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Cash Back

Jonathan Clements

AMAZON.COM is the world’s fourth most valuable company, based on its stock market capitalization. At that size, it isn’t about to get bought by another company. It doesn’t pay a dividend. The last time it repurchased its own shares was seven years ago.

Now, imagine this continued—no buyout, no dividend, no stock buybacks—until the sad day arrives when Amazon goes the way of buggy whip manufacturers. Result: There’s a good chance its shareholders would, over the company’s history, have collectively made no money. Sure, some investors would have bought low and sold high. But in aggregate, investors would have got pretty much zilch.

This is not to pick on Amazon—it gets a bigger slice of my income than any other retailer—but rather to highlight two key points. First, most companies eventually disappear. Second, before that happens, we should want them to return as much cash to shareholders as possible.

In my investing lifetime, I’ve seen countless companies fall from grace. At their peak, corporations like IBM, Wal-Mart, Microsoft and General Electric seemed unstoppable. Yes, they’re still huge companies. But they no longer inspire awe and their brightest days are likely behind them.

This is all too common. It isn’t that companies necessarily grow complacent. Rather, new competitors emerge with cheaper, faster, better ways of doing business—and the old guard is swept away by a “gale of creative destruction,” to use the memorable phrase from economist Joseph Schumpeter.

Consider the 90 years through December 2016. According to a study by Hendrik Bessembinder, a professor at Arizona State University, there were almost 26,000 publicly traded U.S. companies during this stretch. They were listed for an average of just seven and a half years. Some of the companies that disappeared would have been bought out—but many others would have been delisted as they struggled financially on their way to extinction. In fact, only 36 stocks were around for the full 90 years.

To get a sense for corporate America’s constant upheaval, check out the American Business History Center’s ranking of the largest U.S. companies, based on revenues. Hit the replay button at the top of the page and you’ll see how, over an astonishingly short 24 years, General Motors and Ford Motor were toppled from the top of the ranking, while Apple, Berkshire Hathaway and Amazon soared to claim three of the top five spots.

We look around us and imagine that today’s largest corporations will always be with us, but that simply isn’t the case. That brings me to my second key point: We should want companies to return cash to shareholders—and preferably lots of it.

Yes, today, there’s a disdain for dividends, because they’re immediately taxable, though usually at a favorable rate. Yes, there’s widespread sentiment that management should be left to reinvest corporate profits. While this might make sense in a corporation’s fast-growing early days, it’s not desirable over the long haul.

Why not? Take General Motors, which was delisted from the stock market in 2009 after filing for bankruptcy. The share price when it was delisted was 61 cents, down from $93 less than a decade earlier. (Since late 2010, a new GM stock has been trading, but that was the result of a subsequent initial public offering.)

As Bessembinder notes in his paper, GM paid out more than $64 billion in dividends over the decades prior to its bankruptcy, plus it repurchased its shares on multiple occasions. That means that, even though the stock ended up worthless, its shareholders still made money. “GM common stock was one of the most successful stocks in terms of lifetime wealth creation for shareholders in aggregate, despite its ignoble ending,” Bessembinder writes. In fact, over the 90 years that his study covers, GM ranked eighth among all U.S. corporations when it came to creating wealth for investors.

What does all this mean for you and me? The biggest lesson: It’s imperative to diversify. To protect ourselves against the gales of creative destruction, we need to spread our money across a slew of companies, rather than hitching our fortunes to a few companies that may end up in the corporate graveyard.

I would also think twice before reinvesting a corporation’s dividends solely in that company’s stock. I used to be a fan of dividend reinvestment plans, where you can automatically reinvest your dividends in additional company shares. Indeed, that’s how I first got started as an investor. Problem is, if most companies eventually disappear, you really want to take your dividends and spread them across a slew of companies. That way, you won’t be plowing ever more money into a company that—in all likelihood—will one day disappear.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include Crazy Like a FoxGuessing Game and Improving the Odds. Jonathan’s latest books: From Here to Financial Happiness and How to Think About Money.

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gaspr
gaspr
1 year ago

But as Meir Statman has said many times, you can make your own dividend at any time you wish by selling a few shares… It is economically the same. And maybe even more tax efficient.

