It's a problem that most companies would be happy to see – tens of billions of dollars in free cash flow that can be invested or distributed to shareholders.
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has this happy problem, and one of its solutions was to give some of the cash flow to its shareholders. In fiscal 2019, Apple paid $ 14.1 billion in dividends and spent $ 67.1 billion on the buyback of its shares. There are many billions more on the horizon.
Why does Apple prefer buybacks to dividends? Some consider it a big mistake. Fortune magazine published an article a few years ago entitled "Why Dividends Still Hit Buybacks". The author was seduced by the idea that dividends are tangible evidence that companies care about their shareholders.[Dividends are] a check in the mail. A share buyback goes into the air and never benefits Main Street. It's just money that could come to you without doing it. "
While a dividend introduces cash to shareholders' bank accounts, selling some of their shares can always give shareholders cash – essentially a dividend policy set by shareholders. With today's free commissions, selling stocks is as easy as cashing dividend checks.
A recent Barron article called for a balance between dividends and buybacks: “Apple could take a more balanced approach and double its dividend as the annual buyback program is cut by $ 15 billion to around $ 52 billion. This would result in a 2% dividend yield equal to that of the S&P 500. "
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Balance is good, isn't it? Many employees who are offered a choice between shares and bonds in their defined contribution pension account choose 50-50. Many people will happily answer if asked if the reason for a happy or unfortunate event was A or B.
Maurice G. Kendall, a famous British statistician, once made the wrong remark about equilibrium: “When some people say that the earth rotates from east to west and others from west to east, there are always a few good meanings for citizens to suggest that perhaps something should be said for both sides and that it may have done a little of one and a little of the other; or that the truth is probably between the extremes and maybe not turning at all. "
Balance is superficially appealing, but there is often a single answer – and it is not a balanced division of the difference. The workers would have been better off with 100% shares; A and B are rarely equally responsible; Earth spins its axis from west to east, and share buybacks are generally better than dividends.
John Burr Williams, the father of Value Investing, was the first to enact the law to preserve the investment value: the value of a company depends on the money it generates, regardless of how the money is packaged or labeled. The intrinsic value of a company that distributes part of its free cash flow to its shareholders does not depend on whether that distribution is called a dividend or a share buyback.
However, the label is important for investors. As so often, taxes are the deal breaker – repurchases are far preferable to dividends. The federal government taxes qualified dividends at the same rate as long-term capital gains (0%, 15% or 20%, depending on the registration status and taxable income), while ordinary dividends are taxed at the higher income tax rates that apply to wages, interest and other ordinary income ,
This tax distinction gives buybacks a clear advantage over dividends. A dividend gives shareholders no choice but to take the cash and pay the taxes. The shareholders have a choice when buying back shares. They can either sell some stocks and tax capital gains, or they can get their investment going. Having a choice is better than not having a choice. Even if they sell, they don't pay taxes on the entire sale, only on the capital gain (if any).
Suppose an investor bought Apple for $ 100 per share in 2016 and the price is now $ 300. If the investor receives $ 900 in qualifying dividends, the 15% dividend tax will be $ 135. If the same investor sold 3 Apple stocks for $ 900, a 15% tax on the $ 600 capital gain would be $ 90. The dividend tax is 50% higher than the capital gains tax. The value of Apple's stock is not affected, but the amount that remains in shareholders' bank accounts after payment of the IRS is certain.
Also, investors who have tripled in price may not need to sell Apple to get $ 900. If an investor brought in $ 900 from the sale of another stock that did not rise nearly as much, the capital gains tax would be well below $ 90. Even better, if some stocks in investors' portfolios fall in price, they can sell the losers and deduct the losses from the other earnings.
A great company like Apple that pays a 1% dividend still has an attractive price tag.
Nobody is going to buy stocks whose price will then fall. However, when it comes to selling stocks to raise cash, there is a compelling case to collect losses by liquidating the investment that doesn't work. Paying a $ 135 dividend tax is far worse than paying little or no capital gains tax or realizing tax-deductible losses.
The only compelling reason that Apple pays dividends instead of buying back shares is because Apple believes its stock is too expensive. The way to get this stake is for Apple to issue more shares instead of buying back shares. I don't see Apple there. With 10-year interest rates
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Under 2%, a great company like Apple that pays a 1% dividend is still valued favorably. If Apple doesn't believe its stock price has gotten out of hand, it should increase buyback rather than dividend.
Gary Smith is Fletcher Jones Professor of Economics at Pomona College and author of The AI Delusion (Oxford University Press, 2018) and co-author of The 9 Pitfalls of Data Science (Oxford University Press, 2019) ,
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