Stock Based Compensation, Buybacks & Dividends…S&p 500 Yield Just 1.9%

Here's a comprehensive summary of the provided YouTube video transcript:

Key Concepts

• Shareholder Yield: The total return to shareholders from earnings, encompassing dividends, share buybacks, and reinvested growth.
• Stock-Based Compensation (SBC): Compensation provided to employees in the form of company stock, which can dilute existing shareholders.
• Dilution: The reduction in the ownership percentage of existing shareholders due to the issuance of new shares.
• Share Buybacks (Repurchases): A company's action of buying back its own shares from the open market, intended to reduce the number of outstanding shares and potentially increase earnings per share.
• Non-GAAP Earnings: Earnings calculated using accounting methods that exclude certain expenses, such as stock-based compensation, which can present a more favorable picture of profitability.
• Intrinsic Value: The perceived or calculated value of a company's stock based on its underlying fundamentals, independent of its market price.
• Passive Investing: An investment strategy that aims to track a market index, such as the S&P 500, by holding a diversified portfolio of securities.
• Market Capitalization: The total market value of a company's outstanding shares.

The Tragic Algebra of Shareholder Yield and Stock-Based Compensation

The video argues that the current shareholder yield of the S&P 500, estimated at a mere 1.9%, is insufficient to enable future retirement for investors. This low yield is attributed to several factors, primarily the significant expense of stock-based compensation (SBC) and the inefficiency of share buybacks.

S&P 500 Yield and Historical Returns

• Current S&P 500 Yield: Approximately 1.9%.
• Historical Average Dividend Yield: Historically, stocks have provided around 10% per year. The current dividend yield of 1.14% is one-third of this historical average, suggesting potentially one-third of historical returns based on dividends alone.
• Time to Recoup Investment: At the current S&P 500 yield, it would take an estimated 35 years to get an initial investment back through dividends.

The Impact of Stock-Based Compensation (SBC)

SBC is presented as a significant expense that dilutes shareholder value and can even eliminate profits in some cases. Warren Buffett is cited as having consistently viewed SBC as a compensation expense, not a gift to management.

Example: Amazon

• Net Income (TTM): $76 billion.
• Stock-Based Compensation: While not explicitly quantified in dollars for Amazon in this section, the transcript highlights that Amazon's shares have increased by 176 million over the last 12 months.
• Dilution Management: If the goal is to manage dilution efficiently by buying back shares issued to employees, Amazon would need to spend approximately $41 billion annually just to offset the shares given to employees.
• Cash Flow Impact: Spending $41 billion on buybacks would lead to negative cash flows and consume half of Amazon's net income.
• Impact on Intrinsic Value: Even a 1% annual increase in shares due to SBC can significantly lower the calculated intrinsic value of a stock over time. For Amazon, assuming an 8% annual growth rate and a P/E ratio of 20 in 10 years, a 1% annual share increase reduces the terminal value by 10%, lowering the intrinsic value from $110 to $100.

Example: Nvidia

• Net Income (TTM): $99 billion.
• Accounting-Related SBC: $6 billion. While seemingly small compared to net income, the transcript argues this is still a significant cost.
• Share Repurchases: $51 billion, $40 billion, $12 billion, $11 billion over recent periods.
• Share Count Trend: Despite substantial buyback spending, the number of outstanding shares has actually increased. This indicates that buybacks are not effectively reducing the share count for the benefit of existing shareholders.
• Passive Investor Impact: Nvidia constitutes approximately 7% of the S&P 500, meaning a significant portion of passive investors' retirement funds are allocated to this company, where buybacks are not reducing dilution.
• Cost of Buybacks: Half of net income is spent on buybacks, yet there's no reduction in shares. This suggests buybacks are primarily rewarding management through stock sales rather than benefiting long-term shareholders.

Wall Street's Perspective vs. Reality

The video criticizes Wall Street's optimistic projections and its tendency to overlook the impact of SBC and dilution.

• S&P 500 Earnings Projections: Wall Street analysts project significant growth in S&P 500 earnings, with estimates for 2025 showing a 33% increase from current levels in less than three years.
• Discrepancy in Estimates: A significant discrepancy exists between Wall Street's consensus estimates and actual reported earnings. For 2024, Wall Street estimates were $260, while actual earnings were around $210, representing a 20-25% difference. This gap is substantial and impacts retirement funds.

Buybacks and Dividends: A Closer Look

• Total Buybacks and Dividends (S&P 500): Approximately $1.5 trillion in the latest data, with buybacks around $1 trillion and dividends around $700 billion.
• SBC Growth: Stock-based compensation is growing at an "insane" 10% annually.
• Incentive Structure: The current system creates a perverse incentive where companies increase market capitalization through buybacks, which in turn increases their market cap, leading to more buybacks and higher stock prices, benefiting management who can sell shares. This does not reward true long-term shareholders.
• Net Shareholder Yield Calculation: Of the $1.6 trillion spent on buybacks and dividends for the S&P 500, approximately 25% ($250 billion) is effectively used to compensate for dilution from SBC. This reduces the effective shareholder yield.
• Wasted Buybacks: The speaker estimates that at least another $250 billion of buybacks are "wasted" on companies that may not survive in the long term, further diminishing the shareholder yield.
• Revised Shareholder Yield: After deducting SBC-related buybacks and estimated wasted buybacks, the effective shareholder yield for the S&P 500 shareholder is reduced to approximately 1.9%.

Warren Buffett's Perspective on Buybacks

• Positive Buybacks: Buffett emphasizes that when share counts decrease, shareholders' interest in the business increases, especially when repurchases are made at attractive prices.
• Negative Buybacks: Conversely, when companies overpay for repurchases, continuous shareholders lose, and gains flow only to selling shareholders (management) and investment bankers.
• Berkshire Hathaway: Berkshire Hathaway has stopped doing repurchases, contrasting with the S&P 500's increasing buyback activity as the market rises.

Passive Investing and its Drawbacks

• Inclusion of "Bad" Companies: Passive investors are forced to invest in both good and bad companies within an index. The speaker suggests that up to 50% (and potentially as high as 90%) of current S&P 500 buybacks are a "waste of your pension fund money" because they are spent on companies that may not endure.
• Lack of Control: Passive investors have no say in how their money is spent on these buybacks.

Other Examples and Concerns

• Tesla: The transcript briefly mentions Tesla's dilution, particularly concerning the "trillion Musk package" and potential future dilution from robots. Elon Musk's and his brother's consistent selling of shares is also noted.
• Elon Musk's Business Focus: A quote from Michael Bur is included, suggesting Musk's tendency to shift focus as competition emerges (electric cars, autonomous driving, robots).
• Nvidia Employee Wealth: It's mentioned that roughly 80% of Nvidia employees are now millionaires, highlighting the value created for them through SBC.
• Warren Buffett's Preference: Buffett prefers the 3.7% Treasury yield over the destructive buyback and SBC practices seen in the market.

Conclusion and Future Outlook

The video concludes by reiterating the dire state of the S&P 500's shareholder yield due to the significant impact of stock-based compensation and inefficient buybacks. The speaker hints at future discussions on what could reverse the "passive mania" in the S&P 500 and encourages viewers to check their platform for stock analysis.