Dividends And Buybacks: Frequently Asked Questions

Dividends and buybacks split investors. Both are a form of cash return to shareholders, but both also have their drawbacks. Company executives view these two methods of cash return very differently and are often unsure which is the best strategy to adopt.

Three ways to return cash

When it comes to capital returns, a company should retain its earnings if it can earn a rate of return that is above the cost of capital. But if shareholders can earn a higher rate of return on capital than the company can, the firm should disburse the cash.

There are three ways a company can transfer cash to its shareholders:

  1. The company can sell itself for cash. Rewards all shareholders.
  2. A company can pay a dividend. Rewards all shareholders.
  3. A company can buy back its shares. Only shareholders who sell can cash in.

The topic of how best to return cash to investors through dividends and buybacks is especially relevant in today’s environment as corporate cash levels reach record levels.

However, the case for, and against buybacks and dividends is complex. Some investors swear by dividends, and others want buybacks only. Few have carefully and rigorously thought through their positions.

Credit Suisse’s Michael J. Mauboussin tried to answer some of the fundamental questions sounding buybacks and dividends in a research note issued to clients of the investment bank back in 2014. The following summary is a summary of Mauboussin’s research.

Question 1:  How are share buybacks and dividends the same?

Buybacks and dividends are fundamentally the same; they’re both methods of distributing cash to shareholders. What’s more, assuming that taxation is identical, there are no transaction costs, dividend funds are reinvested at the same rate, and the stock is trading at a fair price, then there’s no clear, identifiable difference between buybacks and dividends.

However, in the real world, these assumptions do not hold. Therefore, from the point of view of the shareholder, buybacks offer more flexibility than dividends because they allow the shareholder to control the timing of taxes.

Question 2: How are share buybacks and dividends different?

The data shows that the most fundamental difference between buybacks and dividends is the attitude of executives. Specifically, executives tend to believe that maintaining the dividend is on par with investment decisions such as capital spending while buybacks are linked more to residual cash flow. As a result, dividends provide a strong signal about management’s commitment to distribute cash to shareholders and its confidence in the future earnings of the business. Buybacks tend to be viewed as a lever that can increase earnings per share under the right conditions.

As noted above, another key difference between buybacks and dividends is the fact that dividends treat all investors the same. Buybacks only benefit those that sell.

Question 3: What are the philosophies that motivate share buybacks?

The simple answer is there are three main philosophies that motivate buybacks, fair value, intrinsic value, and accounting. The first two philosophies help to create shareholder value while the third is a side effect of performance-based pay packets.

The first philosophy, fair value takes a steady and consistent approach to buybacks. Management recognizes that buying back stock is not an exact science and doesn’t try to time purchases. However, management also acknowledges that by distributing funds it’s less likely to do something foolish with the funds. Research suggests that most companies would have been better off buying back stock consistently versus their actual behavior of buying heavily in some periods and lightly, or not at all, in others.

The second philosophy, intrinsic value is based on the notion that a company should only buy back shares when it believes that they are undervalued.

And the third opinion is usually based on management’s desire to increase company EPS. This means that the goals of the program may not be aligned with shareholders. Increasing EPS may help management reach a financial objective that prompts a bonus.

Question 4: Share buybacks add to earnings per share, isn’t that good?

It’s important to note that buybacks do not necessarily increase EPS. The company has to pay for the buyback, which means that earnings are lower with a buyback program than they would be without it. As Mauboussin explains:

“A company can fund a buyback one of two ways. Either it can use excess cash, or it can borrow money. Whether a buyback is accretive or dilutive to EPS is a function of the relationship between the after-tax interest rate (either foregone from cash or incurred from debt) and the inverse of the price/earnings (P/E) multiple.”

Take the following example:

(click to enlarge)

 

Question 5: How should you assess the merit of a buyback program?

The golden rule of buybacks is that a company should only repurchase its shares when its stock is trading below its expected value, and no better investment opportunities have been identified.

