Saturday, January 4, 2014

Rights, warrants, buybacks, dividends 101

Seriously, what does one expect from stocks investments? Capital appreciation, dividends, excitement - win or lose, learning experience?

Investment is a serious game. Unless, you are into it as a replacement for your weekly casino frequency, one should study the behaviour of the management, owner, company besides their financials which is equally important.

In studying the company's management, one should look at the behavioral trend of the company with their financials, which is why how these companies do their capital repayment, dividends, rights, warrants are important.

Think of companies as like running a family's expenses - whenever you need money, you borrow or ask from other members of family maybe in the form of capital investment. If you have more than enough, you will give more to your siblings, parents. You do not take in more debt if you do not need them. You do not mislead your family members that you need more money when you do not need them in order for you to buy a bigger car or a bigger house.

Similarly, rights, warrants, dividends and even buybacks are the same conceptually.

Dividends - Dividends are important when the company feels that it has more than enough money to be used for a period say more than a year and it is willing to share with you, the shareholders the extras beyond its need for operations. If it does not have enough or feel that it needs to use the money for further expansion or in anticipation of future needs, it should not be ditching out more than it should. If you follow my blog, I am wary of companies that issues dividends and yet over the short term, requesting for more money through rights.

Of course dividend is important to most shareholders, as this is a gesture that the company is showing to its shareholders that it is willing to share its extra cashflows - which is why sometimes, dividend policy is useful.

Equally useful to the shareholders is share buybacks. The flipside of buybacks is only that when the management or controlling shareholder uses it for their advantage. It is when they uses the company's financial resources to buy the shares from the market but at the same time, selling their own shares. Buybacks are good when it is used as a tool to provide support for its share price especially during high volatility and even more so, when the prices of the shares are undervalued. One should not underestimate the confidence that the management can create towards its share price especially during high volatility by doing buybacks.

On the other side to sharing their additional funds through dividends or capital repayment, is rights issue. Rights issue is when the company is asking you for more money due to their needs. As a shareholder, we always entrust the controlling shareholders to manage the money carefully - which is why one would probably wonder why I am writing an article on a company which I do not intend to invest in anyway - on its rights issuance.

In my mind, that company does not need the fund - it uses it for its controlling shareholders benefits - which you, as shareholder or potential shareholder have to be careful of. You do not give money to one who will probably misuse your money. Worse still in that case, it is not beneficial to the shareholder to not pick up the rights and it is not beneficial either to pick up the rights as the money may not be used in the right manner. The shareholders of Bright are caught in between a rock and a hard place.

Almost all companies need to reinvest or do investment. Anyone who underinvest, may lose out in the future as competition will always take opportunity on any conservative companies that do not take the more aggressive or continuous investment approach. in this case, rights are not always wrong. On that note, quite a lot of companies - Gamuda, IJM, WCT etc.- that do rights in their early days would go on to be successful as they have acted upon the rights correctly and carefully and by sharing that piece of investment needs with their shareholders. We as shareholders, can only hope their decisions are the right one.

What about warrants? Warrant is an option to pick up more shares of the company in the future. As for the company, it is a way for the company to raise more funds in the future. Warrants should not be used as a tool for the controlling holders to cash out, as that action is almost like misleading the investors - many of whom may be ignorant. Worse still if one is to buy the warrants from the market, and they end up out of the money. The warrants are worthless.

And even if it is in the money, one should think twice of exercising the warrant as putting more money into the management that you do not trust, is something which you should not do.

12 comments:

Unknown said...

Very simple and yet powerful concept for investors.

Unknown said...

Hi Felicity,

I have been following your blog for some time and I find posts like these very useful and insightful, especially for people like me that are still new to this investing/shares world.

I do have a question about frequent share buybacks from a certain company. Should I be careful of such practice?

Also, does resignation of auditors means a company is most likely going south?

Thank you.

felicity said...

Share buybacks very hard to say.There are companies in US which declares that they are going to spend xx amount on buyback and declared that upfront. What they do is that they consistently buyback almost on daily basis. That I think will work if the major shareholder do not hold a controlling stake.

In Malaysia, as most companies have a controlling, it may be different but generally if the price of the share is fair or undervalued and the company has more than enough funds, buyback is even preferred by me. In US, buybacks works positively tax wise but Malaysia, there is less of that impact.

On resignation of auditors, ya - one should do more checking if any auditor resigns.

Unknown said...

Thanks for your insight :)

Betronist said...

Great 101 article! Brilliant as always.

I am very fond of share buy back. Firstly, not many companies in Malaysia are actually serious on buying back own shares. Few examples I can find now are Parkson (genuine buyback project) and YTLP (the intention is unknown, hopefully genuine), where both are buying back million after million worth of shares. Hap Seng and Sports Toto are occasional serious buybackers too.

Secondly, depending on your own judgement, sometimes share buy back can be viewed as "tips" given by the management. Nobody knows the company better than the management, and hence, the buyback price is a great indicator, especially if you are value investor and not fearing for further downfall (share prices can still go down during buybacks, see Parkson).

Lastly, of course, the ultimate benefit of share buyback is none other than enlarging your shareholding in a company, leading to a bigger portion of profit sharing.

Share buy backs -- surf that page in Bursa's webstie occasionally and you might find some gems.

felicity said...

Quite true Fung.

AdCool said...

With solely shares buy back and retain as Treasury Shares without any cancellation, wouldn't that mean nothing to the shareholders?

In order to enlarge your shareholding in the company, would it be necessary to cancel those treasury shares in holding?

Betronist said...

AdCool,

Nope, the enlarging effect is created during the buybacks. Treasury shares don't get dividends, that should explain all.

Cancellation of treasury shares is just a formality which ensures that the treasury shares cannot be resold in the open market.

felicity said...

Fung is right. While I have written about buybacks should be written off, on some cases - if the company does not want to do it and they want the flexibility of selling back to the market, they should do so.

Sometimes, buyback is a way to stabilize the share price.

Betronist said...

Felicity, actually I think it is quite "unethical" to stabilize the share price using buybacks. Logically speaking, buyback (where ultimate purpose is to enlarge shareholding) should be done at the lowest possible price, so that the shareholders can enjoy the enlarging effect at lowest cost. Purposely buying back at higher price (hence, stabilizing the price) is wrong, from business perspective.

Just my opinion.

felicity said...

Never right to buy high and sell low. I meant buy low and sell at higher price. In any case should not be promoted

AdCool said...

Fung, thanks for the info. I have been in the thought that treasury shares must be cancelled off before it enlarges the shareholding.