Stingy Investor Contact - Subscribe - Login
  Home | Articles | Screens | Links | SNW | Rothery Report
 
The New Dividend

The once mighty dividend isn't what it used to be. Although dividends have regained some popularity, they remain largely supplanted by share buybacks with nearly half of all corporate distributions going to repurchase shares. Like dividends, buybacks represent a return of shareholders' equity but they have their own unique characteristics.

A share buyback occurs when a company repurchases and cancels its shares. The process sounds simple but it can have far-reaching implications. After all, decreasing the number of shares outstanding changes many commonly used fundamental figures. Let's use tobacco giant Altria (NYSE:MO) as an example. In 1993, Altria had 2,633 million shares outstanding and, after a series of buybacks, it had only 2,111 million shares in 2002. Over the same period, Altria's net income rose 259.2% from $3,091 million to $11,102 million. The company's already impressive income growth becomes even greater when converted to earnings-per-share. If Altria had not repurchased its shares it would have posted earnings-per-share of $4.22 in 2002. However, due to its share buybacks, Altria earned $5.21 per share last year which represents a 285.9% increase since 1993. Naturally, any per-share figure will increase as the number of shares decreases.

It is important to remember that balance sheet figures will also be impacted when cash is used to buy and then retire shares. Share buybacks have the effect of decreasing current assets when the shares are purchased and decreasing shareholder equity when the shares are cancelled. The resulting decrease in shareholder equity puts upward pressure on return on equity which is calculated by dividing net income by equity. In Altria's case, its return on equity increased from 25.6% in 1993 to 56.8% in 2002. Firms can run into trouble when buying back equity because debt remains constant while equity decreases which increases the firm's leverage. Increased leverage ratios can lead to lower debt ratings which usually increase a company's borrowing costs. Additionally, highly leveraged firms have little margin for error and slight downturns can be magnified into possible bankruptcy. Fortunately, in Altria's case, asset growth exceeded debt growth and the company's debt-to-equity ratio remained within a reasonably narrow range.

Another problem with share buybacks is that they often replace dividend increases and they are not nearly as stable as regular dividends. Investors keep close track of dividends and expect them to stay the same or grow. A dividend cut is seen as disgraceful and is usually a sign of economic weakness. As a result, shareholders often punish the stock of companies that reduce their dividend. Canadian dividend investors may still remember the drubbing that TransCanada Pipelines (TSE:TRP) received when it cut its quarterly dividend from $0.28 per share to $0.20 per share. Speculation of the possible cut, and the cut itself, took TransCanada's shares from $15 per share down to a low of $6.75 per share. On the other hand, share buybacks are not followed nearly as closely and are not expected to be regular. As a result, management can more easily stop share buybacks than it can stop paying dividends which makes share buybacks less certain.

Share buybacks can also displace dividends due to purely selfish reasons. The abuse of stock options given to management has been much in the news during the last few years. So much so that investors can be excused for thinking that we've moved from an era of robber barons to an era of robber CEOs. The huge quantity of cheap options provided to management in the 1990s put pressure on dividends because the options become less valuable as dividends are increased. How does this work? Consider a stock that trades for $50 and an option on the stock that can be exercised at $40. If the manager were to exercise the option it would be worth $10. However, if the company pays a dividend of $2 then the stock is likely to fall to $48. In this case, the manager's option would be worth only $8 after the dividend. A decline of 20%! Most people don't want to lose 20% and you can bet that managers in this situation would not be keen on increasing the dividend to $3; quite the opposite, option-oriented managers would much rather decrease dividends. Share buybacks, on the other hand, help option-oriented managers because they tend to increase share prices and make options more valuable. Not surprisingly, the rise of management options has corresponded to a decline in dividend yield (See Figure 1). Interestingly, the average firm continues to pay about 25% of profits to shareholders but the form of the distribution has shifted from mostly dividends to about half dividends and half share buybacks.