Unfortunately, it’s difficult for shareholders to assess accurately the merits of a buyback program without access to additional (inside) information on the company’s operations and investment opportunities.

Question 6: Aren’t companies that overpay for their stock harming their shareholders?

“Only if a stock trades exactly at intrinsic value do buybacks and dividends treat all shareholders the same. If a stock is over- or undervalued, the effect of a buyback is different for selling shareholders than it is for those who continue to hold. “

Since management’s key focus should be on building value per share for continuing shareholders, it should always try to buy back shares that are undervalued. Therefore, buying overvalued stock does indeed harm shareholders. That said, assuming you own shares of companies that you think are undervalued buybacks will, by definition, increase value per share.

Question 7:  Does it ever make sense to repatriate cash, pay taxes, and then buy back shares?

There’s a surprisingly simple answer to this question: Only if the stock price’s discount to intrinsic value exceeds the incremental tax rate of the repatriated funds.

The matrix below provides a guide to the analysis required for this calculation assuming an 8% cost of equity.

PEs and buybacks 2

 

Question 8: Isn’t it true that the majority of total shareholder returns are the result of dividends?

No. According to Mauboussin, this is one of the great misconceptions of the investing industry as price appreciation is the only source of investment return that increases accumulated capital over time.

The key to understanding this comment is to distinguish between the equity rate of return and the capital accumulation rate. The capital accumulation rate, often measured as total shareholder return (TSR), is a multi-period measure that assumes all dividends are reinvested in the stock. The equity rate of return is a one-period measure that merely adds price appreciation to dividend yield.

The value of the compounding reinvested dividends means that the TSR, or capital accumulation rate, is always higher than the equity rate of return as long as the stock has a achieved a positive return.

But the problem is, almost no one reaches the full TSR potential available to them. As Mauboussin explains:

“First, most individuals do not reinvest the dividends they receive from the stocks they hold directly. While no definitive public statistics exist, individual investors appear to reinvest just 10 percent of the dividends they collect…Second, unless investors own individual, dividend-paying stocks in a tax-free account, they have to pay taxes on their dividends. This means that they can only reinvest a fraction of the dividends they receive, which prevents them from earning the TSR.”

The bottom line

Overall, buybacks and dividends have similar qualities but treat different groups of shareholders differently. Buybacks only benefit continuing shareholders when the stock is undervalued while dividends treat all investors equally.

You can read Michael Mauboussin’s full PDF at ValueWalk.com where the original version of this article was first published.

What You Should Look For In The Perfect Dividend Stock

If you’re a regular reader of this blog, you might have noticed that I’m not a big fan of dividends. Personally, I would rather invest in a company that’s using excess cash to pay down debt or buy back stock — a more tax efficient method of returning cash to investors.

Buybacks and dividends are fundamentally the same; they’re both methods of distributing cash to shareholders. What’s more, assuming that taxation is identical, there are no transaction costs, dividend funds are reinvested (by the investor) at the same rate, and the stock is trading at a fair price, then there’s no clear identifiable difference between buybacks and dividends.

However, in the real world, these assumptions do not hold. Therefore, from the shareholders point of view, buybacks offer more flexibility because they allow the shareholder to control the timing of taxes.

The data shows that the most fundamental difference between buybacks and dividends is the attitude of executives. Specifically, executives tend to believe that maintaining the dividend is on par with investment decisions such as capital spending while buybacks are linked more to residual cash flow. As a result, buybacks tend to be viewed as a lever that can increase earnings per share under the right conditions while dividends provide a strong signal about management’s commitment to distribute cash to shareholders and its confidence in the future earnings of the business.

Unfortunately, management’s commitment to dividends can also damage a company’s prospects. Indeed, as I’ve covered before (here) enterprises that are set on returning the majority of earnings to investors via dividends chronically underinvest in growth. As management seeks to protect the dividend at all costs, growth spending takes a back seat.

