When management of a company is looking to make good use of incoming capital for shareholders, there are various options.
If they have a good expansion opportunity, or believe stronger advertising can provide good returns, then the money may be beneficially reinvested for organic growth. Organic growth is often the best use of capital, but there’s a limit to how quickly a large company can grow in a given amount of time.
Alternatively, if there is a complementary business that management believes is appropriately priced and will strengthen their company, they can make an acquisition. The downside is that, in many industries, acquisitions are often over-priced empire-building activities rather than truly beneficial to shareholders.
And of course, if a company has a weak balance sheet, some incoming capital can be used to pay off debt and add additional liquidity to the balance sheet.
In addition, there are two more direct ways to give money back to shareholders. The most direct way is to pay a dividend, where a company sends a portion of the profits to shareholders, ideally on a regular basis.
Alternatively, or in addition to dividends, company management might want to use some incoming profits to buy back shares of the company, and thus decrease the number of shares outstanding, and therefore increased the percent ownership of each share. All else being equal, share buybacks boost EPS, and are functionally similar to reinvested dividends, but are treated better than dividends under current tax law. The downside to buybacks is that a lot of companies buy back shares when they are expensive and hold tightly onto their money when times are tough, with the end results being similar to a nervous investor that avoids investing in market bottoms and happily invested in market tops.
There are some companies that pay regular growing dividends, and then use any extra cash flow after that and other options, to buy back some shares. The dividend yield and share buyback yield, put together, are the shareholder yield, which gives the investor a decent idea of what rate of return can be expected merely from taking existing profits and giving them back to shareholders, on top of all other growth prospects.
One of the criticisms about the sustainability of capitalism is that it requires constant growth to function, but that’s only partially true. You can get substantial returns from a company that isn’t growing. When a stock is at the right valuation, then a significant number of share buybacks along with dividends can produce a 10% rate of return even when the company is not growing at all, or only growing due to keeping pricing up to pace with inflation. A good example of that is Chubb Corporation (CB), which has no revenue growth, but has boosted EPS, dividends, book value, and the stock price, over the long term.
This is a non-exhaustive list of five more select companies that are both paying dividends and regularly buying back shares.
Becton Dickinson (BDX)
Becton Dickinson is a global medical device company, producing a variety of medical, diagnostic, and bioscience products, with significantly more than half of company revenue coming from outside of the United States.
The company has over four decades of consecutive annual dividend growth, but due to a modest payout ratio and the recent surge in stock price for 2013, the dividend yield is fairly low at only 2%. Much of the capital goes to buybacks, however. In the past nine years, they’ve bought back nearly 25% of the company’s market cap. Recently, the company has bought back over 7% of its market cap in each of two years, but that has largely been due to taking advantage of low interest rates to increase the corporate leverage. More sustainably over the long-term, the company buys back perhaps 3% of its stock per year, while paying a 2-3% dividend yield, and combining that cash return with solid revenue growth.
I view the current valuation of BDX to be reasonable, if not exactly appealing, compared to many other potential investments on the market currently. A full analysis from earlier this year is available here.
Lowe’s Companies (LOW)
I haven’t published a report on Lowe’s in a few years, primarily due to the low dividend yield of only 1.5% (despite five decades of consecutive annual dividend growth). It’s a good mention in a share buyback list, however, since it couples the dividend with serious regular stock buybacks. The company bought back 30% of its market cap in under 8 years, reducing the share count considerably from over 1.6 billion to well under 1.2 billion. The company offers a decent 5% shareholder yield overall, along with solid core growth.
Overall, I’d classify this home improvement retailer as being a bit pricey at the current time after the 2013 run-up.
J.M. Smucker Co. (SJM)
Smuckers, the maker of Jams and Jelly, is an interesting example. Over the past decade, they went on an acquisition-spree buying brands like Folgers coffee and Jif peanut butter to turn Smuckers into a larger, diversified food company. To afford all of this, the company regularly issued new shares, growing the number of outstanding shares in the process. Over the 2005-2010 period alone, the company doubled its number of shares outstanding. The strategy paid off, as per-share metrics had very strong growth and roughly quintupling the investment of their investors over the most recent 12 year period.
Now, the company is using substantial buybacks and decreasing its share count. The current dividend yield is about 2.16%, with another 2-3% buyback yield. I do feel, however, that the valuation is a bit ahead of itself, and it would be better to watch this one for a while.
