IFB72: Shareholder Yield Metric: Cheap Stocks with Good Capital Allocation

shareholder yield

Welcome to Investing for Beginners podcast, this is episode 72. Tonight Andrew and I are going to talk about shareholder yield, this is a term that I came across when I read a book by Meb Faber. One of my favorite podcasters, he’s a quant investor that runs a ETF that he’s a fantastic guy really interesting super smart and sometimes he can be a little technical.

But he’s very interesting and he wrote some great books that are on Amazon and quite a few of them were actually free. So the book that we’re going to talk about tonight that we’re going to reference let me rephrase that is actually free and I will put the link to that in the show notes. If you guys want to check out a little more deep dive into what Andrew and I are going to be talking about tonight that’ll give you an opportunity to check that out so well then further ado Andrew once you go ahead and start us off and talk a little bit about shareholder yield and capital allocation.

Andrew: yeah so shareholders yield a metric it’s a good kind of description for a metric where you’re essentially looking at a CEO management of a company and seeing how are they allocating capital. You have earnings that you get right profits up that these companies have and as we’ve mentioned in previous episodes two to three episodes ago these companies have various decisions that they can they have various purposes that they can use this cash that they have for.

And so shareholders yield is a measure to evaluate that and it can identify companies if there’s a high shareholders yield can identify companies that are really rewarding shareholders giving a lot of that cash and giving it back to shareholders and it doesn’t have to be in the form of a dividend that’s why it’s different than like the dividend yield.

You have essentially the five ways that they can pay back shareholders and so they can reinvest back in the company and that’s good if the business if the core business is growing they can do a an acquisition a merger and acquisition. Where you’re they’re buying another company hopefully saving money by combining operations and obviously growing earnings and revenues in that way.

They can pay down debt they can repurchase shares we talked about that extensively with the share buybacks episode and they can pay dividends.

What we’re going to talk about today I think really gives a nice little measure and a way that you can take it one step further right. So we took the time to really introduce these kind of things and talk about them from a theoretic level. Hopefully you were able to learn that if you haven’t listened to those two episodes I definitely recommend doing that.

But understanding the how it works and what these things are and then now this is a good idea of how you can apply it and use it practically to find good businesses good stocks to buy.

I really liked the book that Meb Faber wrote shareholder yield he had like really cool kind of metaphor about the way some investors will look at stocks so he talks about this concept some I don’t know it feels like a legend or just a story.

but there’s six blind men right and they’re all told to touch this elephant and they’re told to describe what this elephant is what it feels like and then kind of make some conclusions based off of that. One blind man might touch the tusk one might touch the tail one might touch the side or the bottom of his belly and they all describe different things but neither of them not one of them if they’re all just touching this one place they’re not able to accurately describe the whole picture and so when it comes to investing and buying stocks a lot of investors can fall into that trap as well.

And so that’s why that metaphor was kind of made to the way I interpret it was just to talk about like dividend yield because when people think about companies paying back shareholders and rewarding shareholders for holding their stock a lot of people think of dividends. And I definitely think that way and that’s obviously a really great way to reward shareholders.

But like I mentioned just a second ago there’s actually five different ways that they can pay back investors and give them value from the cash that the business is generating without just paying the dividend.

And so that’s kind of what the book breaks down and spreads out in the different sections and talks about how businesses can pay back shareholders and give this this metric you called shareholder yield and if an investor looks at all of these things rather than just the dividend yield you can find some opportunities that might be being ignored if you’re more just 100% focus on dividends.

I really like that idea obviously it’s something I prescribe to when it comes to looking at a stock in general and so let’s take a complete approach and not be blind to just one aspect.

You’ve kind of seen it in the way that dividends historically have been paying and dividends have been paid now. I thought that was really cool how he kind of brought up others a changing trend in the way that dividends are paid and the way that CEOs and managements have decided to reward shareholders. And there’s a lot of factors in there I thought was really cool how he went over that.

Dave: I agree I think it was it was one of the really interesting parts about the book was that he talks about the decrease over the last 60 years of I’m sorry 70 years of dividends versus stock buybacks and Andrew and I both kind of wondered why that’s been going on but we finally found the answer.

