TL;DR You don’t want your company to pay a dividend.
Dr. Henry Singleton was the CEO of Teledyne from 1960-1986. During his tenure, he was known for his excellent capital allocation. By avoiding the common misconception that dividends were good, he was able to make strategic share repurchases **AND** dilutions to acquire companies. As a result, Teledyne achieved a 17.9% CAGR over 25 years, slightly outperforming the 8% CAGR achieved by the S&P500.
If you had invested $1, you would have received 61x your invested capital vs 6.7x for the S&P 500, simply for understanding why dividends are terrible.
To begin, let’s understand what a dividend is. A dividend is a distribution of corporate earnings to shareholders. Great. But what does this really mean? To answer that, we need to understand an income statement and statement of cash flows.
When a business generates a profit, it is generally required to pay taxes on such profit (assuming no tax credits). This is reported as “Net Income” on the income statement. Then, this taxed profit moves on to the statement of cash flows. In “Cash from Financing”, we can see that there are two line items:
“Common Dividends Paid” and “Repurchase of Common Stock”
As we can see, these two line items are treated exactly the same. There is absolutely no preferential treatment for either item. As such, from a financial statement standpoint, these items are identical. However, you as an investor actually suffer from something else: qualified dividend tax.
Nonqualified dividends are taxed as ordinary income, the same as employee income. Qualified dividends are taxed at 0%, 15%, or 20%, depending on your taxable income. So essentially, you are taxed twice as an investor.
Well what about capital gains? As it turns out, LTCG are taxed **exactly the same**. So what then, is the difference between a qualified dividend and LTCG? A dividend is a **forced taxable sale event**. Receiving a dividend and selling a stock with no dividend is **EXACTLY THE SAME.** By holding a stock with no dividend, you are given favorable tax treatment as you can decide when you want to be taxed.
From a management standpoint, dividends defeat the entire purpose of investing in a company. When you invest in a company, you assume that the company will use your money to generate a greater return than you can. Why then, would you want this management team to simply return your own money back to you?
Now that we’ve covered how terrible dividends are, how did Singleton use this basic financial knowledge to outperform the SP500? First, he focused on making sure Teledyne was as efficient as possible. By retaining company profits and not constantly distributing profits (and thereby weakening the business), he was able to make strategic acquisitions. When Teledyne stock was overvalued (with a P/E in the 50s), Singleton was brilliant and **DILUTED** shareholders with by acquiring businesses with overvalued shares. He also **avoided dividends** as he wanted to avoid the double taxation for investors.
When the 1970s bear market hit, many companies suffered due to being overleveraged and constantly paying out dividends in past years. Teledyne was in no such position.
When their stock crashed in tandem in the market, they recognized that their stock was trading at a ridiculous discount to its intrinsic value. They took their war chest and invested $2.5 billion to repurchase **90%** of their stock. As a result, their EPS grew by **40x**. During his tenure as CEO, Singleton made sure to allocate every dollar generated to its maximum potential. As such, Teledyne crushed the S&P500 and made investors incredibly happy.
