U.S. corporations have been stockpiling cash at rapid rates since the depths of the recession, and some shareholders are reaping the rewards because of aggressive stock repurchases and fat dividends.
Will the trend continue? What does it say about the long-run health of a given stock sector?
Investors might watch the economy and the stock market in tandem to get a better idea. That’s the assessment of S&P Capital IQ, which analyzes relationships across multiple asset classes and markets. In a recent report, its Global Markets Intelligence group took a deep dive into how company management teams have generally driven shareholder value over the last 10 years. The report, “Sector Disruptors: Buybacks and Dividends,”determined that the current corporate environment leans toward dishing the cash out, and that may have implications for the longer haul.
“Companies could be more willing to part with available cash on a combination of buybacks and dividends, instead of or in addition to investment intended to grow businesses long term,” according to the report.
From 2005 to 2014, the study found that S&P 500 (SPX) companies upped the total dollars for buybacks and investments by 85%, or $428 billion, to $934 billion.
“The amount of allocations to repurchases and dividends has risen in each of the past years, and we see this trend continuing,” the researchers suggest.
Buybacks and dividends are hardly new to the public corporation strategy. But the surges in recent years have many industry analysts taking note.
Companies have upped dividend payouts in all but one year in the last 10. In 2009, the lowest point of the recession, dividends dropped 10%, considered a hefty retreat on its own. But in the other nine years, the growth was up 94% to $369 billion in 2014. As such, 2009 became a mere hiccup in long-run analysis.
What makes dividends so special is their yield—what they give back to the investor. The yield is calculated by dividing the annual dividend by the stock price. For example, if shares of XYZ Co. are trading at $100 and the annual dividend is $2.50, the yield is 2.5%. As for investors, their hunt for yield intensified during several years of ultra-low interest rates.
While many investors are chasing rising stock prices, there’s a school of thought—proffered often by Warren Buffett—that stagnant and even declining stock prices of companies with strong yields can be better performers over a longer horizon. Why? Because most companies will up their dividend payout annually, and if the stock price isn’t moving or dropping, the yield turns higher.
If XYZ Co. is still trading at $100 and it raises its annual dividend by 5%, the yield is now at 2.63%. If the stock prices drops to $95, the yield increases to 2.76%. Technically, dividends are not guaranteed, but many companies consider dividends a “promise” to shareholders and will go to great lengths not to cut them.
With some exceptions, as in the depths of the recession, dividend-paying stocks tended to fare well with the ups and downs of the economy. “Dividends tend to be more consistent and resistant to economic cycles,” the study says.
Stock repurchases exhibited what S&P Capital IQ calls “more notable variability” because of extraordinary pullbacks in 2008 (40%) and 2009 (61%). Those, however, were offset by strong jumps in 2010 (119%), 2013 (27%), and 2014 (16%). The net result: buyback dollars soared 79% to $566 billion in these years covered by the study.
Buybacks can be used to spread company wealth, push up the share price, and/or engineer prettier earnings per share. If the bottom-line profit tumbles in any given year, but a huge share buyback is put in place, on a cursory level it won’t be as evident that the per-share profit has dropped. It’s always something for investors—who are responsible for their own deep dive into any stock—to keep in mind.
S&P Capital IQ notes that when money is pouring into a company, buybacks become the investor prize. “[Some companies] treat buybacks as a safety valve for excess free cash flows after CAPEX [capital expenditures] and dividends have been addressed, and as a result, buybacks tend to be higher in strong cash-flow years and weaker in poor cash-flow years,” they said.
Companies also use buybacks to offset share dilution when executives exercise stock options.
Stock repurchases, unlike dividends, tend to be more sensitive to economic push and pull. “Buybacks more broadly reflect the economic and stock market backdrop,” according to the report. There are analysts who argue that a retraction in the stock is exactly when corporations should be scooping up their shares as a show of confidence in the company.
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