Stockholders Share In The Wealth

7/9/2012


In a perfect world, full of completely rational and informed investors and devoid of taxes and brokerage costs, dividends would not matter. When investors needed cash, they could create their own dividend by selling a bit of stock.

But in real life, brokerage costs and taxes can skew the math, and investors are not always certain that management knows best when it comes to returning cash to shareholders.

Partly because the S&P 500 Index has gone nowhere since 2000, today many investors want cash in hand, rather than holding out for capital gains in the uncertain future. Companies, aware of these biases and of the signaling effects of dividends, have been increasingly willing to oblige. The S&P 500 Index has seen a total of 200 dividend hikes, along with nine dividend initiations, through the end of June. There were four dividend cuts and one suspension. Positive dividend actions outnumbered the negative by 204 in the first half of 2012, the best start in at least eight years.

At the same time, many companies fear committing too much cash to the dividend. Instead, they prefer the flexibility of share repurchases, a spigot they can switch off with far less fallout.

Share repurchases fell sequentially for a second straight period in the March quarter. Repurchases are still high compared to recent years. Companies appear to be getting more conservative with buybacks, even with cash holdings above historical norms. Still, index companies' spending on dividends rose 5% to an all-time high in the June quarter from the March quarter.

Shareholder yield — the sum of buybacks and dividends, divided by stock-market value — measures both components of a company's payout policy. Shareholder yield has trended downward in the December and March quarters, again signaling caution, though it looks much healthier today than it did from the last half of 2009 through the first half of 2011.

BUYBACKS AND DIVIDENDS
Immediately below, we show rolling 12-month stock repurchases as a percentage of all repurchases for sectors within the S&P 500 Index. The proportion of buybacks for consumer discretionary and financial stocks has steadily climbed in the past four years, while repurchases for technology are currently light relative to recent history.
As shown in the bottom table, through June, more than half of companies have already raised their dividend in six of the 10 S&P 500 sectors. Headlining the list of 2012 dividend initiators are recommended stocks Agilent Technologies ($39; A) and Apple ($593; AAPL). Just four S&P 500 stocks have slashed or suspended their dividends this year.
Stock Buybacks: A shifting landscape
------------------ Percentage of Index Buybacks ------------------
S&P 500 Sectors
March 2009
(%)
March 2010
(%)
March 2011
(%)
March 2012
(%)
Consumer Discretionary 
17.8
17.0
11.3
8.7
Consumer Staples 
11.9
16.4
19.3
12.5
Energy 
11.5
8.2
9.6
19.6
Financials 
11.7
7.5
7.3
6.4
Healthcare 
14.6
14.7
15.4
12.3
Industrials 
9.3
7.9
6.1
12.3
Materials 
2.2
1.7
0.9
1.9
Technology 
19.9
25.2
28.8
24.0
Telecom Services 
0.6
0.2
0.2
1.5
Utilities 
0.5
1.0
1.1
0.6
Dividends: Continued growth
----- Median Yield -----
Cos. That
Have Raised
Their
Dividend
In 2012
(%)
Median
Dividend
Increase
(%)
No. Of Cos.
Initiating A
Dividend
In 2012
S&P 500 Sector (No. of Cos.,
No. Of Div.-Payers)
All Stocks
(%)
Div.-
Payers
(%)
Consumer Discret. (81, 59)
1.7
2.2
54
20
1
Consumer Staples (41, 39)
2.6
3.0
53
8
0
Energy (44, 33)
1.0
1.6
30
15
0
Financials (81, 75)
2.4
2.4
52
13
2
Health Care (52, 32)
0.9
1.6
31
8
3
Industrials (61, 58)
2.2
2.2
53
11
0
Materials (30, 29)
2.2
2.3
48
16
0
Technology (71, 39)
0.8
2.4
53
17
3
Telecom Services (8, 5)
4.7
7.3
0
NA
0
Utilities (31, 30)
4.1
4.1
60
4
0
Source: Standard & Poor's.

Four stocks with shareholder yields well above that of the S&P 500 Index are reviewed below.

CA Technologies ($27; CA) sells mainframe and enterprise software that helps make its clients more productive. The company holds net cash of $1.38 billion, or nearly $3 per share, and recent history suggests much of that cash will go to shareholders. In January, CA hiked its quarterly dividend fivefold to $0.25 per share. Shares outstanding have declined in 10 consecutive quarters, falling 14% during that period. Buybacks and dividends combine to give CA a shareholder yield of 9.8%.

CA seeks to return up to 50% of free cash flow to shareholders through dividends and repurchases. Operating cash flow and free cash flow have increased five straight years, and management sees more growth ahead, with cash provided by operations projected to rise 4% to 6% this year in constant currency. In addition to the dividend and buybacks, CA plans to deploy some of its cash on midsized acquisitions in the next couple years. With shares up 34% for the year and a dividend yield of 3.7%, CA is a Buy and a Long-Term Buy.


Since beginning its stock-repurchase program in 2006, DirecTV ($50; DTV) has spent $22 billion, slashing its share count nearly 54%. In May, CEO Michael White promised to continue the aggressive buybacks. Management expects to repurchase about $100 million in stock each week for the rest of 2012. It's hard to blame DirecTV for being attracted to its own shares. At 13 times trailing earnings, the stock's price/earnings ratio lingers at its lowest level in more than six years.

DirecTV has funded repurchases by taking advantage of historically low interest rates. DirecTV's $17.46 billion of debt had a weighted average interest rate of 4.9% at the end of March. The company sold $4.0 billion of debt at a weighted average rate of 3.8% in March, then retired $1.5 billion of debt at 7.6% in May. The bulk of DirecTV's debt won't come due until after 2016. DirecTV is a Focus List Buy and a Long-Term Buy.


