Generous To A Fault
Are U.S. corporations being too liberal with investors?
In the 12 months ended June, companies in the S&P 500 Index spent a record $923 billion on dividends and stock buybacks. A dive into those numbers reveals some interesting trends:
• Dividends rose 11% year-over-year, the 18th consecutive rolling 12-month period with double-digit dividend growth. Combined with a 4% gain in buybacks, the amount returned to shareholders rose 7%.
• Over the last four years, index companies bought back $2.3 trillion in shares and paid $1.5 trillion in dividends; buybacks accounted for 60% of the total amount returned to shareholders.
• In each of the last six quarters, at least one-fifth of index components repurchased enough stock to boost per-share earnings at least 4%.
More money coming back to shareholders in the form of dividends and buybacks? Sounds like an investor-friendly trend — but only if corporate America can keep it up. Unfortunately, we see signs that such largesse may not last.
Based on shareholder yield (dividends plus buybacks as a percentage of stock-market value), today's dividends and buybacks don't look too high. In the year ended June, the index's dividends equated to just over 2% of market value and buybacks just over 3%, for a shareholder yield of 5.1%, not much higher than the average of 4.9% since 2009.
Yield compares dividends and buybacks to prices, ratios that mean a lot to investors. However, businesses don't think that way. Corporate America considers dividends and buybacks as a percentage of income or cash flow, ratios that gauge how well they can cover the costs. S&P 500 Index companies paid out two-thirds of their operating income in dividends and buybacks in 2009, versus 96% in the year ended June. Credit that boost to buybacks, which consumed 58% of earnings over the last year, versus just 27% in 2009.
To put the trend in perspective, let's focus on free cash flow, a metric designed to reflect what a company has left after paying its production and operating expenses, interest, taxes, dividends, and capital expenditures. In 2009, S&P 500 companies devoted 45% of their free cash flow to buybacks. Over the next five years, free cash flow rose 57% while buyback spending tripled. In 2014, buybacks equaled 116% of free cash flow.
Such spending cannot continue forever.
A combination of historically cheap debt and a reluctance to plow cash back into their businesses has driven plenty of U.S. companies to gorge on their own stock rather than invest in new projects, in some cases borrowing to do it.
In the future, debt will become more expensive as interest rates rise, and corporate America will likely gain the confidence to spend more on growth initiatives. With the index's dividend payout ratio of 39% near historical norms and buybacks growing so aggressively in recent years, we expect spending on buybacks to come under pressure more than dividends.
All that said, some companies that have increased spending on both dividends and buybacks in recent years still have the flexibility to keep up the growth. We've listed nine of them in the table below, and three are reviewed below.
Over the last three years, Disney ($103; DIS) spent nearly $13 billion to repurchase its own stock, reducing its share count 5.6% during that period. The media giant hasn't always been that aggressive with buybacks, but we'll take it for as long as it lasts. Disney has been somewhat steadier on the dividend side, boosting the payout in each of the last five years; the dividend has increased at an annualized rate of 22% over the last five years and 40% over the last 10.
The shares have declined 15% since guiding slightly lower on sales and earnings in August. We see the sell-off as overdone, considering the company's four largest business units posted higher sales and operating profits in the nine months ended June. Analysts expect per-share-profit growth of 27% in the September quarter and 18% for the year ended September 2015, followed by a slowdown to 10% next year. We see plenty of potential for upside in year-ahead results, encouraged by such catalysts as the December launch of the new Star Wars movie, the opening of a theme park in Shanghai in early 2016, and Disney's powerful presence in the expanding market for digital video consumption. Disney is a Long-Term Buy.
Foot Locker ($69; FL) never seems to slow down. In each of the last seven quarters, per-share profits rose at least 13%. Double-digit growth should continue at least through the next six quarters. The consensus projects growth of 13% in the October quarter, 12% in the January quarter, and 11% in the year ending January 2017. Earlier this month, Nike ($122; NKE), which supplies 73% of Foot Locker's merchandise, reported robust results for the August quarter and better-than-expected orders for the next five months. Nike's news boosts our confidence in Foot Locker's ability to exceed expectations.
Over the last three years, Foot Locker increased its dividend at an annualized rate of 16%, while buybacks rose at a 63% annual clip. Despite the aggressive spending on buybacks, Foot Locker's shareholder yield over the last year was a reasonable 5.0%, above the five-year average of 4.3%. Foot Locker is a Focus List Buy and a Long-Term Buy.
Employment-services leader Robert Half International ($52; RHI) has raised its cash dividend every year since its initiation in 2004, most recently an 11% hike in February. Over that 11-year period, the per-share payout has more than tripled. During the last three years, Robert Half spent $281 million on dividends and another $445 million on buybacks. The company has purchased more stock than it issued in every quarter for at least 10 years, averaging net buybacks of $47 million per quarter during that period. Given Robert Half's consistent growth in cash flow, we expect the dividend increases and buybacks to continue.
Over the last year, Robert Half grew sales 12% and per-share profits 26%. While job growth slowed in September, the key word is still growth; U.S. nonfarm payrolls have expanded in 60 consecutive months. That reliable, if moderate, job growth should support continued double-digit growth in per-share profits for Robert Half. The consensus projects gains of 19% this year and 18% next year. Robert Half is a Long-Term Buy.