Dividends are key

Having said all of the above, an overwhelming volume of research shows that dividends are the most significant driver of equity returns over the long-term. This research can’t be ignored.

For example, according to investment bank Société Générale since 1970 US equities with dividends reinvested have produced an annualized real return of 5.2%. However, if dividend payments were spent instead of reinvested over the same period, the average investor’s real return would be 3% per annum. Excluding dividends entirely, equities have produced an annualized real price return of only 2.2% since 1970. The compounding effects of the dividends really do dominate returns in the long run.

sg 1.png

Unfortunately, picking the best income stocks to help you reap the benefits dividend compounding isn’t as easy as it may first appear. Contrary to popular belief, if you want to achieve the best long-term returns from dividend stocks you should be looking for the companies with the lowest dividend yields.

According to SocGen’s research, on average, the spread between the expected dividend yield (the payout analysts expect) of a particular stock, and the realised yield (the payout that investors actually receive) starts to widen above 4%. In other words, if a stock’s expected dividend yield is greater than 4%, the chance of the actual payout being less than the market expects, increases with every 100bps increase in yield, as the chart below illustrates.

sg 2.png

SocGen’s research appears to show that high dividend yields should be avoided. Even index trackers can’t be trusted. Take the FTSE World High Yield index for example. As shown below the index has consistently produced a realised yield below what has been expected. Many of the stocks in the index yield more than 4%.

sg 3

Dividends: Hunt for quality

Unsurprisingly, SocGen’s research on dividends concludes that the companies with the most secure dividends have two key qualities; 1) strong balance sheets; 2) high-quality businesses.

SocGen’s preferred methods of calculating a company’s balance sheet strength and quality, (as a result its dividend sustainability) are the Merton model (balance sheet strength) and Piotroski F-score.

The Merton model looks at the equity of a firm as being a call option on the firm’s assets. SocGen employs the model to determine a company’s ability to service its debt, meet its financial obligations and to gauge the overall possibility of credit default. Companies with the highest Merton model scores have produced the best returns for investors over the long-term with the least volatility.

sg 4

Also, the evidence shows that the shares of companies with higher F-scores have outperformed those of lower quality peers.

sg 5.png

The bottom line

So all in all, the evidence is pretty clear. If you want to achieve the best returns buy quality dividend stocks and don’t chase yield. Chase quality and the returns should follow.

Nine Value Picks For 2016

First published at ValueWalk.com

2015 has been the year of the FANGs, (Facebook, Amazon, Netflix and Google), which collectively are up 86% in 2015. FANG names plus six other high-growth plays added 74 points or 3.6% of S&P 500 returns as investors followed the ‘growth at any price strategy.’

But Fundstrat’s Tom Lee believes that the FANG group will struggle in 2016 as value is set to stage a comeback.

See also: Is Value Set For A Comeback?

FANGs rarely repeat outperformance in the following year

Tom Lee highlights several key points which support his argument that the FANGs will underperform in 2016, and let value lead the market instead.

First off, since 2005 the top 10 winning stocks of one year, always underperformed the following year by an average of 290bp (48% win-ratio). For example, last year, the best-performing stocks of 2014 subsequently turned into the worst drags in 2015.

FANG stocks3 FANGs

Since 2005, the top ten stocks underperformed the S&P 500 by 290bp on average in the following year. Figures show that the odds of FANGs outperforming again is 48%. That means the group as a whole has a 52% chance of underperforming the S&P 500 by 290bps next year. The odds are against further outperformance.

Value is set for a comeback next year

With the figures suggesting that FANGs will underperform next year, Fundstrat’s Tom Lee sees value outperforming for the year. Why? Well, FANG names now trade at an eye-watering average forward P/E of 100 and each FANG name is a member of the Growth Index. These stocks account for 9% of the Growth index, which means that they’ve done much of the heavy lifting for the index during the past twelve months.

