“I am a small-cap investor. The stock market for large companies is fairly efficient since the large companies are well known and well analysed by analysts, and there’s no big money to be made there, so I hunt for the small companies”.
Have you ever met investors who have told you that?
On 2nd February 2024, this same investor (let’s call him Dave) texted me to tell me about Meta’s 20% jump in share price, leading to a surge of around $200 billion in market capitalisation, the largest in stock market history.
And that he regretted missing this Meta boat, where Meta’s share price had become a five-bagger in just slightly more than a year, since November 2022 (with share price of $90 then, versus share price of $470 in early February 2024).
So much for the so-called ‘market efficiency’ among the large-caps…
We at MoneyWiseSmart don’t (and don’t proclaim to) know why Mr. Market does what he does. We are just happy that once in a while, he throws up good opportunities for us to compound our wealth, for example with us buying Meta’s shares at around $160 in September 2022 which we have been holding since (on top of selling lots of put options at good prices, generating us good cash flows).
So for Dave, after pondering about how many multibaggers he has actually “made” from his small-caps throughout his investing journey, he now wants to jump back on this Meta ship. However, he wonders if the share price is still attractive after the jump, and he is also perplexed at Meta’s decision to start giving out dividends, and unclear whether that’s a good or bad move for shareholders.
Those are good questions, and let’s try to debunk these (together with other important things to take note of for Meta) in this article…
Meta’s “Good” Growth
For Meta, year 2023 has been a year of “efficiency”, where it optimised its operations and cost structure to become leaner, and execute things better and faster, amidst its recovering growth.
These had led to its revenue, (adjusted) operating income, and (adjusted) net income growing by 16%, 50% and 56% respectively in 2023. (Note: The operating income and net income figures here and below are adjusted for the non-recurring restructuring charges incurred in 2022 ($4.6 billion) and 2023 ($3.5 billion).)
Over the longer term, from 2016 to 2023, the compounded annual growth rate (CAGR) for its revenue, operating income and net income has been impressive, at 25%, 22% and 22% respectively.
Many investors tend to focus only on growth metrics, and forget that there are two types of growth – good growth and bad growth.
For Meta’s case, what makes it a solid company is not that it has been growing fast, but that those growth are actually good growth which is value-accretive to shareholders.
Where, from 2016 to 2023, to drive a growth in operating income of $38 billion, Meta needed only to spend an additional capital employed of $135 billion (excluding goodwill amount, which only increased minorly).
That means that the 22% CAGR in operating income had been achieved with an incremental return on capital employed (ROCE) of a high 28% (= $38 billion / $135 billion).
Because of the high ROCE for Meta, it has been able to grow its revenue and profits well, and at the same time return lots of free cash flows back to the shareholders (in the form of share buybacks, leading to its total share count decreasing by 11% from 2016 to 2023, giving a further boost to the growth in earnings per share).
This high-quality growth might not be the case for all high growth companies, where companies with low ROCE would need much more capital to grow fast, and hence would not have much free cash flows left to distribute back to shareholders, and in some cases even having to raise more external capital to support those growth, leading to shareholder dilution. This is why it’s so important to evaluate and ensure that the company’s overall ROCE, and the ROCE of which recent growth is achieved with, are high, as we have previously explained in our article on “Return on Capital” here.
Track Record Of Returning Capital To Shareholders
With Meta being flooded with free cash flows, has it been returning that capital back to shareholders, and has it been doing it in a value accretive manner?
And why now for a case of dividend distribution?
To answer these questions, let’s first examine Meta’s track record of returning capital back to shareholders.
First of all, Meta has been diligently returning its free cash flows back to shareholders in a disciplined way every quarter, in the form of share buybacks (as shown by the medium blue bars in the chart below).
From 2017 to 2023, Meta generated operating cash flow (OCF) (before deducting non-cash share based compensation expenses) of $308 billion. After spending 43% ($132 billion) on capital expenditures and 3% ($10 billion) on merger and acquisition, it was left with $165 billion of free cash flow.
It returned most (71%, or $118 billion) of it back to the shareholders, in the form of share buybacks, instead of hoarding the cash which would otherwise dilute the value of those cash to shareholders.
So that’s an example of ‘good intention’.. However we will soon see if those good intentions actually translated into ‘good deeds’ of allocating capital in a way that benefits shareholders. (Note: Many investors naively assume that the intrinsic value calculated in a discounted cash flow (DCF) analysis would translate to the real final value of the company, overlooking how capital allocation by the company can have a huge impact on the final value.)
So, the second question is, how well had the buybacks been done – e.g. were they done at good prices?
As seen in the chart below, Meta had been doing the repurchase every quarter (since March 2017), spending about $1 to $4 billion each quarter. It became more aggressive on buybacks in mid 2021 to early 2023, spending $5 billion to $20 billion each quarter, repurchasing its shares at an average price of around $114 to $340 during those quarters.
In terms of the number of shares bought back, it was the greatest in the same periods (per the chart below), with Meta:
repurchasing massively, at 40-59 million shares a quarter in 2021 Q3 and Q4 (when share price was around $340); and
then repurchasing massively again at 41-60 million shares a quarter in 2022 Q3 to 2023 Q1 (when its share price crashed, at around $114 to $167).
Some of you might wonder, maybe Meta spent lots of money repurchasing during those periods, because it was generating lots of OCF during those quarters, and hence could afford to do so?