And one of the reasons is that it due to an SEC rule instituting a rule it was a 10 B – 18 in 1982. So it provided a safe harbor for firms conducting share repurchases from stock manipulation charges.

This basically gave them a safe haven to be able to do stock buybacks as a capital allocation strategy for what to do with their money. And they found if the companies have found that has been more profitable for them as well as the shareholders by providing a safe haven from taxes.

And it’s cheaper for us as a shareholder to do the share buybacks than it is the dividends because the dividends have attacked can have a tax implication. And so the company have that’s one of the reasons why they’ve gone this route.

And it’s been a gradual decline and you’ve seen in the financial news over the last year or two years there’s been an increase in chatter about share buybacks and that’s one of the reasons why Andrew and I chose to talk about that a few episodes ago.

Those because we wanted to kind of shed some light on why this is happening what’s going on is it good is it bad and how it can help us as shareholders.

Now one of the cool things about this book is that he talks about that he also talked about dividends and he talks about a few other factors that go into kind of the whole shareholder yield metric if you will.

But it all really kind of comes back to a kind of a capital allocation which is what Andrew was referring to earlier where that that’s what the companies are doing they’re figuring out what to do with their money just like you and I do.

And he also kind of dumped a few other little tidbits of information that I thought were kind of fascinating to kind of again pound into everybody why dividends can be such an important factor in our investing even though there’s an a decrease in the actual the amount of companies paying a dividend or the  dividends actually being paid.

But he just the first of numbers at yeah uh since 1871 which I understand is a really long time ago. US stocks have had an eight point eight three compounded return from 1871 to 2011

Andrew: if that’s or if that’s before or after inflation I’m assuming it’s uh

Dave: it’s after it’s after inflation so if you reduce really like a lemon yeah exactly so if you actually were but the cool thing is that if you reduce if you take dividends out of that let’s say you just buy companies that do not pay dividends that would be cut in over in half it would be four point one three percent a year so that is a huge amount.

And as we talked about in the past about compounding when you start talking about reducing a one percent two percent four percent from your returns that can add up to some serious coin as time goes by.

And to kind of illustrate that a little bit more if you had invested $100 in 1871 by the end of 2011 it would have compounded to 228 thousand eight hundred and seventy dollars that’s gross of fees transaction costs and taxes.

When you consider the total return portfolio which were what’s the price return and dividend reinvestment the ending value for the same time period so if you put a hundred dollars in an eighteen seventy one with a company that’s reinvesting their dividends and also seeing a price increase by two thousand eleven you would have had thirteen million dollars and $955 I’m sorry thirteen million nine hundred fifty five thousand nine hundred fifty two so a four hundred eighty fold improvement.

That’s some serious increase and granted who’s going to live a hundred and forty years not I’m not going to but that’s just insane.

Again that’s just another illustration of how much dividends can have an impact on your returns you can over our meager forty or fifty sixty years that we’re going to be investing so again dividends they’re your friends embrace them enjoy them use them and let’s kind of keep going on with what we’re talking about so just a few numbers I wanted to throw at you.

Andrew: and so that that’s like the good news right dividends yes compound money. The bad news like you mentioned earlier is that the trends for dividends have steadily been decreasing like it’s not even the thing where it’s volatile or going up or down or going through cycles these companies are trending to pay dividends less and less. Something actually popped in my head when you’re mentioning that Dave the this idea so we had the SEC rule in 1982 which made the easier tax wise blah blah blah.

The other thing is I think stock based compensation these stock options for the people who are in charge and for you and employees. I think that’s a relatively newer kind of thing that we’ve seen I mean even Buffett talked about adding this basic versus diluted thing right.

Because he’s been quoted as saying before I think it was in the 90s we said  if we’re not going to count share stock options as what they say liabilities or as compensation whatever. If we’re not going to reflect it in the income statement then what what really is it? Like you’re not looking at really what the real earnings are.

And so just the fact that like this change from basic to diluted EPS is something that’s new within the last 20 years. I think maybe that might have some it’s showing a shifting landscape right. And so are we going to be able to get those kind of reinvestments from dividends in the future that we saw in the past?