Figure 2

Despite the mischief that can be caused by option-focused managers, stock buybacks are an excellent way to return money to shareholders. With half of modern 'dividends' being paid in the form of buybacks, investors should keep an eye on both buybacks and dividends. With this in mind, I investigated the thirty companies in the Dow to find firms that decreased their share count from 1993 to 2002. I further narrowed down the list by discarding companies with debt-to-equity ratios of more than 1.5. Of the thirty Dow stocks only the twelve shown in Table 1 passed both tests. For these twelve stocks I determined the average annual percentage of shares that were repurchased from 1993 to 2002. I then added this buyback percentage to the stock's current dividend yield to find a total yield. The list in Table 1 is sorted by total yield and several stocks appear much improved on a total yield basis. As with dividend yield, the total yield can only be sustained by firms with sufficient earnings. Any stock with an earnings yield that is less than the total yield is in uncertain territory. Also, stocks with total yields larger than long-term bond yields usually have some form of hidden risk. For instance, Altria is exposed to tobacco-related litigation risk. Nonetheless, many Dow stocks trade at attractive yields when compared to short-term government bonds and are worth consideration by investors.

Table 1: High yield DOW stocks
Stock PriceBuybackDividend YieldTotal YieldEarnings Yield
Altria (MO)40.002.43%6.10% 8.53%12.8%
Eastman Kodak (EK)26.601.32%6.70%8.02%9.3%
DuPont (DD)41.963.38%3.30%6.68%4.6%
30 Year US Government Bond4.90%
IBM (IBM)86.743.08%0.70%3.78%3.6%
3M (MMM)127.621.18%2.00%3.18%4.0%
5 Year US Government Bonds2.75%
Procter & Gamble (PG)88.580.53%2.05%2.58%4.1%
Merck (MRK)61.73 0.27%2.30%2.57%5.2%
Coca-Cola (KO)42.910.55%1.90%2.45%3.8%
McDonald.s (MCD)21.121.23%1.00%2.23%3.7%
United Tech (UTX)72.190.73%1.40%2.13%6.3%
Wal-Mart (WMT)56.650.36%0.60%0.96%3.2%
Intel (INTC)25.310.65%0.30%0.95%2.2%
Source: globeinvestor.com, morningstar.com, July 16 2003


Although dividend yields are declining, dividend oriented investors should take heart because much of the slack is being taken up by share buybacks. Share buybacks are a little more difficult to keep track of, and not nearly as certain as dividends, but they represent good value to shareholders.

Disclosure (09/01/03): Altria is currently my largest public stock holding.

First published in September 2003.

  MoneySense Articles
 Cdn Top 200 2016
 US Top 500 2016
 Retirement 100: 2015
 Cdn Top 200 2015
 US Top 500 2015
 Retirement 100: 2014
 Cdn Top 200 2014
 US Top 500 2014
 Retirement 100: 2013
 Cdn Top 200 2013
 US Top 500 2013
 Retirement 100: 2012
 Buffett Buys
 FB IPO
 Stocks that pay
 Value in the S&P500
 Cdn Top 200 2012
 US Top 500 2012
 Retirement 100: 2011
 Where to invest $100k
 Where to invest $10k
 Summer Simple Way
 A crystal ball for stocks?
 Cheap & safe
 Risky business
 Cdn Top 200 2011
 US Top 500 2011
 Retirement 100
 Dividend investing
 Value investing
 Momentum investing
 Low P/E P/B
 Dividends
 Dividend growers
 Cdn Top 200 2010
 US Top 500 2010
 Graham's prescription
 Income 100: 2009
 The case for optimism
 Cdn Top 200 2009
 U.S. Top 500 2009
 Wicked investments
 Simply spectacular
 Income 2008
 Small stocks, big profits
 Cdn Top 200 2008
 US Top 500 2008
 Value that sizzles
 So simple it works
 Income 100
 No assembly required
 Investing by the book
 Cdn Top 200 2007
 US Top 500 2007
 Invest like the masters
 A simple way to get rich
 Top Trusts 2006
 Stocks for cannibals
 Car bites dogs
 Cdn Top 200 2006
 US Top 1000 2006
 So easy, so profitable
 Top Trusts 2005
 Dogs of the Dow
 Top 200 2005
 Money for nothing
 Yield of dreams
 Return of the master

