PPHB (8273) - Musing on Dividends: A Case Study of PPHB
Introduction
A dividend is a cash distribution of a
portion of a company’s earnings to its common shareholders.
Most investors simply love dividends.
Dividend yield, which is calculated by dividing the cash value of dividend per
share by its stock price per share in a given year, is set as a key criterion
in their stock search. Companies that do not pay-out any dividend are filtered.
We are quizzed by investors for picking non-dividend
stocks.
In response to that, this letter is
intended to share our take on dividends, which is essentially business-like and
based on Buffett’s philosophy on capital allocation.
Buffett
on capital allocation
In business, Buffett notes that a company
can allocate its profit (capital) for 4 things:
1.Reinvest in the company (i.e.
for organic growth)
2. Acquire other companies3. Repurchase shares
4. Pay dividends
Buffett explains these options of capital
allocation in Berkshire Hathaway Annual Letter 2012:
PPHB
as a case study
As noted above, the 4 options of capital
allocation are lined up sequentially: start from reinvestment and end with
dividend payout. Each option presents opportunity costs for not selecting the
other 3 counterparts.
Dividends are plausible when its preceding
options fail the Buffett’s $1 test. Therefore, as recommended by Buffett, the
test on dividends is ‘can a company create more than $1 of value with the $1
earnings it retains?’ in maximizing shareholders’ value.
In our earliest publication of PPHB (see here), we noted that PPHB did not:
- Pay any dividends
- Repurchase its own shares
- Make any significant acquisition (New Merit Development Sdn Bhd was acquired for a negligible amount of RM2 in 2012).
Result
of organic growth
PPHB invested in measures which have proved
effective in enhancing efficiency, productivity, and profitability (see the
recap below).
Shared value with common shareholders
The growth record is commendable, but a
management does not necessarily share the same interest of common shareholders.
The management can maximize their own per share value (at the expense of common
shareholders’ value) by issuing new shares (i.e. ESOS at lower entry costs)
and/or pay Directors lucratively.
Throughout our study period (FY11-FY16), PPHB’s
total outstanding shares remain unchanged at 109.896m units. No new share was
issued.
Based on previous annual reports, PPHB’s
management consistently drew approximately 10% of gross profit to pay Directors
(see the Table below).
(RM'000)
|
FY16
|
FY15
|
FY14
|
FY13
|
FY12
|
FY11
|
Gross profit
(a)
|
51,630
|
47,286
|
42,371
|
37,744
|
36,432
|
33,801
|
Directors' remuneration
(b)
|
N/A
|
4,977
|
4,305
|
3,778
|
3,930
|
3,044
|
(a) / (b)
|
N/A
|
10.5%
|
10.2%
|
10.0%
|
10.8%
|
9.0%
|
Note: Annual Report 2016 will be released in the end of April 2017
Passed
the Buffet’s $1 test
As depicted earlier, PPHB recorded
increasing ROICs. It is an effective compounding machine, and consistently surpassed its
Weighted Average Cost of Capital (WACC).
One can view that WACC as an opportunity
cost for forgoing other capital allocation options and a required rate of
return.
The decision to reinvest the entire
retained earnings was proved plausible: every RM1 reinvestment generated RM2.07
additional value for PPHB shareholders.
Most important of all, the total added value
was realized in the form of Free Cash Flow.
Conclusions
Since investing is more intelligent when it
is most businesslike, it is necessary for investors to understand decisions with
regard to capital allocation made by the management.
Every choice comes with opportunity costs.
Dividends are most desired when the return
(value) of other preceding options to shareholders is lower than the required
rate of return. That said, as suggested by Buffett, dividends should be the last
choice in the list.
Since dividend is a cash distribution, cash
is extracted from a company’s net worth. It effectively reduces the value of that
company on per share basis, and is reflected on its stock price after the
payout day.
“The
total amount paid out in dividends is roughly equal to the amount lost in
trading and investment advice, so net dividends to shareholders are zero. This
is a very peculiar way to run a republic.”
~Charlie
Munger~
You should not worry how Mr Market looks at non-dividend paying
stocks.
Value investors should devote their attention at all times to the detection of intrinsic
value which is substantially higher than stock prices.
Continuous undervaluation
gives us more time to acquire the more undervalued stocks, which can only be
acquired by patience. During any acquisition period, our desired situation is
to have the stocks do nothing or decline rather than advance.
PPHB (8273) - Musing on Dividends: A Case Study of PPHB
http://valueveins.blogspot.my/2017/04/musing-on-dividends-case-study-of-pphb.html
