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Comment by don_draper | Hacker News Reader

Another good question: Why are S&P500 stock dividends so low? The average S&P500 stock dividend yield is like 2%. In theory, you buy stocks to receive earnings. But if companies only give out a fraction of those earnings, you as an investor are not really getting much. So how can companies get away with a 2% dividend yield?

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Last year, S&P 500 companies sent 95% of profits back to shareholders, through dividends and buybacks: http://www.bloombergview.com/articles/2015-03-24/private-com....

To oversimplify, companies can distribute earnings as dividends or as capital gains. The US' tax regime strongly rewards the latter. Investors, particularly large investors, have both a) explicitly asked for and b) implicitly expressed their preference (via market mechanisms) for their earnings to be in the form of capital gains.

This is true, though tax reforms have made the distinction less relevant for the average investor (since dividends have been taxed at the capital gains rate for most long-term investments since 2003). Regardless, there is still a benefit to buybacks on the order of a percent or two for large institutional investors as they move in and out of positions, so there is still pressure to distribute profits via stock buybacks as opposed to issuing dividends (see Apple's recent buyback programs as an example).

Dividends are a tax inefficient way to compensate share holders because dividends are taxable. I hope dividends disappear.

Share buybacks increase net asset value without any tax impact.

There might be a downside, but I haven't heard it yet.

Having to pay the bankers 2% for arranging the loans to do the buy back.

As mentioned in Todays Alex

http://www.telegraph.co.uk/finance/alex/?cartoon=11503607&cc...

As the Alex cartoon posted by mauricemir points out, the majority of companies doing stock buybacks are not doing it from profits. They are taking on additional debt through bonds to buy their own stock.

This may look good in the short term, while bond rates are at historic lows, but once they go back to normal levels, the companies will need to sell their own stock to pay the bonds off.

If companies don't want to distribute dividends, the smartest thing for companies to do is invest in additional R&D. This accelerates companies' growth, whereas buybacks just artificially inflate the individual share value.

1. Even Apple borrows money for buybacks rather than spending their giant cash hoard. The reason is taxes. Companies have a lot of cash generated overseas, and if they brought that cash back into the US in order to buy back stock, they would have to pay US corporate income tax on it, at a rate of something like 35%. From that perspective, a 2% fee to the bankers is a steal.

2. As far as I know, most corporate bonds don't have a floating interest rate, so those companies have the option of paying off the bonds at maturity and then just not borrowing more if interest rates have risen. They don't have to continue the buybacks under that scenario, because investors don't expect buybacks to be consistent from year to year -- another advantage over dividends.

3. Pouring money into R&D instead of returning money to shareholders only makes sense if the company can get a better rate of return than shareholders can get somewhere else. For a large, mature company that may well not be true. In that case, they should stick to what they do well, send the profits back to the shareholders, and let them invest it into some growing company which can make better use of the money.

Increases in net asset value are taxed when you realize them by selling the asset, and (to my understanding) at the same rate as qualified dividends. So where is the advantage?

You get to choose when you pay the taxes. All the money you pay in taxes is no longer invested and compounding.

Dividends are not the only way to turn stock into value. Stock is ownership, and many S&P 500 companies e.g. Apple have huge cash holdings in the bank, for example. Your share of one of these companies is a proportionate share of everything they own and everything they are likely to acquire in the years to come.

Warren Buffet avoids companies that pay out dividends. His opinion is that it is better for a company to take excess cash and invest it into itself. If a company pays out a dividend, it means that it would be better for everyone involved if the money was invested in something completely different from that company. This is a sign that either the company is mismanaged, has little room for growth, or is more focused on short term profit than the long term.

It's important to distinguish between the types of investments Buffet makes and those the average investor makes. Buffet buys large shares that either give him a say in how the company runs its business, or sometimes just buys the business outright.

This is important because as a large/sole shareholder you have a huge say in how the company is run. In such a case, money that would otherwise be paid out in dividends can be reinvested in the company in a way which you can influence or control. If merely you buy $1000 of ACME Corp. stock you won't have that kind of influence, so knowing that the company is withholding dividends and reinvesting it is not nearly as sweet of a deal. And if you view the company's reinvestment plan as a net negative for the company and its stock, it would be better to simply have the dividend.

Basically, some investors are mostly interested in using equities as a source of cash flow, and some are mostly interested in using them as a way to grow a pile of money into a bigger pile.

Not true. Berkshire invests in dividend paying companies, and Buffet likes that these companies pay dividends. From Buffet's 2012 letter to investors:

> Most companies pay consistent dividends, generally trying to increase them annually and cutting them very reluctantly. Our “Big Four” portfolio companies follow this sensible and understandable approach and, in certain cases, also repurchase shares quite aggressively. We applaud their actions and hope they continue on their present paths. We like increased dividends, and we love repurchases at appropriate prices.

Berkshire itself doesn't pay dividends, but the reasons are largely technical. First, an investor can just sell shares to get a return on their investment. Second, there are tax benefits to doing it this way.

In general, value investors like Buffet don't like the mentality that companies should always invest in themselves. Instead, they like well-managed companies that specialize in what they do well. Growing beyond this is what they consider a bad sign.

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