If the FANGs underperform next year, the headwind against value should be significantly lessened, which could ultimately translate into improved performance for value stocks. Once again, figures going back to 2005 show that when growth struggles, value usually outperforms.FANG stocks2 FANGs

Stock Strategy: 9 Stocks

With value set for a comeback next year, Fundstrat screened the market for those stocks that are most likely to benefit and chalk up a positive performance. Tom Lee and his team screened the market for the stocks that met the following criteria:

  1. Stock is one of the bottom 25 contributors to S&P 500 point change YTD 2015;
  2. Stock’s dividend yield is greater than its bond yield (hat tip to Benjamin Graham);
  3. Market cap is, at least, $10B; and,
  4. Positive implied upside (based on analyst price targets).

Here are the nine stocks that qualify. At the time of writing the author is long IBM and CVX.

nine stocks

If You’re Looking For Capital Growth, Avoid Dividends

Shareholder distributions, defined as total dividends plus gross share buybacks, amounted to $259.8 billion for S&P 500 companies at the end of the third quarter — the highest quarterly total of shareholder distributions in at least ten years. The second highest total was recorded back in April 2014 when distributions hit $252.2 billion.

For income investors, this is good news. Corporations are now returning a record amount of cash to investors — what’s not to like?

Well, as it turns out there’s a lot not to like, especially for those investors seeking capital growth, as a recent research report from Factset INSIGHT points out.

Dividends are rising

S&P 500 company dividend payments amounted to $103.3 billion in Q3, which was the third largest quarterly total in at least ten years. Dividends make up around 40% of cash distributions to investors. Year-on-year dividend payments to investors are up 10.9%. The total dividend payout for the trailing 12 months ending in Q3 was $410.8 billion, which marked the largest trailing-twelve-month payout in at least ten years.

At the sector level, Financials and Information Technology sectors were the most generous to investors. The Financials sector ended Q3 with dividend payments totaling $17.5 billion on a quarterly basis and $70 billion on a trailing 12-month basis. The Information Technology sector paid out $14.6 billion in quarterly dividends and $60.9 billion in TTM dividends. Tech giants such as Apple and Microsoft, along with banking giant Wells Fargo were responsible for the largest cash payouts to investors.

However, while the dollar value of dividends paid per share hit one of its highest levels in ten years during the third quarter, the year-over-year growth in dividends paid per share was the lowest rate seen since 2011. The S&P 500 TTM dividend per share was $42.46 for the third quarter representing 10.9% growth from the year-ago period, below the average YoY growth rate of 12.1% for the past eight quarters.

That being said, the energy sector saw a near 50% year-on-year decline in Q3 per share dividend payouts, and this decline skews the figures somewhat as the chart below shows.

Performance Spread Between Dividend Payers and Non-Dividend Payers

The most interesting finding of Factset’s study is the diverging performance of dividend payers and non-dividend payers on a total return basis relative to the S&P 500 Total Return Index. Since the end of April 2013, non-dividend payers have drastically outperformed their dividend-paying peers, a trend that’s been in place for the past two decades. Since the end of 1995 dividend paying stocks have achieved an excess weighted cumulative return of -52.8% relative to the benchmark, while non-dividend paying stocks saw a return of 88.3% relative to the benchmark. As shown in the chart below:

This return spread (141.1 percentage points) is the highest recorded since August 1999, when the spread was 149.8 percentage points.

Reinvestors vs. returners

The underperformance of companies that return the majority of their earnings to investors is not a new phenomenon. Indeed, a few months ago the Financial Times took a look at the findings of a white paper from the Credit Suisse Holt group. The white paper looked at the fortunes of “reinvestors” vs. “returners”, companies that returned the majority of their cash to investors vs. those firms that reinvested excess cash into operations.

From the FT:

“Historically, according to the Holt white paper, companies have deployed an average of 60 per cent of their cash flows in capital investment (whether organically or through M&A) and have returned 26 per cent to shareholders (12 per cent dividends and 14 per cent share buybacks). More recently, the capital invested has dropped to 53 per cent while cash returned to shareholders has increased to 36 per cent, with an increasing share going to buybacks.”

