When a company goes public, offering share participation to potential investors for the first time, the bargain goes like this:

“I, the company, will get your money, dear investor, without recourse. I will never ever give it back to you. Your money will join my enterprise in good times as in bad. When it comes to the worst and my enterprise should prove loss-making, your investment in me will be annihilated.

“But I solemnly promise that all future profits which we hope to make will be for your sake. The shares you acquired will yield all my net income in the form of dividends and further investments into the business, thereby increasing the book value of your investment. I offer you a growing cake, so to speak, which you can eat at the same time.

“We who set up the company would be much better off, admittedly, if we could keep all profits for us while financing our enterprise with debt alone. But sadly, without assets and shareholders willing to risk total loss, not many creditors would be happy to lend.”

It sounds like a fair deal. Should we ever lose interest we could put up our shares for sale to someone else, in the hope of perhaps even bagging a profit. In a world where all major endeavours would be offered on public stock exchanges, we retail investors could in theory participate in the fortunes of worldwide business without putting all our eggs in one company alone. By investing in a widely dispersed mutual fund, for instance, or through exposure to a stock market index when acquiring an Exchange Traded Fund.

This is what big public pension funds do, like the Norwegian Pension Fund Global, which invests Norway’s oil income into publicly quoted companies. Having amassed more than one trillion US dollars worth of shares over the years, it now owns four per cent of all companies on earth. We small investors are a tiny minority.

Sadly only very few companies are willing to go public anymore and many more which did are taken private. The number of public companies has decreased by almost 50 per cent over the last 20 years. Of six million large enterprises in the US, only 4,000 are traded on stock exchanges these days. Regulations for a listing and compliance rules are cumbersome and costly. It is estimated that legal and marketing costs take 14 per cent of the proceeds of an Initial Public Offering.

Quarterly earnings reports as demanded by market authorities are costly and a disincentive to long-term investing. Private Equity Funds, Venture Capital and many wealthy technology behemoths like Google or Alibaba are awash with cash and willing to gamble on promising start-ups on very competitive terms. Middle Eastern oil money and sovereign wealth funds, disappointed with meagre stock and bond market returns, are willing to place billion dollar wagers while we can only watch from the fence.

The larger part of the new economy, companies like Uber, Airbnb, WeWork or Snapchat, for instance, are purely private enterprises, depriving us of the possibility to profit from their eventual financial success. Our own modest investment horizon becomes narrower over the years, stuck with the old and proven.

The stratospheric rise of Apple, Alphabet or Amazon over the last few years is largely due to the fact that they often represented the only opportunity for retail investors like us to invest in enterprises resembling the promise of a future.

We have to pick our way through the ever thinning forest of the few public companies there are and there’s not much we can do about it, so long as we can’t fork out the millions required as a minimum investment in private equity ventures (This must not be confused with buying shares in publicly quoted PE companies, which are for suckers who naively believe to be sitting on a partners’ table).

For us retail investors, good companies to engage with are those which can pay decent dividends

The ‘grand bargain’ between investors and enterprise, as described above, is sadly more theory than practice. The principal of old does not exist anymore. Large corporations are run by managers these days, who are more interested in distributing wealth to themselves, with ever-growing remunerations and self-serving programmes called ‘share incentives’. The salaries of CEOs vastly outperform the successes of the very companies they are entrusted to run. One of the means to do so is share buy-backs: the company buys shares in the market to then cancel them, thereby reducing the count of outstanding shares. At first glance it looks like a fair deal.

Because, mathematically speaking, it should make no difference for a shareholder whether she receives a dividend or a boost to the share price by making shares rarer. If the same cash flow earned is distributed to fewer shares, earnings per share will arithmetically increase, which should boost share prices – perhaps even with a tax advantage, as capital gains are more leniently taxed than dividend income.

Remaining shareholders should rejoice. Sadly though, after perhaps a short period of technical gains, most stock market valuations will go south again, ignoring good maths. There’s seemingly no logic to this. But this is what happens. After a closer look at the underlying business, sentiment will change. Hoped for long-term gains are elusive. What remains is the fact that management will have bought at the peak, when the only action profitable for the company would have been repurchases at rock bottom valuations, with a strategy to reissue shares when markets are up again.

The first to profit from such scheming will be the company’s management, whose ‘performance related’ remuneration will get a jolly push on payment day. We shareholders will rarely fare well. Cash spent on cancelled shares reduce money otherwise available for research, development, employee education and capital investment. Shareholders will  now hold stock promising a reduced cash flow in the future – a sad affair. It will not take long for the markets to take notice.

A company which knows no better than to splash cash on willing share sellers implies it is disheartened to grow the business. In the worrisome absence of profitable capital investment, shareholders would be better served with a special dividend; or a breakup of the business and sale of its units to entrepreneurs who perhaps know better. Just fiddling share prices is pure alchemy. Dangerously more so when share buy-backs are debt-financed. We’d then better vote with our feet.

For us retail investors, good companies to engage with are those which can pay decent dividends. Half of net profits are a good yardstick. In times of dire returns on bonds and term deposits a decent – and reliable – dividend yield may offer a compelling alternative. We should tread carefully though when dividend payments are too high to be sustainable. This is usually another means for management to artificially boost the share price in a self-serving manner while choking the cash flow needed for survival. It may not take long for such companies to run into grave difficulties. Companies which pay decent dividends they can afford are big consumer groups like Nestle or Unilever, for example, or large oil or drug companies.

This does mean though that companies which pay little or no dividends at all are to be shunned. If a corporation decides to forgo profit taking now for the sake of large-scale investments to boost further growth it shows trust in their business model and confidence in their future. A good example is Amazon, which paid out nothing until some proof of financial viability was demanded by markets. The company is churning out profits now practically at will, calibrating for large-scale investment.

The promises of a bright future could easily be from the realm of fairy tales though. It is difficult to tell with certainty, but the car company Tesla seems to offer profits too far away. It is the story of railway companies repeating itself in the 21st century: a good story, a bright future for the business, but a dearth of hard-knocked figure crunching.

For us retail investors the rule should be: do we understand how money will be earned? This still leaves room for devastating failure, but at least we can dare to hope.

Andreas Weitzer is an independent journalist based in Malta. He reports on the economy, politics and finance. The purpose of his column is to broaden readers’ general financial knowledge and it should not be interpreted as presenting investment advice or advice on the buying and selling of financial products.

andreas.weitzer@timesofmalta.com

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