Exxon Mobil ($85; XOM) boasts 100 years of continuous dividend payments. It has raised its distribution every year since 1983 — at an annualized rate of nearly 6%, almost twice the rate of inflation. In April, Exxon surprised investors by hiking its quarterly payout 21%, with CEO Rex Tillerson citing a desire to make the yield more competitive with rivals. Given Exxon's current dividend yield of 2.7%, which lags Chevron's ($106; CVX) 3.4% yield and ConocoPhillips' ($56; COP) 4.7%, shareholders could be in for more — and larger — payout hikes.

Exxon has returned $30.54 billion to shareholders in the past year, with about 70% from share repurchases. Buybacks over the past six quarters have entirely absorbed the shares Exxon issued for its 2010 acquisition of XTO Energy (the deal included about $24.66 billion of new stock). Tillerson said he has no regrets about making the deal, even though natural-gas prices remain sluggish. "We are all losing our shirts today," Tillerson said in June, referring to U.S. natural-gas producers. "We're making no money." But few companies have deeper pockets to wait out the slump. Through 2040, Exxon expects natural-gas demand to rise at an annual clip of 1.6%, more than double oil's 0.7%. Exxon is a Buy and a Long-Term Buy.


Intel ($27; INTC) is one of just three technology stocks in the S&P 500 Index that yields more than 3% and has shaved more than 7% off its share count in the past year. (CA also shares that distinction.) Intel's 3.4% dividend yield looks generous by the technology sector's standards (dividend-payers average 2.4%) and its own five-year average of 3.1%.  Yet Intel pays out just one-third of its earnings in dividends, suggesting it can keep boosting the payout without sacrificing on spending that will grow the business. Combining both buybacks and dividends, Intel has a shareholder yield of 9.7%.

Intel's prodigious ability to generate cash supports the generous payout policy. Free cash flow has exceeded $2.5 billion every year in the past decade, including $6.07 billion in 2011. The balance sheet brims with $13.75 billion of cash, versus $7.09 billion of long-term debt. For the June quarter, the consensus expects per-share earnings to fall 2% to $0.53 per share. Intel has topped consensus profit estimates by at least 4% in 13 straight quarters. Set to post June-quarter results July 17, Intel is a Focus List Buy and a Long-Term Buy.

A TWO-PRONGED APPROACH TO PAYOUT POLICY
Shareholder yield shows what companies returned to investors through both dividends and share buybacks in the past 12 months. To measure the endurance of companies' strategies for dividends and buybacks, we calculated the free cash flow coverage ratio — the sum of free cash flow and dividends, divided by the sum of dividends and net stock repurchases. Typically, free cash flow coverage ratios significantly below 1.0 are unsustainable for the long haul. Today, low coverage ratios indicate that many companies are tapping debt markets to take advantage of low interest rates. Stocks on our buy lists are presented in bold.
Company (Price; Ticker)

Div.
Yield
(%)

Divs.
Paid,
Last 12
Months
($Mil.)
12-Mo.
Net
Share
Repur-
chases
($Mil.)
Divs. &
Net
Repur-
chases
($Mil.)
Share-
holder
Yield
(%)
3-Year
Annual.
Div.
Growth
(%)
3-Year
Change
In Share
Count
(%)
12-Mo.
Free
Cash
Flow
($Mil.)
Free
Cash Flow
Coverage
Ratio
Industry
Advance Auto Parts
($68; AAP)
0.4
18
340
358
7.2
0.0
(22)
512
1.48
Auto retail
Aetna ($39; AET)
1.8
228
1,939
2,167
16.2
63.6
(23)
2,349
1.19
Managed care
Bed Bath & Beyond
($62; BBBY)
0.0
0
1,140
1,140
8.0
NA
(10)
958
0.84
Homefurnishings
BlackRock ($170; BLK)
3.5
1,027
2,989
4,016
14.4
24.4
38
1,648
0.67
Asset management 
CA Technologies
($27; CA)
3.7
192
1,053
1,245
9.8
84.2
(13)
1,214
1.13
Systems software
CF Industries
($193; CF)
0.8
88
984
1,072
8.4
58.7
35
1,666
1.64
Agricultural
ConocoPhillips
($56; COP)
4.7
3,531
11,329
14,860
21.1
12.0
(14)
3,708
0.49
Integrated oil & gas
CSX ($22; CSX)
2.5
509
1,546
2,055
8.9
17.8
(11)
544
0.51
Railroads
DirecTV ($50; DTV)
0.0
0
5,351
5,351
16.4
NA
(33)
2,302
0.43
Cable & satellite
Exxon Mobil
($85; XOM)
2.7
9,053
21,484
30,537
7.7
5.5
(5)
16,956
0.85
Integrated oil & gas
IBM ($196; IBM)
1.7
3,548
14,016
17,564
7.8
14.5
(13)
12,668
0.92
IT consulting
Intel ($27; INTC)
3.4
4,182
8,803
12,985
9.7
14.5
(8)
4,725
0.69
Semiconductors
J.P. Morgan Chase
($36; JPM)
3.3
4,170
8,984
13,154
9.5
(13.0)
2
 NA 
NA
Diversified financial
Norfolk Southern
($71; NSC)
2.6
589
1,989
2,578
11.1
11.4
(10)
823
0.55
Railroads
St. Jude Medical
($40; STJ)
2.3
272
611
883
7.0
NA
(9)
704
1.11
Health care equip.
WellPoint ($62; WLP)
1.8
361
2,745
3,106
15.1
NA
(32)
2,580
0.95
Managed care
Wyndham Worldwide
($53; WYN)
1.7
109
862
971
12.6
79.2
(16)
662
0.79
Hotels
NA Not Available.

 


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