“The Holt paper follows the fortunes of “reinvestors” and cash “returners” and finds that the latter increase their sales by only 5 per cent per year over the ensuing five years on average. Reinvestors managed to grow sales at 19 per cent per year. So the critics’ picture of tired ex-growth companies, out of ideas for growth, and deciding to reward their shareholders to the detriment of the chance for economic growth, has at least something to recommend it.”

“Companies are getting less cash than they used to, they are not optimistic that they can invest it productively and so they are choosing to deploy it in a way that weakens the chances of sales growth in the future. Not encouraging.”

So, according to Credit Suisse’s data “reinvestors” have been able to grow sales three times faster than “returner” peers. In other words, if you’re looking for growth avoid “returners”.

It’s Different This Time, Right?

Amid all the research coverage on the state of the high yield market that came out last week, one report from Deutsche Bank, in particular, stood out. The research report has attracted some attention, mainly because it’s predicting that there’s yet more pain ahead for the high yield market:

Late stages of every credit cycle, by definition, are built on a theory as to why this time is different.

This type of attitude was prevalent going into 2015, when credit markets largely dismissed the oil sector distress, choosing to believe that this was an isolated issue and will stay that way. Historical evidence pointed to the contrary, where no earlier precedents existed of the largest sector being in distress and the rest of the market remaining firm. Today, two out of three sectors in US HY have more than 10% of debt trading at distressed levels.

……

From its starting point in energy a year ago, it has now reached other commodity-sensitive areas such as transportation, materials, capital goods, and commercial services. But it did not stop here and is also visible in places like retail, gaming, media, consumer staples, and technology – all areas that were widely expected to be insulated from low oil prices, if not even benefitting form them.

HYbonds.png

“…what percent of names are in deep distress today, defined here somewhat arbitrarily as 2,000bps (dollar prices around 50pts), the answer we get is 7.1%. This level is materially higher that 2% in US HY back in Oct 2011 or 6% in EU HY back in Jan 2012.”

But it’s not all bad news. In fact, for value investors, there could be some opportunities out there:

“Think about the significance of this number. While some names flirt with modest levels of distress from time to time throughout the normal course of events during the expansionary phase of a cycle, many of them stage comebacks and remain current on their debt obligations. In other words, not all distressed names today will default tomorrow. To witness, the total value of unique cusips in our DM HY index that ever touched on 1,000bps since 2009 through 2014 is $600bn. The actual grand total of defaults during this time is $135bn.”

Although, junk-hunters need to be cautious as few names ever come back from the deeply distressed levels:

“For that same timeframe, $130bn of unique bonds touched on a 2,000bp level. It’s also interesting to note that peak in deep-distress ratio in Figure 2 reflects peaks in actual default rates closely (18% deep distress par vs 20% par default rate in 2002 cycle, for example)3 . It appears that few names ever come back from the deeply distressed levels, and their prevalence in today’s environment has to be taken seriously by credit investors. Ex-energy this metric currently stands at 3.1% of index face value.”

For the first time in many years, some sections of the bond market might be beginning to look attractive for value investors.

Lastly, some thoughts on the Third Avenue Focused Credit Fund closure from Driehaus Capital Management.

South Korean Preference Shares: An Opportunity That’s Too Good To Pass Up?

Two weeks ago (published last week) I interviewed Ori Eyal, Founder and Managing Partner of Emerging Value Capital Management for ValueWalk as part of the ValueWalk Value Fund Interview Series. One of the emerging markets that has caught Ori Eyal’s attention is South Korea (along with Israel), specifically, South Korean preference shares.


 

Rupert Hargreaves: Emerging Value Capital Management ’s largest position is a basket of South Korean preferred stocks. Around a fifth of your portfolio is allocated to this asset class, what do you like about South Korean preferred stocks in particular?

