Having been a board member and CEO of many companies, private and public, I think the first question that needs to be asked when considering whether or not to spend cash on dividends and buybacks, is: What is the proper capital structure for the company?
Unfortunately many companies adopt rigid rules and also set expectations to shareholders regarding buybacks and dividends without considering properly the long-term need for capital, the ability and cost of raising future capital and the return that investment would bring.
If growth expectations for the company exceed the average growth rate of the overall industry, many additional factors need to be considered and it's likely the amount of risk also increases.
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Taking on debt is a risky position for any company and I believe many boards do not adequately address this fundamental factor — especially in cyclical industries with large capital-expenditure requirements.
While taking on debt may significantly increase returns on equity, the interest expense represents cash that might otherwise be distributed to shareholders as a dividend and there are certainly more options for management or a board to stop the dividends, if necessary, than the difficult, expensive and risky process of restructuring debt.
Conservatism does not assure longevity, however — it provides a capital structure that will likely enable the company to weather and maybe prosper in a stormy environment. It also provides an opportunity to acquire an overleveraged competitor in a downturn. Many great companies excelled during significant downturns because they had the capital to invest. Warren Buffett, for example, made a $5 billion investment in Goldman Sachs's 10 percent perpetual preferred stock in 2008, which provided approximately $1.4 million in dividends per day. His acquisition of Burlington Northern Santa Fe for $34 billion in cash and stock in 2010 is also notable.