MoneySaver Articles
 2 Graham Stocks for 2017
 3 Stingy Stocks for 2016
 5 Graham Stocks for 2016
 3 Stingy Stocks for 2015
 3 Graham Stocks for 2015
 3 Stingy Stocks for 2014
 4 Graham Stocks for 2014
 8 Stingy Stocks for 2013
 6 Graham Stocks for 2013
 9 Stingy Stocks for 2012
 8 Graham Stocks for 2012
 Simple Way 2011
 5 Stingy Stocks for 2011
 7 Graham Stocks for 2011
 Simple Way 2010
 5 Stingy Stocks for 2010
 8 Graham Stocks for 2010
 Simple Way 2009
 Timing Temptation
 19 Stingy Stocks for 2009
 4 Graham Stocks for 2009
 Simple Way 2008
 Active at Passive Prices
 Unbundling ETFs 2008
 5 Stingy Stocks for 2008
 5 Graham Stocks for 2008
 Is your index too active?
 Graham's Simple Way
 Canadian Graham Stocks
 5 Stingy Stocks for 2007
 8 Graham Stocks for 2007
 Top SPPs
 The Simple Way
 A hole in your IPO?
 Monkey Business
 8 Stingy Stocks for 2006
 Graham Stock Gainers
 Blue-Chip Blues
 Are Dividends Safe?
 SPPs for 2005
 Graham's Simplest Way
 Selling Graham Stocks
 RRSP Money Market Funds
 Stingy Stocks for 2005
 High Performance Graham
 Intelligent Indexing
 Unbundling Canadian ETFs
 A history of yield
 A Dynamic Duo
 Canadian Graham Stock
 Dividends at Risk
 Thrifty Value Stocks
 Stocks in Short Supply
 The New Dividend
 Hunting Goodwill
 SPPs for 2003
 RRSP: don't panic
 Desirable Dividends
 Stingy Selections 2003
 10 Graham Picks
 Growth Eh?
 Timing Disaster
 Dangerous Diversification
 The Coffee Can Portfolio
 Down with the dogs
 Stingy Selections
 Frugal Funds
 Graham Revisited
 Just Spend It
 Ticker Temptation
 Stock Mortality
 Focus on Fees
 SPPs for the Long Term
 Seeking Solid Stocks
 Relative Strength
 The VR Approach
 The Irrational Investor
 Value Investing

Globe & Mail Articles
 Indexing advice
 Media-shy stocks
 Curse of size
 Market uncertainty
 Be even lazier
 Scary beats safe
 Small, illiquid, value
 Use the numbers
 What value is good value?
 Sculpt for value
 Value vs CAPE
 Graham Rules
 CAPE vs PeakE
 Top value ratio
 Low Beta
 Value and dividends
 Walter Schloss
 Try unloved AIG
 Why I'm a value investor
 New world of ETFs
 Low P/Es possible
 10 yielders
 Be happier
 Long-Short
 Dividend Downside
 Shiller's P/E
 Copycat investing
 Cashing in on class
 Index roulette
 Theory collides
 Diving too deep
 3 retirement villains
 Scourge of inflation
 Economic omens
 Analyst Expectations
 Value stock scarcity
 It's all in the index
 How to pick good funds
 Low Beta Wins
 Hunt for dividend stocks
 Think garage sale

Advisor's Edge Articles
 Passive Rebundling
 Doing the math

Norm Speaks
Flip Books

Tools:
 Asset Mixer
 Periodic Table
 ETF Fee Calculator



 
About Us | Legal | Contact Us
Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...