Ori Eyal: This is actually my favorite topic. There’s an anomaly in South Korea that I don’t believe exists anywhere else. These shares, we call them preferred, but their correct name is preference shares. These preference shares are almost the same as common shares, but the main difference is that the preference shares don’t have voting rights — somewhat similar to Class A and Class B shares in the US. Now, when you have a company, let’s say Samsung Electronics with these two share classes, you would expect the shares to trade at roughly the same valuation, or maybe a 10% discount due to the different voting rights attached to the stock but what we actually see is a huge a price discount, a discount of maybe 50% to 60% price different. It makes no sense. I’ve looked at all 140 of these preference shares trading in South Korea and carefully selected a basket of 20 shares. I’ve already said that I believe South Korea is one of the best-emerging markets in the world to invest, so having a great market, plus these super cheap securities make it highly compelling. I see a potential upside of 100% on this basket. These aren’t junk stocks either. All the companies are profitable and pay dividends. The only difference between the common and preference shares is that the preference shares don’t have any voting rights, but even if they did, it wouldn’t be much use to you because these companies are all controlled by the owners. It would be irrational to pay a premium to acquire the common shares when you can acquire the preference shares for much less.

RH: I remember this idea was pitched several years ago by Andrew Weiss at the Sohn London Conference. The Weiss Korea Opportunity Fund, which also tracks a basket of South Korean preference shares, is up by 36.1% since inception, 14 May 2013. The discount on the preference shares has narrowed since 2013, but not by much, do you see a catalyst that’ll drive a higher valuation going forward?

OE: Since I first put it together, my basket is up by around 100%, the discount is narrowing in some securities. When I first put the basket together, around three years ago, the discount was around 70% – 80%, now it’s narrowed to around 50%, which is still high, but if you started at 80%, that’s a big difference. There’s a second element that’s going on and that these preference shares, all 140 of them, don’t move together. Some of them, their discounts have narrowed a lot. For example, with Samsung Electronics there’s no longer a big discount. Others, the discount, is still quite wide, you need to do your research and pick and choose the ones that still have a good discount.

I have tremendous respect for Andrew Weiss, we both started investing in South Korean Preference Shares around the same time in 2013 but the Weiss Korea Opportunity Fund started out with too much capital, they got stuck with the relatively less attractive preference shares, while I’ve been able to pick and choose among the smaller but more attractive preference shares.

RH: Are there any restrictions on trading these shares?

OE: No, there are no restrictions but if you want to trade in Korea you have to get something called a Korea Investor ID, it’s just some paperwork. When the Emerging Value Fund first entered the Korean market and applied for the investor ID, the Korean regulators asked me to promise that I was not going to short any individual names, I guess they were worried that if I shorted the market it might cause some problems, but there are no serious restrictions on the long side that I know of.

RH: Do you have any examples of the South Korean shares you currently own?

OE: Of course, one of the names in the basket is Lotte Chilsung Beverage Co Ltd

(KRX:005305). This is a subsidiary of the Lotte Group, and it has a 40% share of the South Korean beverage market, including soft drinks, coffee, tea, energy drinks, beer, whiskey, etc…They also own some other assets, including approximately 30% of Pepsi Cola Philippines and some real estate. They have a real competitive advantage over peers. If this were a US company, you would pay more than 20 times earnings for shares of this kind of company but because it’s South Korea, the company’s shares are quite cheap. The preference shares are trading for under six times EBITDA [Coca-Cola is trading at 20 times EBITDA], the preference shares are trading at a huge 57.5% price discount compared to the respective common shares.

Lotte Chilsung Beverage Co Ltd

Emerging value: The performance of Lotte Chilsung Beverage Co Ltd’s preference shares (blue line) vs. the company’s common stock (red line) since 2009.

