13 Comments

If you want to compare it on a like for like basis, wouldn't you have to reinvest the dividends received in scenario 1 back into the stock?

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Gisli is right that you need to compound the dividend, either by buying more shares or by investing elsewhere.

To me the difference boils down to timing of tax payments. With buybacks I decide when to sell my shares and pay taxes (maybe never).

And one tiny complication: US companies now pay a 1% buyback tax.

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Jan 13Liked by Six Bravo

In addition to Gisli’s good point above, why would there be tax on a stock bought for $50 and sold for $50? No gain there. Similarly in Scenario 2, only tax on sale to the extent of gain.

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Jan 13Liked by Six Bravo

What Mark said. No tax on sale of stock when it's a 'push'.

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author
Jan 13·edited Jan 13Author

Excellent points regarding the capital gain tax. I misapplied the tax to the sale of shares in both cases as no tax would be applied to the $50 share and only the gain above $50 would be taxed on the $372.54 share.

As far as reinvesting the dividends goes that could be a worthwhile third scenario to run. I was primarily interested in how the company’s capital allocation decisions can influence investor returns independent of the company’s performance or the investor’s decisions.

Not all investors reinvest dividends, some spend them. Retained earnings used for share buybacks are more valuable than dividends even for investors who intend to sell a portion of their shares to create dividend esq cash flow because the earning per share are higher and when multiplied by the P/E ratio lead to more than a dollar in share price for every dollar of would be dividend's. Assuming of course a P/E greater than one.

In summary, it’s an honor to get honest intelligent feedback from such a fine group of investors as yourselves. I’ve learned a tremendous amount both through writing these posts and from the high quality interactions with all of you. Thank you again for the great feedback!

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With regards to the reinvestment, I beg to differ.

In its current presentation, the comparison disregards the time value of money. An alternative approach to fix that, would be to apply a discount rate to both scenarios (instead of reinvesting the dividends).

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Great exercise and discussion! Thanks, Six Bravo!

I agree with Gisli that it’s not really apples to apples with the dividends not reinvested. This results in the two investments having significantly different Durations. Scenario 2 is a full 10 year investment and Scenario 1 has dividends coming out throughout. I’d guess that S1 has about a 7 year duration. To be applied to apples to apples in S1 the divs should be reinvested to give it the same duration. Thanks!

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I don't see how the "math is Occam’s Razor-like" ... if anything it seems like Zeno's paradox. Occam's Razor is in no way a paradox but rather a problem-solving principle requiring the minimization of explanatory causes.

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Another good catch, Zenos paradox was on my mind and Occam’s Razor is what I wrote.

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Jan 15Liked by Six Bravo

Repurchase is such a powerful tool because it’s so simple. Any firm trading at a low valuation but has a stable earnings base can retire shares so quickly that either investors catch on and drive up the price (e.g. Apple pre-2020) or the company buys out most of the free float (e.g. NVR/Autozone in its first 10 years of buyback).

Three conditions for great buyback accretion: low valuation, stable earnings, and management consistency. Recently AMR is probably the best illustration of that. Crazy they retired 30% of shares in less than 2 years... Would’ve been higher if the price didn’t skyrocket last six months.

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author

Well said, Michael. Yes, AMR is a great example. We wrote about it here:

https://specialsituationinvesting.substack.com/p/a-buyback-monster-alpha-metallurgical

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Why did you assume a reinvestment rate of 0% in Scenario 1?

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Good exercise. Thank you for the write up. I have a small Q: in S1, wouldn't the share price reflect the "ex-divident effect"?

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