribute them out as a regular dividend. Nowaday, they don't need this astronomical number to develop new products.
2015-06-22 09:58
If the share price increases no one would complain about not receiving dividends. Here, not only they don't pay dividend but the value of share keeps dropping. Kan ni na !
2015-06-22 12:17
Comparing Xinghe to Apple seems like a stretch. Unless Xinghe can earn ROE above cost of capital in the long term, or else long term investors should demand all earnings be distributed and liquidate the business.
Companies that never pay dividend is only an 'ideology'. There will be a point in a company life stage where distributing profits is the best option. And there will be, ultimately the best run company that generate great high ROE - the ultimate reason to reinvest all profits, attract competitions and drive down ROE. And when 1. Reinvestment is unable to generate return better than cost of capital, being driven down by competition 2. Share price is overvalued to consider share buyback, it is best to distribute dividend.
If you ask me comparing Xinghe to GAB, it is obvious which company is better and well run, although i shouldnt compare them because of different industries. And GAB is distribution large portion of earnings precisely because there are no reinvestment opportunities. GAB can start buying land and go into property development like every other 100 companies, but you call that great management for knowing what not to do.
2015-06-23 14:53
Guys, here's a follow up entitled "Xinghe is no Apple. Yet it's 14 times better." which caps my last article "The best run companies do not pay a single dividend" at http://klse.i3investor.com/blogs/princeanpauperstocks/79074.jsp . The same is made in response to kcchongnz, JT Yeoh et al.
2015-06-29 00:29
The amount of misinformation that goes around here is absurd.
The reason Buffett doesn't give out dividends is simple - there is no other person in the world who can compound returns like he can - so the money is kept for reinvestment because he is simply stating that "I am better than you, bar none", and backed by over 30 years of track record. Mind you, he actually gave out dividends at the start, and found that people are stupid with their money - you may want to check your facts, mate.
The question is, can your Xinghe compound returns like him? Do they have the track record?
So please, do us a favour, don't quote Buffett and compare him to Xinghe.
2015-06-29 09:08
Fellas check out my response to valuelurker entitled "The better run companies pay their dividend in kind. Not cash." http://klse.i3investor.com/blogs/princeanpauperstocks/79484.jsp
2015-07-06 04:52
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Chinaboleh
Nice sharing. What is noticeable from non paying dividend stocks is their growing NTA(rise in assets) whether cash or other assets as oppose to high paying dividend stocks.
2015-06-20 12:40