Another example from Korea is Amorepacific Corp (KRX:090430); this is South Korea’s leading cosmetics group. They have a 34% market share in multiple leading brands in all cosmetic distribution channels, online, door-to-door and duty-free. They also produce some other household products. The Chinese also love these South Korean cosmetics; this company is on the way to becoming one of the world’s leading cosmetics brands. The preference shares of Amorepacific trade at a 42% price discount to the common shares, so you’re paying around ten times free cash flow — that’s a bargain basement valuation for such a fast growing, wide moat, free cash generating business. I think it’s very attractive.

Amorepacific Corp Emerging Value

Emerging value: The performance of Amorepacific Corp’s preference shares (red line) vs. the company’s common stock (blue line) since 2009.

RH: Are you hedging the FX risk here?

OE: Good question. There are two things you can hedge. You can hedge the Korean market by going short a Korean index ETF, or you can hedge the FX risk. In the global value fund, I chose not to hedge because I believe that both the market and Korean currency are undervalued. I do offer the Korean Preference share strategy for managed account clients, and if they want me to hedge, I will.

Regarding the question on hedging in general: I hedge on a case by case basis. I’ll only hedge if I feel the wider market and currency is expensive. I’ll consider factors such as purchasing power parity, the market’s valuation, price to book, price to earnings, etc…Is the economy growing? It’s on a case by case basis but right now, the majority of our investments are in the US, Canada, Israel and South Korea, and I feel that all of these markets (except possibly the US) are cheap, so I’ve not hedged them.

You can find the rest of the interview at the links below.

Whale CEO Hunt: Malone, Thompson, Musk, Kirk And Breen

First published on ValueWalk.com.

Exemplary business owners or CEO’s are a rare breed, but they do exist and Fundstrat recently set out to find them.

Five CEOs immediately stood out to Fundstrat’s researchers: John Malone, Randal Kirk, Ed Breen, Elon Musk, and Scott L. Thompson. These five have all shown exceptional returns both on a cumulative basis and on a weighted average compound annual growth rate basis.

Of these five, John Malone is the clear outlier. Over a span of 40 years, Malone has achieved a weighted average CAGR of approximately 23% compared to 11% for the S&P 500  through the appropriate use of leverage, buybacks, and artful corporate structuring.

Investors underestimate the importance of a key CEO

Last month, I covered a survey of Berkshire Hathaway’s operating managers from the Stanford School of Business’ Corporate Governance Research Initiative. The survey questioned approximately 80 managers of Berkshire subsidiaries. The managers had an average tenure of 12 years, and because they’d been in the position for so long, always planned for the long-term, which ultimately improved business performance.

Fundstrat’s research points out that since 2004, an average of 53 CEO’s, or 11%, are new to S&P 500 companies each year. As a result, investors have, on average, 50 opportunities every year to identify potential inflection points in a corporation’s fate based on management change.

Between 2004 and 2014 there have been 580 CEO departures from S&P 500 companies. Assuming that each new CEO brings several changes to the business he/she is taking over, it’s easy to see why so many businesses struggle to execute a clear, consistent long-term strategy.

Still, Fundstrat has picked out five “Captain Ahab” CEO’s who have been able to achieve outsized returns over their careers. The report goes on to dissect the factors that helped each investor outperform over their careers.

Following the Malone Returns

John Malone has been able to generate impressive returns consistently for more than four decades, and for this reason, the media mogul gets the bulk of the coverage in the Fundstrat report.

Malone started his career at Bell Labs/AT&T and eventually found himself as one of the company’s largest shareholders. He then went on the helped to build TCI into a cable industry giant eventually selling the business to AT&T for stock during 1999 achieving a total return on investment of 93,200% or 30.3% CAGR. Liberty Media was spun out of AT&T in August 2001 leaving Malone in full charge. In the 14 years since the Liberty Media spin, it’s estimated that Malone’s assets have returned 238% cumulatively and 9.1% CAGR.

