Hacker News Reader

Comment by onlyrealcuzzo | Hacker News Reader

Everything is valued based on growth - because capital gains tax is so much lower than income tax.

Share buybacks make this a lesser issue for megacap stocks with massive profits and margins.

When you're talking about two companies with small profit margins and profits (or negative profits / losses) - if Company A is growing much faster than Company B - the valuation comparison might seem ridiculous.

Here's a spreadsheet that makes it clear why the multiple on growth is so high when you consider tax and inflation: https://docs.google.com/spreadsheets/d/1Q00Y8PEyQaiahEvJN0Aq...

It's obviously a flawed analysis, because stock prices are unpredictable (and, to a lesser extent, future revenues and margins). But it should make it clear why growth has such a high multiple.

View on HN

The capital gains / income tax rates have only a minor impact on the weight of growth in valuation models. One way to see this without getting to technical: there are a number of (very large) institutional investors that pay no tax at all (university endowments, charities, etc). If what you're saying is true, untaxed investors would have radically different allocations than similar taxed investors. That's not the case.

> If what you're saying is true, untaxed investors would have radically different allocations than similar taxed investors. That's not the case.

Except it is the case for endowments and charities. They both have much lower risk tolerance than HNWI (~33% of capital).

The bottom ~50% of capital is in R/E and is mostly about living, and less about taxes.

Dividends and increased share value through buybacks are taxable as capital gains (usually).

Most dividends are ordinary / ordinary income.

> Dividends are the most common type of distribution from a corporation. They're paid out of the earnings and profits of the corporation. Dividends can be classified either as ordinary or qualified. Whereas ordinary dividends are taxable as ordinary income, qualified dividends that meet certain requirements are taxed at lower capital gain rates.

https://www.irs.gov/taxtopics/tc404#:~:text=They're%20paid%2....

When are dividends qualified (capital gains)?

> For a dividend to be qualified, there are certain criteria that must be met, according to the IRS. For stocks, the criteria is: The stock must be held for at least 61 continuous days, unhedged, out of the 121-day period, beginning 60 days before the ex-dividend date.

This covers most passively managed funds (most 401k funds these days), but still eliminates nearly all actively managed funds (the majority of capital invested).

That's the whole point of share buybacks - it's a way to transfer value to shareholders that definitely isn't considered income.

> That's the whole point of share buybacks - it's a way to transfer value to shareholders that isn't considered income.

If the presumption is that share buybacks increase stock prices more than simply in the short term, then, sure, that'll work out in practice. A pitfall to share buybacks is that many executive compensation packages are tied to stock price performance which can be juiced by billions in share buybacks. What we can observe is that short term stock buybacks are pushed in favor of financial resilience, maintenance, and necessary investments that ultimately leads to the company needing few-strings attached government bailouts. One of the most recent examples is the airline industry in the US. I do appreciate the discussion around qualified and unqualified dividends and their relative tax treatments. As a short term shareholder, I'd prefer stock buybacks. As a long-term shareholder, I'd prefer more investment and financial resilience.

> A pitfall to share buybacks is that many executive compensation packages are tied to stock price performance which can be juiced by billions in share buybacks.

You're assuming that shareholders don't want this, too.

There's a reason executive pay is tied to stock price performance - that's all investors care about - because all they want is capital gains.

Friendly reminder that the US government turned a profit from the 2008 bailout. People often hear the word bailout and think it was free money when it actually was a loan.

> That's the whole point of share buybacks - it's a way to transfer value to shareholders that definitely isn't considered income.

I thought the point of buybacks was "This company doesn't have growth ideas--invest elsewhere"

Not unless you think every company that returns money to shareholders is out of ideas - at which point - if you're never going to get money back, why invest in the first place?

> if you're never going to get money back, why invest in the first place?

That's a question for tomorrow's (hopefully larger) bag-holders, not today's.

Believe it or not, the S&P 500 returns something like 90%+ of net income to shareholders.

That’s because net income is after R&D spend etc. is accounted for.

The argument for retaining net income is that you have future capital expenses that you want to save for (like factories or servers), but that’s an increasingly less pressing need for modern companies.

Given the above, companies can choose to return that net income as cash, but then shareholders have to redeploy immediately (and potentially in competitors’ stocks/bonds) OR companies can choose to buy back and burn their own shares, allowing shareholders to defer any decisions and keeping all capital locked up in the company’s stock.

> but that’s an increasingly less pressing need for modern companies.

Maybe in the US and EU.

We exported factories and manufacturing to the developing world, where CapEx is very important.

Considering that China grew at 2x the rate of the US and >3x the rate of the EU - CapEx seems to still be worth considering...

If you have a lot of cash, and ultimately decide you can't deploy it all quickly and efficiently, you can return it to shareholders and avoid losing 9% a year sitting on cash in this inflation environment.

Shareholders will be happy and feel taken care of and are more likely to buy your stock next time you have an offering when you are ready to spend that money

> If you have a lot of cash, and ultimately decide you can't deploy it all quickly and efficiently

Exactly, when you don't know what to do with cash, send it back to the investors in hopes someone else has an idea.

Yeah, just clarifying because what you said was "this company doesn't have growth ideas" which is highly negative, makes it sound like it's a tired dinosaur like AT&T.

It can also just be a prudent decision not to flush money down the toilet on expansions or ideas that aren't investable yet because of a misplaced need to show that that company is not "out of ideas"

Right that’s why companies return money to shareholders. The question is “should we do buybacks or dividends?” and companies are now leaning toward buyback because of the tax advantage.

Why you decide to pay out to shareholders rather than keeping the capital is a complex question with many schools of thought. But once you've decided that you're going to pay out the money, doing it as a buyback rather than a dividend is almost entirely about the tax treatment.

Reply on news.ycombinator.com