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Minyan Mailbag: Is Management a Good Investor?


Bias in management may affect dividends.



Wouldn't you rather see management apply a very strict value standard to any share buybacks? Something along the line of Ben Graham's 30% below book? As a small investor I'll take a dividend over share buybacks any day.

Dear Alex,

As I mentioned before I prefer dividends versus share buybacks. Your question raises a different issue: is management a good investor? More often than not, it isn't. Management has a bias - it is usually in love with its company. They spend an enormous amount of time to increase the company's profitability, to build a stronger franchise. This investment of time creates an attachment to its company leading to a loss of objectivity. The same way a parent loses objectivity of his child's drawing skills - I believe everything my four-year-old son draws is a masterpiece (it really is, LOL) - management believes that its company is extra special, thus usually overestimating its value and overpaying for the stock. In other cases management is aware that its stock is overvalued, but it still overpays for it to make their earnings numbers.

I do favor dividends to share buybacks, the same way I favor Lloyds TSB (LYG) 7.7% dividend to US Bank Corp's (USB) 4% dividend at 3%+ a year share buyback - both banks have the same payout ratio (dividend plus share buyback) of 80%. Ben Graham lived in a different time, though his principles are still alive; 30% below book value means very little in most cases as the concept of book value is becoming more and more distorted (to a lesser degree for banks and insurance companies) by gigantic write offs, spin offs and share buybacks (mixture of cost accounting and market prices, take a look at Colgate's capital structure). Yes, management should only buy back shares when the stock is undervalued. They'll always argue that their stock is
cheap, you should be the judge.



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