For a VC in NYC, Fred Wilson demonstrates a remarkably unsophisticated understanding of stock buybacks:
I don’t remember the exact details of the buyback at TheStreet.com but we started buying the stock and it kept going down. [...] Eventually the market came back and the stock rose. And the company started making money and its reported earnings per share were higher as a result.
But I don’t view that stock buyback as successful. It didn’t fundamentally change the company in any way. We just gave back a lot of cash to the investors.
Um, Fred, that’s the explicit goal of a stock buyback. If the firm can use the cash productively — on positive-NPV projects — then it keeps the cash to invest in itself. If it can’t, it returns the cash to its shareholders — via a dividend or a share buyback.
The dividend indiscriminately gives all shareholders some cash, while the stock buyback gives shareholders the choice of selling their shares for cash or holding their shares, which should appreciate in value, as the bought-back shares are retired.
Either way, it’s not the kind of thing a growth-oriented firm should be doing — which Fred didn’t realize at the time:
With our stock buyback we were signaling to the market that we had no good ideas about how to spend that cash. We were signaling that we didn’t see much of a future in our business. And smart investors bet against those kinds of companies, managements, and boards.
Smart investors realize that a stock buyback signals a lack of growth opportunities, which is a terrible portent for a tech startup’s future — but just fine for a mature cash cow’s.
If a buyer receives a dividend, they still have the choice of using that cash to buy new shares. “Indiscriminately giving shareholders cash” is funny way to phrase things. The entire point of a company is to give shareholders cash. All companies go through a life cycle — growth, maturity, decline. The problem with stock buy backs is that the shareholder who holds for the long term may never see a return on his investment, he will go through all three stages without ever getting any cash back. For that reason, I never buy the stock of mature companies that do not pay dividends. There’s no way you can win. And if you run the numbers on historical returns, the empirical evidence matches logic, mature companies that do not pay dividends give less of a return.
Absolutely, a dividend, which the shareholder can use to buy more shares, is theoretically no different from a share buyback, in which the shareholder can hold onto or sell back shares. In practice, a dividend forces a taxable even on investors who want to compound their wealth.
I disagree that the entire point of a company is to give shareholders cash. The point of investing is to trade some cash now for the expectation of more cash later. Only a fraction of investors — widows and orphans — are looking to slowly divest and receive a steady stream of cash. Many young investors are doing the opposite — slowly investing and “dollar-cost averaging” with a fraction of their income. And some investors are making big moves in or out. Dividends are not obviously the single best way to handle excess cash.