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Cash dividend or share buyback?

Tong Kooi Ong
Tong Kooi Ong • 5 min read
Cash dividend or share buyback?
SINGAPORE (Dec 24): Uncertainties and volatility remain heightened in global equity markets. Swings of several hundred points are now a daily occurrence for the Dow Jones Industrial Average, probably the most closely watched market barometer in the world.
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SINGAPORE (Dec 24): Uncertainties and volatility remain heightened in global equity markets. Swings of several hundred points are now a daily occurrence for the Dow Jones Industrial Average, probably the most closely watched market barometer in the world. It is enough to give investors whiplash — and may well be quite disheartening for those buying on fundamentals.

It does appear as though share prices are temporarily disconnected from underlying fundamentals and markets are being driven by momentum and sentiment, dictated by headlines of the day. This could be a symptom of the increase in beta investing — where analysis of fundamentals becomes secondary — or funds raising cash, given prevailing uncertainties.

Case in point: The share price of DIP Corp remained caught in a downtrend, sliding to a year-low even though the company reported upbeat earnings in its quarter ended August.

Sales grew 10.3% y-o-y to ¥9,884 million ($121 million) on the back of the rising number of job ads; net profit was up an outsized 21.5% to ¥2,055 million. The margin improvement was due to economies of scale, including lower staff and advertisement costto-sales ratios, which indicate better sales productivity and application efficiency.

The outlook for job ads remains healthy, with a high ratio of job openings compared with job seekers. Japan recently passed a bill that allows more low-skilled foreign workers into the country, which bodes well for recruitment companies.

DIP revised up its net profit forecast for the financial year ending February 2019 by 8.6% to ¥8,647 million and raised interim dividend to ¥24 a share from its previous forecast of ¥20 a share. Total dividends for FY2019 is estimated at ¥49 a share, compared with ¥43 a share paid in FY2018. That gives a yield of 2.6% at the current share price. Raising dividends is a positive sign of management’s confidence in the future.

In view of prevailing market sentiment, it makes sense for companies to return excess cash to shareholders. As I have noted, companies that pay out most of their earnings do seem to attract higher valuations in the market.

US companies, in particular, appear big subscribers to this theory. Companies in the Standard & Poor’s 500 index have been returning record amounts of cash to shareholders in recent quarters. Total shareholder return increased to US$919.9 billion ($1.3 trillion) in 9M2018, up from US$692.8 billion in 9M2017 — and nearly reaching the 2017 full-year total of US$939.2 billion.

Notably, companies in the US prefer to return excess cash via share buybacks than dividends. The amount spent on buybacks totalled US$583.4 billion in 9M2018, compared with US$336.5 billion paid out as dividends over the same period.

This could be due to the greater flexibility accorded by buybacks. Anecdotal evidence suggests that investors react less negatively if companies subsequently reduce their buybacks in less good times.

On the other hand, share prices usually get severely battered down in the event of a dividend cut. Thus, companies tend not to raise dividends unless they are fairly certain that the higher payments are sustainable.

Therefore, it is interesting that companies in Malaysia and Singapore are not big fans of share buybacks. Tables 1 and 2 list companies with the highest percentage of treasury stocks on their balance sheets. Most are relatively unheard-of small-cap stocks.

I have also reproduced the two lists of select companies that consistently return high levels of cash to shareholders in both countries (see Tables 3 and 4). None of the Malaysian companies hold any treasury stock whereas the percentages are marginal for those in Singapore that do.

By contrast, the top five US companies with the highest buybacks in 3Q2018 were also some of the largest — led by Qualcomm, Apple, Oracle, Wells Fargo and Cisco Systems. Share buybacks are not only common in the US but also well liked by investors.

Share buybacks raise the earnings per share by reducing the number of shares. If valuations stay the same, it should be reflected in higher prices. A shareholder can then choose when to realise the cash payout according to his cashflow needs. Perhaps there is a certain negative perception attached to the trading of one’s own shares, which companies prefer to avoid? It is likely not all shareholders would be happy with the buyback price. What would be a fair price to pay that would not be frowned upon and/or dilutive?

Case in point: The Singapore Exchange recently cautioned companies not to breach insider trading or market manipulation rules when conducting share buybacks. It also warned that creating a false market by artificially inflating the share price and/or trading volume is illegal.

Dividend, on the other hand, is transparent and easily understood. It is cash for shareholders today. The market determines the yield and, if favourable, gives the stock premium valuations. No dispute.

That said, transparent share buybacks could be value-accretive. This is especially so when the market fails to properly assess the company’s underlying worth in times of massive broad market selloff and price collapse. Only a fool believes the equity markets are efficient all the time.

All of the stocks in the Global Portfolio except for Sunpower Group ended in the red for the past one week, mirroring the deteriorating investor confidence in global markets.

Total portfolio returns now stand at -17.4% since inception. The portfolio is underperforming the benchmark index, which is down by a lower 8.3% over the same period.

Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore

Disclaimer: This is a personal portfolio for information purposes only and does not constitute a recommendation or solicitation or expression of views to influence readers to buy/sell stocks, including the particular stocks mentioned herein. It does not take into account an individual investor’s particular financial situation, investment objectives, investment horizon, risk profile and/or risk preference. Our shareholders, directors and employees may have positions in or may be materially interested in any of the stocks. We may also have or have had dealings with or may provide or have provided content services to the companies mentioned in the reports.

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