On dividends and share buybacks

Note: Today’s post is solely based on French references. For once.

As some of you may know by now, corporate finance is one of my ‘little weaknesses’ and I am always fond of press articles illustrating – with very variable success – simple corporate finance theories. Last Friday the French newspaper Les Echos involuntarily published two great articles on the use and impact of dividends and share buy-backs.

In a nutshell, the first article voiced the disappointment of TF1’s shareholders – TF1 is the largest private TV media group in France – as the dividend in 2015 was lower than in 2014 and the share buyback program of €30m was less sizeable than expected. One expert quoted in the article stated that “one could have expected more cash return to shareholders after the Eurosport disposal”.

Credits: Jantoo.com.
Credits: Jantoo.com.

And yet this is a common fallacy in which many shareholders fall. Higher dividends can be seen at best as neutral, but more often than not they are send a negative signal to the investor community. Why? Dividends are by definition money paid by the company to its shareholders. It is simply a transfer of wealth, not a value-creating mechanism, and as a consequence any dividend payment is reflected in the share price ‘at cost’ – i.e. if a share is worth $100 pre-dividend and it pays a dividend of $5, the post-dividend share price is $95. Therefore, any shareholder can decide himself of the dividend he would like to receive, by selling (if the dividend is perceived as too low) or buying (if the dividend is perceived as too high) an appropriate number of shares. Worse, a ‘forced’ dividend payment implicitly assumes that the company cannot do anything better with the money than giving it back to its shareholders. This is a gloomy conclusion, if we consider the fact that many Treasury Bills pay a negative interest rate and stock markets stumble around.

And this is why the second article offers a more balanced view on the benefits of share buybacks. In one hand, several experts interpret this as a positive sign if the company is able to maintain its margins in the future and benefits from a strong cash position. On the other hand, many others perceive this as “waste” and missed opportunities in a low interest rate environment. France is by no means isolated, as the chart below shows.

Quarterly Share Repurchases ($M) and Number of Companies Repurchasing Shares. Source: FactSet.
Quarterly Share Repurchases ($M) and Number of Companies Repurchasing Shares.
Source: FactSet.

To conclude, the fact that share buybacks are making a comeback is worrying sign for the state of the global economy. Companies are struggling to spot even barely profitable investments while shareholders are ready to claim their money with limited investment alternatives available. At a global level, all the money leaving the economic circuit is ultimately harming the recovery – through what economists call the multiplier effect, more on that in another post. This is no more, no less the vicious circle Joseph Stiglitz was also condemning in his latest Les Echos column. Shareholders must be careful about what they ask.

Updated: As I was finalising this article, I came across this article from today’s Financial Times which not only provides further quantitative evidence to the rise of dividends in 2015 but also jeopardises my promise to only quote French articles…