Well hopefully and I know I’m personally targeting companies that have adequate dividends that’s kind of the bad news. The good news which is what the rest of the book talks about is that there are other ways that companies have purchased or have reward shareholders other than dividends and so that is like we mentioned stock buybacks.

And that’s actually been on the on the rise and so a lot of the drop in dividend payments can be accounted for with the increase in share buybacks.

I thought that was really cool and the really cool point made in the book and he has some cool charts showing that as well.

Essentially there’s three ways so we talked about dividends we talked about buybacks there’s a third way that a company can really I guess provide a lot of value to the investor and that’s by paying down debt and this is the third component of shareholder yield that Meb Faber talks about.

I didn’t like I didn’t really understand because that that obviously helps the business right. I don’t I don’t see why that would be different than like reinvesting in the core business because you’re helping the underlying business not necessarily giving the cash directly the shareholders right. But it’s still like an added plus it’s a good use of capital.

I don’t know why name would be a bad use I mean unless you’re paying like a super low interest rate but for somebody who’s like a conservative investor you want to see as little debt on the balance sheet as possible so that’s going to be an obvious plus.

Meb Faber talked about three kind of metrics to measure how the shareholder yields being calculated. and in turn how management is rewarding shareholders giving some of that back so he said dividend yield, net buyback yield, and net that net debt paid down yield maybe we can talk about those three just a little bit and then see if that helps us understand how we can take what these companies are doing identify them in the market and then use that to potentially find the companies that are regularly rewarding shareholders.

Because they’re doing that and they’re showing that that’s what they like to do outside of some condition out of their control it’s likely that they’ll probably continue that I think it’s reasonable as an investor to make that kind of connection right. And maybe over the majority you will see that happen.

It’s obviously a good idea to try to find stocks and businesses that are doing that and shareholder yield through dividend yield net buyback yield and that that pay down the old can be great metrics to kind of identifying them really quickly.

Dave: yeah I totally agree you mentioned the companies are basically once they go down a path or they don’t change much and he mentions that in the book that they’re really hesitant to ever cut back a dividend as we’ve talked about in the past.

That’s one of us that could be one of the signs of trouble and that’s why companies try so hard once they go down that path to not go away from that because they can cause a lot of panic in in the market about the company because that can be a sign the there is  some underlying trouble.

Let’s kind of start diving in a little bit to the three different I guess sections of it.

First one is a dividend yield so how he calculates this as he looks at the trailing 12 months cash dividends and he divides that by the market cap. Basically he says this means that the total value the cash dividends the company paid out divided by the market value of the stock.

That’s pretty easy you just look at the last twelve months of the cash dividends that have paid out you divide that by the market cap of the company and that will give you your dividend yield so that I think that’s pretty self-explanatory do you have anything you wanted to throw on that?

Andrew: nope.

Dave: okay next we got the net buyback yield so we’re looking at that we’re so for this the way we’re going to do this is we’re going to calculate this by looking at the trailing 12-month stock repurchases minus the stock issuances. So in other words anything that they’re buying back versus what they would create more stock of and divide that by the market cap.

Basically this means that the total value of the stock buybacks the divided by the market cap of the stock another simple measurers to use the percent change in shares outstanding. I think that again is pretty self-explanatory did you have anything else you’d like to add to that one.

Andrew: uh well I guess you can like you said take the change in shares outstanding it’s something I don’t because it’s not like a metric that you will see on any financial website right?

You’re going to you’re going to have to dig into this one to define it.

Dave: for sure yeah.

Andrew: and doing so is something you should be doing anyway right. If you’re looking at maybe not so much but what the valuation or price based metrics are but if you’re looking at like how a company is changing from year the year.

If you’re seeing changes and share and shares outstanding where you’re not the same dilution that can be a cause for concern

essentially what we’re saying is if shares outstanding is is reducing that means they’re buying back stock if it’s increasing that means they’re diluting shares right.

And so you’re basically looking at that and then I guess comparing that to the market capitalization so in essence you are accounting for however many shares are bought back.

Dave: yeah.

Andrew: okay sorry I don’t think through that yeah exactly yeah no I thought I make it we’re not just like brushing over that one because that one can be kind of confusing.

Dave: yeah I would agree yeah I think one of the things I would throw out there to is this is new to me I had never heard this term before reading this book.

