Meb Faber Waves Red Flag On Dividend ETFs

September 29, 2014 What’s the story with buybacks in the U.S.? I read recently that they are at record levels this year. Does it make sense for companies to be buying so much of their own shares if their prices are overvalued?

Faber: On aggregate, no. And on aggregate, CEOs are terrible at timing buybacks. Buybacks largely are cyclical and follow the stock market. If you look at how companies use cash, the two most volatile are M&A and buybacks. Typically they tend to move together. M&A hasn’t really been that cyclical yet, but it’s starting to catch up, but not at levels that you saw in 2007 and the 1990s.

When times are good, and they have cash sitting around, is when they typically do buybacks and acquisitions. It’s the exact opposite of when they should be doing it, which is when the market’s down 50 percent and in general their equities are cheap—like in ’08 and ’09. But if you look back, there were no companies doing buybacks. They were actually issuing shares.

However, that should never really matter to the individual stock picker. You need to pick the companies that are cheap that are buying back their stock, because dividends and buybacks are the exact same thing if the stock’s trading at intrinsic value. If it’s below intrinsic value, it’s a transfer of wealth from the seller to the buyer. You're buying a dollar for 80 cents, 60 cents, whatever.

You have to have a valuation-screening criteria to buy cheap companies buying back their stock. The last thing you want is expensive companies buying their stock. This is one of the biggest problems with dividends right now. You recently tweeted that dividend ETFs have lower dividend yields than the broad market. Are dividend-yield ETFs overpriced or what?

Faber: This is the problem: As billions of dollars have rushed into dividends in the search for yield over the past decade, it has changed the asset class. If enough money goes into something, it can change the characteristics of a factor. Factors aren’t static.

With dividend factors, for example, when you buy dividends, historically, you're buying value. And dividend stocks historically have traded at 20 percent discount to the broad market. That's why they work, they're cheap.

Typically, they're not great companies, they're overleveraged, have a lot of debt and in many cases are not doing that great. Again, you have to have a valuation filter. Back in ’99, dividends were a fat pitch. They were at the biggest discount to the market they've ever been, but no one wanted dividends in ’99. People were talking tech, dot-com, biotech.

Fast-forward to ’08, as interest rates have come down, and no one wants bonds, investors went searching for yields into dividends. Dividends have done great. In ’08 they got hit, but for the first time ever, they're trading at a valuation premium to the S&P 500.

Dividends not only are not at a 20 percent discount, they're more expensive than the S&P 500. That’s the last place you want to be—buying these companies that have high leverage that are more expensive than the S&P. That’s the reason dividends, and dividend funds, have underperformed so much, unless they have a valuation framework.


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