Let’s look at how many % of OCF did Meta spend on buybacks in those quarters. Per the chart below, the story shown is the same, i.e. Meta was spending a relatively higher % of OCF on buybacks during those same quarters.
So, overall, it seems to us that Meta has been doing a pretty good job (although not exceptional) in their buybacks.
Arguably, Meta could have spent less on buybacks in late 2021 (when its share price was relatively higher, at above $300), but it would not have been possible for it to predict then that its share price would come down thereafter. In addition, it did make up by repurchasing massively in 2022 and early 2023, when its share price crashed to low $100s.
Overall, its weighted average repurchase price from 2017 to 2023 was $222 per share (= $118 billion spent, divided by 530 million shares repurchased). Compared to the share price in early February 2024 of $470, that’s a gain of 112%.
That means that the total $118 billion amount that Meta had deployed to buybacks (from 2017 to 2023) had grown in value to about $249 billion in early February 2024.
If we consider the timing of the repurchase cash outflows (in each quarter), the overall XIRR of Meta’s repurchase activities has been an impressive 30.2%, so kudos to Meta!
Lastly, as seen in the chart below, Meta’s quarterly repurchases had been done at an owner earnings (OE) yield of around 3% to 5%, or much higher at 6% to 15% in 2022 and early 2023, which were pretty decent yields (relative to the US 10-year bond yields of mainly ~1%-3% in 2017 to 2022).
Valuation & Why Dividends Now?
If Meta has been executing its share repurchases well, why the decision to start distributing dividends now?
Meta’s CFO, Susan Li, said that “We believe introducing a dividend really just serves as a nice complement to the existing share repurchase program.
The dividend doesn’t change how much we will be — or it doesn’t change the way we determine the total amount of capital we return. And we expect that share repurchases will continue to be the primary way that we return capital to shareholders.
But introducing a dividend just gives us a more balanced capital return program and some added flexibility in how we return capital in the future.” [emphasis ours]
So, is Meta now deciding to return capital back to shareholders through dividends (on top of just share buybacks) because it thinks that its share price is overvalued now (or expects it could be so in the near future)?
Let’s examine Meta’s latest valuation, by estimating its latest owner earnings (OE).
In 2023, it generated an operating income of $46.8 billion, and a net interest income of $0.7 billion (which we will not include in estimating the OE to be conservative, since the level of that interest income would depend on external factors like interest rates).
In 2023, it also incurred some restructuring costs of $3.5 billion, relating to the consolidation of its office facilities, one-off severance and other personnel costs, and the cancellation of multiple data centre assets. As these expenses are not expected to keep recurring in the future, we add it back, to arrive at an adjusted operating income of $50.2 billion.
Assuming the maintenance capital expenditure is roughly equal to the depreciation & amortisation expenses, and that the change in net working capital is zero if Meta does not want to grow further, the estimated pre-tax OE is the same as the adjusted operating income, at about $50 billion.
Dividing that by the total share count of 2.56 billion at end 2023, we get an OE per share of $19.60.
Relative to the share price of $470 in early February 2024, that’s a pre-tax OE yield of 4.2%, similar to or slightly higher than the US 10-year bond yield then of around 4.0%, so the share price seemed reasonable.
It could be that Meta is starting the dividend policy now to give it “some added flexibility” in the way it can return capital to shareholders in the future, particularly if its share price shoots up significantly, which it has no way of predicting, nor controlling.
On the quantitative impact of whether buyback or dividend is more beneficial for existing shareholders, dividend distribution has the disadvantage of incurring withholding taxes for some non-US investors (e.g. 30% rate for investors with Malaysia or Singapore tax residence).
What this means is that, if Meta wants to return capital of $30 billion in a year, and if its share price is $600 per share, then if it does buyback on its own, it can buy back 50 million shares (ignoring transaction costs).
However, if it decides to return all these capital through dividends instead, and if (for simplicity purposes) all the investors have to incur a 30% withholding tax, then the investors in aggregate would receive only $21 billion in cash after tax, which would allow them to buy only 35 million of Meta’s shares (i.e. 30% less than the number of shares that Meta could have repurchased on its own).
Thus, in such a scenario, share buybacks would be more favourable for existing shareholders.
However, if Meta’s share is highly overvalued, say 50% overvalued, and if Meta returns all the capital through dividends (which we assume attract a 30% withholding tax), then the investors receiving the dividends in cash after paying taxes can use those cash to purchase relatively more economic share ownership (5% more to be exact (= [ (1 – 30%) x (1 + 50%) – 1] ) in another equally great business trading at fair value (instead of 50% overvalued), if such opportunities arise then.
In such a scenario, the existing shareholders of Meta would be better off if Meta returns the capital through dividends (instead of through buybacks).
What’s Your Take on Meta's dividend for shareholders?
Overall, Meta’s dividend distribution is still small now. At $0.50 of dividend per share, that’s $1.3 billion (= $0.50 x 2.56 billion shares) of cash spent on dividends per quarter, or around $5 billion annualised.
This is still small, compared to ~$43 billion of free cash flow generated in 2023, or the $20 billion to $45 billion spent on buybacks annually in 2021 to 2023.
Thus, at the current dividend rate, the overall impact on shareholders is not massive yet. We shall continue to monitor Meta’s capital return policy and activities in the future, to ensure that it is value accretive or optimal to shareholders.
So, what’s your take? Do you think Meta has done its buybacks well in the past? Would you prefer Meta to return capital through buybacks or dividends, or a mix? Let us know your thoughts in the comments below!
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