Jonathan Clements
Jonathan Clements
1 year ago
Reply to  gaspr

That’s absolutely right. But for shareholders collectively, it’s important that companies return cash by paying dividends, or buying back stock, or selling themselves to another firm. If a company doesn’t do any of those three things and eventually goes bust, shareholders will collectively make zero, even if some lucky shareholders managed to buy shares at a low price and sell at a higher one.

gaspr
gaspr
1 year ago

Agreed. At some point in the future, there must be some expectation of profit, and that profit must be paid out, otherwise the agreed share value would be zero.

Jerome
Jerome
1 year ago

‘At their peak, corporations like IBM, Wal-Mart, Microsoft and General Electric seemed unstoppable. Yes, they’re still huge companies. But they no longer inspire awe and their brightest days are likely behind them.’ > not sure that’s the case for Microsoft at all!

Ferdinand2014
Ferdinand2014
1 year ago

Buying and holding an S&P 500 index fund for a lifetime and reinvesting its dividends, you are taking money from dividend paying companies and buying more shares of all companies including those without dividends – like Amazon. Dividends are neither good nor bad. It is simply one way a public company returns value to its shareholders. The other being buybacks or reinvesting in the companies growth.

Rick Connor
Rick Connor
1 year ago

Really excellent article. I also started in DRIP plans, including GE and Merck. Neither inspires awe anymore. Another issue with DRIPS is record keeping. In my TaxAdie work with AARP I’ve run across number of clients who put money into DRIPs decades before they finally sold. We’ve had to be pretty creative to figure out basis on occasion.

miles dudley
miles dudley
1 year ago

Thanks, Jonathan. Michael Batnick put out a note on the same subject where he explores how to escape the losers… interesting subject. I have an approach that includes div growth stocks (etf VIG) and quality stocks with high roic & modest debt (etf QUAL)
along with AMZN, FB, GOOGL, MSFT my pick of the fast growth dominators… Before exploring alternatives, Batnick says the safest way to participate is via index investing.
Buying everything, you get the winners.

macropundit
macropundit
1 year ago

>> “It isn’t that companies necessarily grow complacent. Rather, new competitors emerge with cheaper, faster, better ways of doing business—and the old guard is swept away by a “gale of creative destruction …”

I think this is dubious. The gale of creative destruction that sweeps large companies away is less often competitors doing the same thing faster and cheaper but rather disruption of their business models. That is an entirely different thing.

https://hbr.org/2013/04/three-rules-for-making-a-company-truly-great

>> In my investing lifetime, I’ve seen countless companies fall from grace. At their peak, corporations like IBM, Wal-Mart, Microsoft and General Electric seemed unstoppable. Yes, they’re still huge companies. But they no longer inspire awe and their brightest days are likely behind them.

The conglomerate GE shouldn’t be in the same category as IBM, MS, or even Wal-Mart. No matter what anyone says or thinks, no individual investor should ever have been invested in a conglomerate, which is *by design* impossible to understand. No financial advisor should ever have recommended they do so. The fact is that those who made fortunes in IBM, MS, and Wal-Mart are a great many people, and the fact is their money is still safe today, even if some of them have either not been good investments for twenty years or there was reason to think they shouldn’t be or soon may not be. Individual investors aren’t managing other people’s money. They don’t need to get out of huge winners to find other winners if they’ve got what they need. Their needs change and then they need a large margin of safety. Financial advisors scaring people into believing IBM, MS, or Apple is the next GE flies in the face of reality. The heirs of hundreds of thousands of “lucky” multimillionaires know otherwise.

Bruce Trimble
Bruce Trimble
1 year ago

“We should want companies to return cash to shareholders—and preferably lots of it.”

I think that is a very myopic view. Companies should pay their workers more and hire more
workers rather than exclusively shovel more cash to stockholders.

Sure this will will cause a short term hit to the stock market, but it will make the economy much more stable in the long run. Only enriching stock holders is re-distributing wealth
upwards in dangerous ways. Both the Great Depression and 2008 crisis happened
because wealth was concentrated very narrowly.

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