Sorry for the unannounced disappearance, but a week ago Monday I contracted the mother of all flu bugs, which morphed into the mother of all head colds, which morphed into the mother of all killer sinus infections. I haven't had anything remotely like this since I quit smoking back in 1998.
Anyway...
In my absence Richard "Our Dickie" Murphy was alerted by one of his dim-bulb readers that I, Kenton E. Kelly, CPA, was a complete fraud, and that my sophisticated yet soothingly syncopated moniker was not my real name but yet another devious nom de guerre utilized by the anonymous yet offensive fellow blogging as Dennis the Peasant. As usual, neither Dickie nor his readers can handle a fact without mangling it. As you can imagine, Our Dickie was not amused in the least by my commenting under my real name... It seems that in his world, I'm bringing my profession into disrepute by leaving straightforward, nonabusive questions and comments under my own Christian name at other people's (i.e., his) web sites.
The man is dumber than a box of dead crabs.
In any event, Murphy never did get around to actually providing documentation supporting his contention the entirety of 4 years worth of profits earned by the S&P 500 "weren't real", although he did address a meandering and for the most part off-topic post to yours truly entitled "What is profit?". Evidently that was supposed to tide me over. It didn't.
What is of interest to me in this whole episode - beyond confirming that in any battle of wits Richard Murphy will enter the fray virtually unarmed - is just how bad the journalism was in the original New York Times article that Our Dickie quoted. Here's the link to said article.
The first thing I would ask you to note would be the title of the article:
Easy Loans Financed Dividends
That's a pretty straightforward, declarative statement, right? You'd assume - or at least I'd assume - that if some reporter from the New York Times was writing an article with such a title, there would be some evidence of businesses actually borrowing money to pay dividends, right?
Wrong.
Look at this statement from the article:
From the fourth quarter of 2004 through the third quarter of 2008, the companies in the S.&P. 500 - generally the largest companies in the country - reported net earnings of $2.4 trillion. They paid $900 billion in dividends, but they also repurchased $1.7 trillion in shares.
Notice anything? Like the rather minor fact that if you subtract $900 billion in dividends from $2.4 trillion in net profits you end up with a residual net profit of $1.5 trillion? Based on the numbers supplied, it would seem there would be no need to borrow money to pay dividends, right?
Wrong again.
It least you're wrong if you buy into the argument of New York Times journalist Floyd Norris. According to Mr. Norris (and absolutely nobody else), open market share repurchases by companies are a form of shareholder dividend. Why?
Who knows.
When one gets over the hurdle of accepting Norris' rather novel construct, one can then subtract the $1.7 trillion in share repurchases from the residual $1.5 in net profits and voila! - Wall Street has financed dividend payments to customers by borrowing cheap money printed by The Bush Administration. (The bastards.) However, it should be noted that there's a tiny problem with Mr. Norris' analysis, such that it is.
It's wrong.
And meaningless. Other than that, though, it seems to reach the level of journalistic competence one associates with the New York Times. The first problem I noticed is obvious: Mr. Norris has assumed that the S&P 500 companies repurchasing shares did so with borrowed money. Why?
Who knows.
Norris provides no statistics regarding cash positions or debt levels from either the fourth quarter of 2004 or the third quarter of 2008 to support his contention. Evidently it never occurred to Norris that companies could have had on hand (or generated) the $200 billion in cash that was in excess of anticipated needs. In his primitive world, net profits and cash flow move in lockstep (which they most certainly don't in the real world).
Had Mr. Norris a bit of learning, he'd know that when a company finds itself with a pile of cash on hand that exceeds the company's operational needs, the company has a number of perfectly valid options for using that excess cash. Several of those options are as follows:
Obviously, the decision amongst options is dictated by the individual company's circumstance. And once again, had Mr. Norris a bit of learning, he'd know that when a company repurchases shares on the open market, it can have several reasons for doing so. First, and most obvious, is to attempt to boost share price by reducing the number of shares available. However, there is a second, and we'll mention it here because it demonstrates just how far off base Mr. Norris could be...
Let's say Peasant Enterprises is an S&P 500 company selling chrome balls and plastic pink flamingos in the lawn ornament industry. Peasant Enterprises has 100,000 shares of common outstanding, which is presently selling for $50/share. The common has a yearly dividend of $5/share, and therefore yields 10%. This means Peasant Enterprises pays out $500,000/year in cash as dividends.
Now let's assume that the President of Peasant Enterprises, Mr. Dennis T. Peasant, is a greedy capitalist bastard who votes Republican and drives an SUV. He'd rather pay himself a larger salary for his hard work in looting and pillaging than pay shareholders $500,000 per year so they can retire in poverty at age 65. So what does Mr. Peasant do? If he lowers the dividend, chances are the stock price takes a dive, which will in all probability will get shareholders and analysts all cranky. No, that won't do at all...
Well, how about this: Mr. Peasant goes to the bank and borrows $200,000 @ 6.5%. He has just incurred an annual interest expense of $13,000. However, if he repurchases $200,000 of Peasant Enterprises common stock, he will save himself $20,000 in dividend payments (4,000 shares x $5/share) per year. And if Peasant Enterprises' marginal tax rate is 30%, the company will save itself $3,900 in taxes. All told, borrowing the $200,000 could increase Peasant Enterprises' cash flow to the tune of $10,900 per year ($20,000 - ($13,0000-($13,000 x .3))).
So you see, you could actually increase your company's cash flow while at the same time lowering net profit and increasing debt. Is it the wrong or right thing to do? That's entirely dependent on the facts and circumstances surrounding that particular company. Which is why Mr. Floyd Norris of the New York Times is so completely off base in his assertion. Then again, it seems clear from the tone of his article that he isn't so much interested in providing fact-based analysis as he is providing his readers a quick and easy villain to a economic situation that is well beyond their (and his) comprehension. For Norris, it's less taxing and more rewarding to nudge his readers and remind them that it's all about Greedy Capitalists. That, of course, is what attracted Richard Murphy's attention in the first place.
And here we see the difference between a CPA, a trained and certified professional, and a journalist that potentially isn't trained in what he is reporting on. I have taken the CPA exam(2 1/2 days of fun) and it ain't easy, but Joe the Plumber can be a journalist. I can't, however, figure out the Richard Murphy excuse for sloppiness.
Posted by: jcw | January 21, 2009 at 09:37 AM
It's worth noting that in Ohio you have to have five years' field experience, no felony convictions and pass a two part test to become a plumber. To become a journalist you need only be hired as such.
Posted by: Dennis The Peasant | January 21, 2009 at 10:30 AM
I am new to this board, but both dividends and stock repurchases can be financed out of current or retained earnings. To judge where the funds came from, you need to know the retained earnings at the beginning of the period. I believe corporate law will not allow you to create a negative equity position through either dividends or repurchases.
The problem here is going to be whether the assets were knowingly overstated such that the retained earnings on the balance sheet were overstated.
Posted by: SES | January 21, 2009 at 11:36 AM
Like the workthroughs Dennis. No coincidence that zealots and fools like Murphy never use them, and only rely on bombast.
Isn't it the case that the company in your example has replaced an expensive source of capital (the shares) with a a cheaper form of capital (the loan). On that basis it makes sense.
But enough of economics, how about a return to Pandaland ?
Posted by: Simon | January 21, 2009 at 05:24 PM