I obviously knew what stock repurchases were but I had never heard this term net buyback yield that was that was new to me.

Andrew: so I thought that was kind of interesting the next compare that the the price is right yeah

Dave: exactly the next one is net debt pay down yield so this is the net changes in short and long term borrowing and debt divided by the market capitalization. Basically this means it’s a total value debt a company has paid down divided by the market value of the stock.

and again this is not something you’re going to find on  any sort of financial website it you’re going to have to go to the SEC.gov and look at the 10-K’s and dig into this a little bit. This is not something you’re just going to find out there so it will take a little bit of digging around.

But as Andrew was saying to as you’re looking at the financials of the company this is something that will be relatively easy to find and I think to kind of takeoff of what Andrew is saying about is this directly beneficial to us I think it is.

The one I guess negative about paying down too much debt is if you wipe out all your cash and something bad comes along that could be a problem. I guess  having a conservative and it’s going to sound a little strange maybe but maybe having a conservative approach to paying down your debt would be more beneficial than to being super aggressive and paying it all off and then also you got nothing left. I guess that way I get what’s it that’s sound counterintuitive.

Andrew: I totally agree yeah.

Dave: so those are really the three components of shareholder yield. Hopefully you guys understand those if you don’t you can just kind of sit back a little bit and listen to them real quick or you can also download the book and you can read through those as well and they’ll help explain it a little bit more.

Andrew what did you want to word you want to go from here?

Andrew: so then what’s important when you’re looking at these numbers it’s really easy to get lost in the massive scale of them so we’re talking about billions of dollars millions or billions of shares being repurchased or diluted. you can just get you can see these numbers and be like okay cool I made the calculation but I don’t know what it means.

And so that’s why that’s why it’s referred to as a yield and it’s giving you when you have contexts on data and this kind of relates to everything when it comes to looking at stocks and looking at their financials you have to have context on the data. And so when you see the data then you understand what it’s trying to tell you with each of these.

It’s very easy for us to think about that with dividends right because let’s say I pay 30 bucks for a stock it pays me a three dollar dividend that would actually be really high right but I can understand what company is that exactly the ticker with that that would be you.

We can easily intuitively understand that that’s really good and by using like dividend yield we understand that’s a 10% yield we’re going to get 10% payments every year. That’s why he did that for the buybacks and the net debt pay down you’re comparing it to the to the market cap you’re finding out a yield and so that’s giving you a percentage.

And if you think about share buybacks I’ve kind of talked in length I talked about positive ending is about share buybacks right like I’m not a hundred percent disciple on them talked about that in previous episode. But you can buy using like a yield you can see that hey I’m getting like two percent from a dividend payment and then this share buybacks really given me like another half percent and and so I’m really getting paid back nicely by the company here.

That can kind of give you that can help you understand what the numbers are really meaning rather than just saying well okay they bought back three hundred million shares what does that mean doesn’t mean anything without context.

What I found very something I know this as well and I think we should talk about. The each of these metrics like I said are related to a market cap.

When we talk about shareholder yield which again seems like a great way to figure out to figure out and find stocks that are paying back shareholders and allocating capital well. When you have all three metrics tied to a single data point which is market cap. Then you can have companies that have really high shareholders yield just based simply on the fact that they are so super cheap.

So Dave you talked about like a 10 percent there then then Gamestop like yet super close to that at some time if not there right now yeah good yeah.

And it’s we’ve talked about how it’s it seems like a really great value pick and who knows how it’s going to play out it probably will take several years.

But that you talk about stock that’s hated that price was so low that that dividend yield went so high it wasn’t like they were super aggressively paying off paying these dividends out so you can see the same thing with companies with high shareholder yield.

That can be sometimes a good thing right and it might speak to why buying stocks with high shareholders yield has resulted in great results for investors because they’re essentially being value investors because to have a high shareholders yield. A lot of times those are owned stocks that are lower priced.

And it’s a similar kind of idea to buying stocks with low price if you have a stock with a really low price or a really low market cap you’ll see that in the price earnings the price to book price to sales price to cash. The kinds of things I like to look for when I’m talking about not being a blind man and looking at the whole picture trying to look at the whole elephant.

