Marty Whitman: Dividends and Share Repurchases

In chapter 15—Other Resource Conversion Topics—of Value Investing: A Balanced Approach the author Marty Whitman devotes a section to the discussion of dividends and share repurchases (emphasis added).

Assuming that a company has superior uses of cash to expand its productive asset base and that the company has only uncertain access to capital markets to sell new issues of common stock, it is always far more productive from a long-term point of view if a company retains cash rather than distributes it to shareholders. For growth companies, distribution of cash to shareholders can be a good use of cash, but it frequently is not the best use of it. It was far more productive for IBM, Xerox, Intel and Microsoft, in their early days, to plow back cash into the business than it would have been to distribute that cash to shareholders.

Once a decision is made to distribute cash to shareholders, there are two ways of doing so: dividends and share repurchases.

The characteristics of a dividend are as follows:

• Dividends are mandatory; each stockholder is required to accept the cash payment.
• Dividends provide ordinary income for most recipients.
• Many OPMI [Outside Passive Minority Investors] stockholders like dividends. Benjamin Graham and David Dodd were big fans of dividends.
• Dividend payments can improve access to capital markets, especially common-stock markets for those companies that need relatively regular access to outside capital markets include electric utilities, finance companies, and real estate investment trusts.
• Shareholders receive cash without giving up any ownership interest.

The characteristics of share repurchases are as follows: On a short-term basis, they bring a buying group into stock. On a long-term basis, they are a far superior use of cash from the point of view of most corporations than are dividends.

The superiority of a program of long-term share repurchases for most companies over paying dividends is demonstrated in the letter (see Appendix), that the author sent to the chief executive officer of GATX Corporation in March 1985. At the time, the author was a member of the GATX board of directors. GATX never implemented his suggestions, but the letter is a very comprehensive analysis of the long-term effects of distributing cash to shareholders by the stock buyback route compared with those of distributing cash to shareholders by paying dividends. Thus, the letter is repeated here in its entirety.

Cash distributions to shareholders in any form are generally limited to adequately financed issuers. Creditors probably will prevent any meaningful amounts of cash distributions to shareholders in any form when the company is poorly financed, even if solvent.

See here for PDF of Appendix as referenced to above.

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Disclosure: I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company or individual mentioned in this article. I have no positions in any stocks mentioned.

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