My Special Situations portfolio owns stock in Prudential Bancorp (PBIP), a thrift that recently demutualized in October. Demutualized thrifts can make excellent investments because they often trade below tangible book value, and smart management teams then buy back stock, creating immediate and real value for shareholders. So that's what makes Prudential's recent announcement of a dividend ...well, let's say, perplexing. So I'm using my bully pulpit (such as it is) to call the company out.
On Wednesday, the company announced a 3 cent quarterly dividend. At today's price that puts the yield at a modest 1.1%.
It's fine to pay a dividend, but look how the company's press release justified it. The release has CEO Thomas Vento declaring: "This dividend reflects our commitment to enhancing shareholder value and is, we believe, the best use of our capital."
There are two ways to interpret this, neither of which is flattering.
The last phrase is what I find perplexing, because there's no way a dividend is the best use of shareholder capital when the stock is trading below 80% of tangible book value. I realize, of course, that there's a one-year moratorium on buybacks, but that period will be complete in just five months and doesn't change the issue.
So the bank can buy $1 for less than 80 cents via buybacks, or it can send the money to shareholders who immediately pay tax of 15-20% on it. Instead of getting a dollar of value, shareholders get 64 cents (80 cents less 20% tax). As the Spanish say, don't give me four pesetas and call it five.
Because of their taxability, dividends are an inherently substandard means to return capital to shareholders when the stock is so cheap. That's why masters of capital allocation – companies that include John Malone's various Liberty entities and Warren Buffett's Berkshire Hathaway, among many others, do not pay dividends. They prefer to reinvest, which is what a buyback effectively is. Such suboptimal capital allocation decisions are what bring bank activist extraordinaire Joe Stilwell calling. Management rarely enjoys having activists on their back, even if they do often help ordinary investors.
There is one other interpretation, much less charitable than even the first: If a dividend is truly the best capital allocation, then it implies that tangible book value itself is even overstated. I don't think this is an interpretation that managements wants to suggest, but it's what the logic implies.
So I'm going to assume for the moment that the bank here is making a sub-standard capital allocation and calling it the best use. If they want to pay a dividend, fine. But don't pretend that they're making the smartest capital allocation decision.
Despite all this nonsense, I may still buy more Prudential stock in the months leading up to October. With the bank reserving more than 40% of the capital raised in the demutualization at the holding company, I expect to see an aggressive buyback authorization – at least 5% of shares and ideally 10% -- announced within a month of the lifting of the moratorium. Otherwise, I think it's quite likely my Special Situations portfolio will sell its position in Prudential Bancorp. After the rhetoric of smart capital allocation and the reality, it would only be prudent, when there are so many other excellent investment opportunities out there.
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