Target Corporation (TGT)
It’s tough to dig any sort of moat in retail, which is a low margin and hyper-competitive industry. Being a “middle of the road” retailer, avoiding the bargain or luxury extremes, is a particularly dangerous place to be. Target has found a niche at the high end of the budget space- typically a classier shopping experience than Wal-Mart and membership chains, but still with rather low prices. The company’s four and a half decade streak of consecutive annual dividend increases is evidence of the success of this strategy so far, and the current dividend yield is 2.68%.
Target also buys back shares, having bought back nearly 30% of its market cap in the past decade. The company often purchases up to 5% of its market cap in a single year, although it can vary year to year. I view the company as reasonably valued, but with large retail competitors, bulk membership competitors, and disruptive online competitors, I’d like to see a bigger margin of safety.
Texas Instruments (TXN)
Texas Instruments is the largest producer of analog chips in the world. Their products tend to have long life-cycles and high margins, and they supplement those strengths with a particular focus on their large sales team. The headwind for the company is that they’ve been exiting some commodity product lines to focus in their core analog area, and as can expected this decision has impacted revenue.
The company wasn’t much of a dividend payer until the last few years, where it has quickly grown its dividend to a current yield of 2.89%; fairly high for the tech industry. The company bought back 35% of its market cap in the past decade, and continues to buy back ~4% of its shares each year.
Full Disclosure: As of this writing, I am long CB, BDX, and SJM.
You can see my dividend portfolio here.
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Dividend investing Martin
I have mixed opinion on buybacks. I have read it serves well to former investors of the company who decided to sell their shares rather than those who hold the stock thru the thick & thin. Look at it this way, the company announces a plan of buying back their shares. The price bumps up and is steady growing as the company is buying back. Those who deiced to sell their shares to the company take the profit, we who continue holding can enjoy price growth, but since we mostly never sell we never enjoy the profits from the ride and our yield is getting smaller to buy more shares. What do you think?
Matt Alden S.
The holder of the stock benefits by owning a larger and larger share of the company, with the most immediate benefit being EPS growth. By fueling EPS growth and all other per-share metrics, buybacks are also fueling dividend growth.
But the cost of that growth is that the company could have been paying a higher current yield. In addition, studies have shown that companies tend to buy more shares when share prices are high, and fewer shares when prices are lower, which is the opposite of what is ideal.
In the hands of many companies, I think share repurchases are a lackluster use of capital. In the hands of some companies like Chubb or IBM, I think they end up being about as good as reinvested dividends, because they do them so consistently.
Dividend investing Martin
Exactly as you said: the cost of EPS fueling could be spent as larger dividends to shareholders. I think you would agree with me that the EPS growth is not always a sure way of increasing the stock price. In today’s market the stocks are beaten down although they post a good EPS results. So to me as a dividend investor this is an imaginary term. However, the buy backs also do not guarantee anything.
Matt Alden S.
I currently view the market as pretty heated actually- having a stock beaten down is often a good thing.
Over the long-term, stock price does follow EPS/dividend growth, even if in the short term it may not. And the longer it does not, the better it is for investors, because it presents more buying opportunities, and reinvested dividends and share repurchases buy more shares for the same money, which improves the rate of return.
The Dividend Guy
That’s an interesting point Martin. If you never sell, you will ultimately never get your paper profit back. On the other side, Companies using money to buyback shares are most likely using a part of their cash flow to increase their dividend payout at the same time. Most investors want both: stock growth and dividend growth. It’s hard to please everyone!
What I like about shares buybacks is the company helps keeping the stock to a certain level of value during market turmoils. It’s good for my mental health :-)
Martin, you have a good point here. But, this is the way of the world. If an earnings increase occurs and the valuation remains the same, the share price goes up. This is the intended affect.
I was looking at XOM in 2010, when it’s yield was over 3%. If you can buy XOM at this yield, you will make money. Fast forward to today, and XOM is again approaching a 3% yield. Unfortunately, the earnings/share of the company are up 45% since then so you won’t get the shares at $60, but somewhere $85. The valuation is the same, so the shares are attractive to buy.
Share buybacks had a large part to do with this.
short term investments
Wow thjat was strange. I just wrote an very long comment but after I clicked submit my comment didn’t appear.
Grrrr… well I’m not writing all that over again. Regardless, just wante to say excellent blog!