TSR - The Season Tickets of Finance

My favorite thing about the Fall is football season. I obviously love the Badgers and the Sooners, which are my teams from undergrad and grad school, but I want to focus on my NFL team of choice – one that I have faithfully supported for almost 20 years. The Indianapolis Colts.

I started my fledgling support of the Colts in a small sunroom in Columbus, Indiana at my aunt and uncle’s house. On that fateful day in September 2006, I was watching a game taking place 50 miles away at the RCA Dome in Downtown Indianapolis. The game felt like a movie. The heroic antics of Peyton Manning, the quickness of Reggie Wayne, the strength of Dwight Freeney, and the hard hits of Bob Sanders dazzled my young mind. I was hooked. Thus started a passion that continues strong to this day. When I started supporting the Colts, it was at the beginning of their fated season where they would (ironically) play and beat my hometown Bears in Super Bowl XLI in Miami. I remember being the only kid at my elementary school wearing Colts gear on the Friday before the game and wondering why everyone was so sad on Monday. I was ecstatic!

Yes, the Colts have fallen from their winning ways and just (painfully) missed the playoffs after a 7-1 start. However, win or lose I always go to at least one game with my family per year. Some may write off my passion for the Colts as pure insanity, but why subject my family to this fate? Funny enough, they want to go! Why you may ask?

The Indianapolis Colts’ ability to do a good giveaway.

Whether they are 1-5 and give away free beanies, or 3-8 and give away a free bobblehead, my aunt is excited to be at the game on time for the free merchandise. Is a scarf worth watching Sam Ehlinger lose to the two-win Texans? Did I mention it was free?

What is truly important is that each team must appeal to their fanbase. While Colts fans desire freebies to make it worth their while to go to games, Rams fans may not need freebies to incentivize them to come to games – watching Matt Stafford throw for 500 yards is motivation enough to buy a ticket.

From an owner’s perspective they want to keep fan demand high, and maximize their profit. There are two levers they can pull as discussed above:

(1)   Increasing Team Value– winning games increases the perceived value of the team and what an individual is willing to pay to watch said team

(2)   Distributions – freebies can be given out to fans to incentivize them buy a ticket to at minimum get a free item and potentially see a win if they’re lucky

Now this example may seem silly and convince you that I’m insane for supporting the Colts for 20 years and only having one Super Bowl to show for it at the very beginning of that tenure, but I use this to show that the equity markets are no different. And when you’re looking for a stock, you can use this same concept that the Colts Owners use to keep my family coming back every year.

What is a Shareholder?

Before we talk about shareholder return, what is shareholder? While this term sounds complex and intimidating, it’s just another one of those terms finance professionals made to sound fancy.

A shareholder is someone who has percentage ownership in something. While this is primarily used for companies, to illustrate the example, when you bought your lawnmower at the Lowes, you became the 100% shareholder in that lawnmower, congrats! It’s that simple.

Companies are no different, but unlike your lawnmower, they aren’t located in your garage, and you are amongst millions of other individuals (or institutions) that own tiny slivers of ownership in it. While there are some nuances about share ownership, for simplicity right now, I’ll say that what you’re truly “sharing” in is the cash flow of the organization.

Let’s say that you are amongst 999,999 other individuals and you all own one share in the company. Now that right to share future profits did not come for free! How valuable is that right? It all depends on the ability of the company to generate cash as well as how many people you have to share that right with.

Let’s say you paid $10 for that right in our example. Now let’s say the company generates $2,000,000 in cash flow that year. Since there are 1,000,000 total shareholders (yourself included) , the company can do one of two things. They can either give every shareholder $2 or reinvest it back in the business to attempt to generate more cash and lift the price for the right to share in profits. Does that sound familiar? It’s exactly what NFL owners do.

The company can either give out a distribution in cash (called a dividend) or increase the value of the share by reinvesting it back in the business (called capital gains). However, each has their tradeoffs. Dividend payments reduce the cash in the business and may result in companies taking longer to fund new projects or seeking more expensive methods of funding. Keeping the cash in the business is risky if projects do not bring the desired value and the share price decreases.

