To some it seems illogical that simply taking money off of the balance sheet (or using leverage to partially fund a dividend) and returning it to investors would create value. In fact if “all else was equal” this situation would not occur.
In an ideal situation, a high return-on-investment business would have the opportunity to re-invest significant capital at an above average rate of return in its own business. Yet this is not always possible or prudent, particularly in today’s difficult business environment. Good expansion opportunities that provide a solid return can be very hard to come by.
In fact, corporate investment in “growth initiatives” have a very mixed record: For some companies it has led to phenomenal returns, but for many others the cost of the “growth” ends up eating away all of the extra return, leaving investors no better off (or even worse off).
In our present circumstances, the relevant “other factors” are far from equal:
- Significantly higher future tax rates on dividends will reduce the “cash on cash” real return to shareholders. “Pulling this money forward” so that it can be taxed at a lower rate creates value.
- The Government has created an ultra-low interest rate environment where for many companies the cost of borrowings is equal or less than a realistic expectation of future inflation rates.
- Borrowing costs are expensed on the income statement making the real borrowing cost lower than it at first seems.
One other factor to consider:
After having listened to and read a significant number of small-cap company CEO statements and conference calls over the prior three months, my impression is that there was a tremendous desire for November 6th to have lead to a change in the countries leadership. However, this did not happen, and the reality is that political factors do influence how a business chooses to redeploy its capital.
It is possible that a different November 6th outcome would have led to a boom in productive business investment rather than an increase in special dividends, but it is impossible to know with certainty. Click here to return to the main article