Should there be a relationship between the value of a company and its dividend distribution policy? A practical illustration may guide our thinking. Say you purchased an apartment building early in the year and profited $100,000. The market value of your apartment building is independent whether you chose to take the $100,000 from your checking account or not (and the IRS will take its share of your taxable income regardless of your decision). Similarly, how management allocates profit should be of little importance to the overall value of the company.
That is rarely the case though. Capital markets often infer, suspect and view a dividend distribution policy as either euphoric or clandestine market signals; here are the three common ones:
But a change in the dividend policy does not necessarily signal anything. Let us observe the valuation of New York Community Bank (NYCB), a commercial bank. The bank profited an average of 88 cents per share and paid out a dollar of dividends per share over the last ten years. In 2015, management reported a loss of 11 cents per share and in the following year, it had lowered the dividend payout to 67 cents a share. In 2016, NYCB attempted to purchase Astoria Financial and closed its year-end books with earnings slightly higher than the ten-year average earnings. In short, the reduction in dividend policy had little effect on management’s appetite for growth in was not indicative of future earnings (as evidenced by the 2016 results.)
Capital markets devalued NYCB as a result of the 33% reduction in dividend policy. If you look at the 10-year average column in the table above, you may deduce that over 100% dividend payout policy was unsustainable (compare that to the average distribution policy of about 40% for companies in the S&P 500). It should also be obvious to you that an increase in the dividend payout policy, say, to $2 a share, would be artificial and adversely affect the value of NYCB in the longer run. Just as one is not wealthy because one is driving a luxury sports car, how much dividends a company pays each year does not make its owners rich or not. In the particular case of NYCB, the change in dividend distribution was an unimportant, distracting data point.
Nonetheless, capital markets thought the data point was of great importance. So, at a common stock price of about $12, I added a few shares of NYCB to my well-these-are-better-than-holding-cash portfolio of stocks. Over the past decade investors were happy to trade shares of NYCB at an average earnings multiple of 18 to 13 times. At greedy times, the earnings multiple was as high as 22 times and in fearful times the multiple was as low as 7 times. While I am uncertain whether the common stock price will return to a valuation of $15 to $17 per common share in a year or two, I also didn’t mind the wait since I purchased the shares at a discount to book value alongside an expected 5% in dividend yield.
While I felt it is reasonable to hold a position in NCYB for 2-3 years, I have no interest in becoming a long-term shareholder. First, NYCB’s management had inflated its “currency” and mercilessly diluted shareholders. In 2007, the company had about 310 million shares outstanding. As of the second quarter of this year, there are about 489 million shares outstanding. Second, management had issued preferred shares this year, which resulted in less earnings available to the common shareholder. From my perspective, this is an unfavorable trend and an illaudable behavior by management.
Over the next few months, I will write on NYCB’s income statement, balance sheet, management and corporate governance. If you would like to know when I post articles, just click on the orange “follow” button at the top of this page. I hope you will join the conversation.
In the meantime, there are articles on NYCB in Seeking Alpha I thought may be of interest to you. Stephen Rosenman had bought a few shares in NYCB for different reasons than mine. In “New York Community Bank Needs A New Plan,” he wonderfully comments on the business strategy. Yet Herman Tai thinks differently. In “New York Community Bank: Decreasing Shareholder Value Day After Day,” he laments on management capabilities and on the future of the bank. Finally, in “New York Community Bank: The Sky Isn’t Falling,” author Ian Bezek comments on the Astoria Financial merger attempt and provides us with meticulous research and analysis on the operating financials.