Malone Value3

While the majority of Malone’s gains came during the first part of his career, before the creation of Liberty, his pioneering use of spin-offs and tracking stocks to maximise tax efficiency, management incentives and leverage while managing Liberty shouldn’t be overlooked.

There are 19 key corporate events, excluding mergers, which have helped Malone unlock Liberty’s value over the years all of which are shown below. What’s more, Fundstrat has reconstructed Liberty’s stock form a series of assets and tickers into one entity, to show how much value Malone’s corporate tinkering has created since Liberty Media first became independent.
Malone Value1

Malone Value2

Fundstrat points out that there are ten key tenets of “Malonism” that have characterised his value creation over the years. The central pillar of these tenets seems to be “pay as little tax as possible.” As Fundstrat points out, “the art/science of tax minimization exists deep within the Liberty DNA.” The top five commandments of “Malonism” are as follows:

  1. Tax efficiency: Tax department often the largest at Liberty
  2. Capital structure optimization: Uses leverage, particularly on subscription businesses; “Better to pay interest than tax.” Relucant around equity issuance unless accretive deals; Strategic buybacks; No cash dividends
  3. Long-term: Not worried about near-term acquisition impacts and near-term ROI
  4. Scale leverage: Builds and leverages scale for better pricing and strategic equity stakes
  5. Cash flow focused: Pioneered EBITDA measure; focus on free cash flow; EPS irrelevant.

Following Randal Kirk’s returns

Compared to John Malone, Randal Kirk is relatively unknown outside biotech circles. Nevertheless, Kirk’s record of value creation remains highly impressive.

Kirk founded and sold his first medical device company, General Injectibles and Vaccines, after 15 years for $145 million for a total return of 1,449%. In the 17 years that have passed since Kirk sold General Injectables, he has founded or actively invested in several companies that have later been acquired by larger competitors, including Scios (SCIO), New River Pharmaceuticals (NPRH), and Clinical Data (CLDA). Today, Kirk’s holding company, Thrid Security Investments is currently invested in 15 publicly traded equities, the largest of which is Interxon (XON).

Randal Kirk value1

Ed Breen

The third “Captain Ahab” CEO picked out in Fundstrat’s report is Ed Breen, who is currently the lead director on Comcast’s board and CEO of Dupont.

Breen’s career started at General Instruments (GIC), where he spent 21 years rising through the ranks when the company split in three Breen severed as the CEO of the set-top box unit for two years until selling it to Motorola in 1999. While Breen was in charge, GIC’s 474% on a cumulative basis to the close of the sale.

After GIC Breen took over as CEO of Tyco. Through dramatic house cleanings, balance sheet restructurings, divestitures, and spin-offs Breen achieved a 407% return for Tyco’s investors on a cumulative basis during his ten year period as CEO.

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Elon Musk

When it comes to innovation, there are few CEO’s that can stand up to Elon Musk. At the age of 12 Musk began creating value through innovations in technology. He has sold two companies he co-founded — Zip2 and PayPal— and has helped create groundbreaking innovations in the auto, energy/utility, and aerospace industries.

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Because one of Musk’s key ventures, SpaceX is still private, his exact returns are difficult to calculate. Still, the present value of publicly traded Musk ventures shows that Musk has returned 1,424% since inception to date.

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Scott L. Thompson

The last outlier CEO highlighted in Fundstrat’s report is Scott Thompson, who has recently been appointed CEO of Tempur Sealy, through the efforts of activist investor H Partners.

Scott Tompson has a short, but highly impressive record of unlocking value for investors. Tompson helped found Group 1 Automotive, which has since grown into the third-largest dealership group in the US. In 2008, Tompson was appointed as CEO of Dollar Thrifty Group, at the time the stock was trading at around $1. Through efforts including cost cuts, “re-franchising” and “risk fleet” car management, Thompson not only saved the company but also pushed it to industry leading margins. With its eventual sale to Hertz, Dollar Thrifty’s stock rose over 80-fold during Thompson’s tenure.

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