“Stealth Dividends”: The only way a company can pay you tax free dividends!
You get “stealth dividends” from a company when it does a share buyback.
Basically a share buyback is an effective way for a company to boost its share price – and your retur ns – without paying an actual dividend which is subject to income tax.
So what is a share buyback you ask?
Well, quite simply a share buyback is when a company buys its own shares on the market.
You see, share prices go up when company earnings go up, that’s why Prof its! is one of my PowA! strategy criteria.
That’s why I call this a “stealth dividend”. It’s a way for companies to return you money without the need for you to pay dividend withholding tax by physically buying back its own shares on the market.
So how does a share buyback work?
A company can buy its own shares on the JSE, just like you would, but with one big difference. The moment the company has bought back its own shares they are eliminated from its share registry.
That means there are fewer shares in issue after the buyback.
Let me show you what I mean. Say a company has 1,000 shares worth R1 each, and R100 in prof its for the year.
This means the company’s ear nings per share would be R100/1,000shares = 10cps.
Now let’s say the company buys back 100 shares of its 1,000. That means it only has 900 shares in issue after the buyback.
Even if this company’s total prof its stay constant for a full year it’s earnings per share would go up.
That’s because there’s only 900 shares in issue now, while profits are still R100. So the earnings per share increases to R100/900shares = 11.11cps.
That means the share buyback increased the earnings per share by 11.11%, without the company having to do a thing! Now imagine the potential of a share buyback when a company actually increases its prof its as well!
Let’s say the company increased its prof its to R150 that year. With 1,000 shares its earnings would be R150/1,000shares = 15cps. Compare that to 16.67cps if the company did a share buyback and left only 900 shares in issue (R150/900shares = 16.67cps).
By now I hope it’s clear to you that there’s a great profit opportunity when a company does a share buyback.
But how can companies actually steal money from you legally?
Rights Offers, the hidden traps that can steal your money!
Sometimes a company needs more cash to expand or simply to keep going... That’s when it tur ns to shareholders in what’s called a share issue or rights offer.
The company says it’ll give you “X” more shares and you only need to pay “Z” per share…
This isn’t necessarily bad. Sometimes companies use this money for good purposes. Take Metmar, one of the shares in our PowA! portfolio, for instance. Metmar is issuing a few hundred million rands worth of shares to a group of investors in return for a new mine. Now that adds value, and in the end will be good for you as a shareholder because it’ll increase earnings more than it’ll dilute share value.
But not all companies’ boards consider the best interest of their shareholders at all times.
Some unethical boards actually use these rights offers and share issues to legally steal your money.
Take Blue Financial Services for instance. The company almost went bankrupt after losing shareholders’ money following the financial crisis in 2008.
To get the company back up and running it issued new shares to investors. But it wasn’t selling these shares to investors like you and I. No. It sold the shares to a turnaround partner at a discount...
Effectively this means that if the company had 1000 shares before this deal it now had, let’s say 1250 shares.
So if you held 100 of the shares you’d have gone from being a 10% shareholder to only holding 8% of the company’s shares. That means 20% of your shares were taken from you, unless you forked out additional cash and followed the rights offer!
And guess what? These deals are usually done in such a way that the turnaround partner gets a massive bonus in the deal as well. Again using money you invested in the company!
That’s why Open Communication is such an important part of my PowA! strategy. I look for the hidden truth behind what a company does and says, to make sure you don’t end up holding a company that ends up stealing your money!
I’ll keep my eyes open for opportunities in the market when companies do share buybacks, but more importantly whenever I pick a share I’ll make sure it doesn’t plan on diluting shareholders’ interests to enrich its directors. That way we’ll be sure to make money instead of lose it…
Make sure you get my weekly e-mail update on the shares in our PowA! portfolio so you don’t miss any news I might have on shares to avoid because of new issues – or shares you need to buy before they pay out a big “stealth dividend”!