When you have these stocks that are hated you’ll see them pop up in multiple ways so there’s lots of different ways that you can kind of achieve the same thing using different numbers.

I would say if we try to cover a lot on this podcast and it’s not necessarily always the stuff that we personally implement their own portfolios.

I think if you just stick to one thing and kind of run with it then you can start to understand like we do now right then we have this kind of mastery and understanding now we can start to make conclusions like a high a high shareholders yield can happen from just solely on low price. And you can also do things like looking at a 10k and just watching the share the shares outstanding every year.

And that’s how you’ll find companies that are buying back aggressively or you can take like a shareholders yield or net buy back you can we talked previously Joel Greenblatt likes to use earnings yield and return on capital that can be another way to find companies that are allocating capital well.

So many different ways to do it but it has owners or means so many different ways to do it just maybe try to pick one understand one and then move forward from there.

The last thing I found interesting about the book and I really liked how he did this he obviously he introduced these metrics where I talked about why that makes sense why they benefit the investor and then he did some back tests on it. And the back tests turned out to be very successful I don’t know if you have the exact numbers Dave.

But it showed that they would routinely outperform the market when they would rebalance buy these stocks with high shareholders yield and there were some cool conclusions that Meb came out with he wrote he wrote in the book and as a result of that back testing kind of proved that makes sense right.

Like what these companies allocate capital well tend to do well in the stock market.

Dave: yeah he did the one that I’m looking at right now is showing the comparison from 1982 to 2011 of the sp500 dividend yield and the shareholder yield was that the one you’re referring to?

Andrew: yeah.

Dave: he’s showing so he’s showing the returns so for that time period for the sp500 it was returning at ten point nine six percent not bad dividend yield was coming back at 13 for thirteen point four percent which is pretty darn good but the shareholder yield was coming back at fifteen point oh four percent.

That was outstanding so almost a four net and pretty close to a four percent increase of just over the SP for that time period. I thought that was pretty impressive.

Andrew: sorry so what did that the dividends were thirteen percent that’s that same just what can you lose it 13.4% for the dividend yield for stocks with high dividend high dividend yield stock?

Dave: yes yep exactly yep.

Andrew: man if you just if you went with stocks with had a high shareholder yield there was 15.15 point zero four percent the same as my peers at 10% the a ten point nine percent six percent.

Dave: yep yes so yet had lower drawdowns it had lower volatility and had a better return over the over that time period all three of those metrics.

So yeah I was pretty impressive it’s a very interesting study that he did.

Andrew: yeah and that was a cool back test and a good way to kind of show how these companies who do pay back shareholders like it obviously the market tends to like it and so I think the back tests had rebalancing every year and so these ones with the high shareholders yield were currently paying back shareholders nicely and so it makes sense that their stock prices would tend to rise over 12-month period.

I like that I think that was cool data I think it was I got really excited after I finished reading it the second time Dave. remember it makes is you I was like oh I need a cigarette yeah I was just yeah this is really cool super short I think I finished it  under an hour so there’s really no reason why and then go out and like at least check it out.

See if it teaches you something right hopefully we tell you something today maybe it teaches you something about to give you insight if it didn’t make sense well share buybacks or all these other things this is how companies use cash and this is what fuels growth so you need a good balance of growth and you need a good balance of paying back shareholders.

I think this is an excellent way just another metric that you can use to determine that quickly and easily.

Alright folks well that is going to wrap up our discussion on shareholder yield I hope you enjoyed our discussion he learned a thing or two. It was a very fascinating book for me to read and I know Andrew enjoyed it again the second time obviously.

And there were some great points and I think there’s some great learning things you can get from this book again. It’s free fre e free did I say that again free? I will put the link for that in the show notes.

If you want to check that book out its fantastic and like Andrew said it’s less than an hour to read. So much is a constant it’s free my favorite F word free so enjoy. it’s our little gift to you well it’s actually Meb’s a little gift to you and don’t hesitate to check out his podcast as well very interesting you’ll learn a lot from him I have definitely learned a lot from him.

Without any further ado I’m going to go ahead and sign us off you guys go out and invest with the margin of safety emphasis on the safety have a great week and we’ll talk to y’all next week.

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