Market Value

A key topic here that I hinted at above is market value. Market value is simply calculated by (shares outstanding x share price). All this represents is how much someone would be willing to pay for the right to be the only person to collect all the company’s cash flow forever. Companies like Google with a $4 Trillion market cap means that if one entity had $4 Trillion dollars, they would be willing to sink that into Google for the right to collect Google’s cash flows forever. What a strong signal of what investors think of Google! Think of market value like your lawn mower. Just like you would pay $500 for the exclusive right to own and use that lawn mower, market cap is no different, and guides decision making when companies acquire each other.

Looking at companies with similar market caps illustrate our point about capital gains and dividends. Workday and Ford both have a market cap ~$50 Billion. However, Ford pays a dividend and Workday does not. If the market values them the same, why do they have different strategies? The answer there is the nature of the business.

Like the Colts offer freebies to get fans to buy tickets while the Rams focus on improving their team and winning games with less freebies, companies tailor their strategy around their specific operation and industry.

Often times software companies don’t pay dividends because they believe that investing that cash in research and development of new technologies will increase share value and how the market values the company. For example, Apple shareholders would much rather Apple spends cash to make a new iPhone that the market will easily pay top dollar for rather than paying out cash to shareholders. In a similar vein, Workday’s value proposition is that they will continue to develop their software (and demand for it) and thus increase their value as a company. In finance, this is a capital gains focused stock.

Ford meanwhile does generate cash flows with its tried-and-true automobile manufacturing business, but it does not have the same upside as a software company. Put more simply, while Ford is depended upon to release the same F-150 every year (with some slight tech and cosmetic improvements), the value increase year over year is not drastic. Short of the company making a flying car, people will not pay 100-150% more for a 2025 Ford vehicle than they would a 2024 vehicle. Workday comparably could integrate AI automation into its software and customers would be willing to pay more. There is more revenue-gain potential in the software space. So how do reliable companies like Ford incentivize people to hold stock? They pay out cash distributions. Retirees, pension funds, and even some investors wary of the "revenue-gain potential" value of capital gains stocks may hold dividend stocks.

So does that mean people should only buy capital gains stocks? The answer is the opposite. Dividend stocks should also be considered because there are TWO ways to make money. Through an increase in price or a dividends.

A Tale of Two Bakeries

Let's go ahead and take a look at an example. I've been wanting to start baking my own bread, but I've been struggling with weighing the cost of maintaining a sourdough starter vs the amazing taste and convenience of home-baked loaves of bread. Since it's on my mind, for our example we'll have two bakeries. Bakery A and Bakery B.

Bakery A uses an assembly line for making sourdough and is incredibly efficient with producing a lot of it. However, this is all they do. Their entire bakery is configured to make sourdough. Their stock price is $10 per share and pays a $2 dividend per year.

However, Bakery B has figued out a way to make zero calorie bread. It has sunk more cost into developing this recipe so it focuses its cash flow in the business. Their stock price is $50 per share and they do not pay a dividend.

At the end of the year Bakery A's stock price is $12 while Bakery B's stock price is $65. Initially one may look at the price change (+20% for A, +30% for B) and argue that Bakery B is the better investment, but that does not tell the whole story!

Let's look at total cash payments for holding each stock and selling it at the end of the year. Bakery B is straightforward.

($65-$50)/$50 = 30% Bakery B Total Return

However, Bakery A not only had the increase in the price, but it also paid a $2 dividend

($12-$10+$2)/$10 = 40% Bakery A Total Return

If we consider both the dividend and the price gain, Bakery A is the better investment!

Takeaway

So what do NFL owners, lawnmowers, and bread have to do with you. They all relate to the strategy of how to make money off stocks. So many people want to invest in a stock and think the only way to make cash return is if the price goes up. However, the concept of total shareholder return allows for businesses to uniquely deliver for their shareholders in a way that best fits their business. Simply put:

Total Shareholder Return = Capital Gains + Dividends

Or put this way

Total Fan Return = Freebies + Winning Games

Whichever way you want to see it, it’s crucial to know as you get out there in the markets and evaluate any equity investment. Or maybe you’re looking for an NFL team to pick and just wanted to know the formula a finance nerd would choose.

If it’s the latter, let me invite you to join Colts Nation! Yeah, you won’t see a whole lot of wins, but I promise if you hang in there and show up to a game on time – there will be a bobblehead waiting for you in your future.