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Yielding to Buybacks

Mike Zaccardi

DIVIDEND YIELDS MAY be tiny, but they sure they get talked about a lot. As Rick Connor pointed out on Friday, the S&P 500 stocks collectively yield just 1.3%—near 20-year lows. Yields have fallen as share prices have climbed and as companies have put more emphasis on stock buybacks. In fact, today, companies spend more on buying back their own shares than paying dividends.

Companies continuously manage their capital structure—how much of the enterprise is funded by issuing stock and how much with debt. Financing a company with stock is usually more expensive. Why? Delivering the earnings that shareholders expect typically costs more than meeting a company’s obligations to its bondholders, especially at today’s rock-bottom interest rates. It can make sense for a chief financial officer to buy back the company’s shares while taking on more debt, thereby lowering the firm’s weighted average “cost of capital.” The risk is that the firm ends up with too much debt, but the reward is a lower hurdle rate for profitable projects.

When a firm repurchases shares to reduce the relative importance of its “equity” financing, its “buyback yield”—the amount of money returned to shareholders through share repurchases—goes up. These share repurchases, coupled with stock dividends, make up a company’s “total shareholder yield.” There’s a great chart that occasionally appears in J.P. Morgan Asset Management’s Guide to the Markets. It shows total shareholder yield by sector.

What I find surprising: The lowest-yielding sector is utilities. Income-oriented investors know that utility stocks almost always have juicy dividend yields. These companies usually have reliable cash flows, so they can safely carry debt while paying out a high proportion of profits to shareholders. What these firms haven’t been doing recently is buying back their own shares.

Utilities and real estate are the only two industry sectors, out of 11, with a negative buyback yield. These two sectors are issuing stock, while the other nine industries are net share repurchasers. As of the end of the first quarter, the energy sector featured the highest total shareholder yield (5.2%), followed by financials (3.8%). Meanwhile, real estate (1.9%) and consumer discretionary (0.7%) have the lowest total yields.

The S&P 500’s dividend and buyback yields sum to 2.9%, which is the lowest since 2003. For perspective, total shareholder yield peaked above 7% in 2008 and was near 6% in late 2018 and early 2020. Contrarians see today’s paltry yield as a sign of stock market exuberance. But it could also reflect the composition of today’s market, which is dominated by low-yielding tech companies, coupled with low interest rates that have driven valuations higher.

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John Wood
John Wood
10 months ago

Interesting article, Mike.

Whenever I hear about buybacks being a “return to shareholders”, it sounds analogous to me to “cash out financing”, in that the term used does not accurately describe the transaction (as the latter should rightly be called an “equity to debt conversion”).

Buybacks are a cashing out of the least committed shareholders, which is why it should only be done at or below the company’s intrinsic value per share, otherwise it’s a lovely parting gift to the company’s least committed owners, at the expense of its more loyal, remaining owners.

The return to the remaining shareholders is in the shrinkage of the outstanding shares, which increases the earnings per share, which should raise the stock price if the PE multiple remains the same or goes higher, and results in the Corporation buying each remaining shareholder a larger percentage of the company (to take a simple example, assume 5 shareholders, each owning 20% of a company, where the company buys back 20% of the stock, with one shareholder selling out their stake, resulting in the four remaining shareholders now owning 25% of the company, courtesy of the corporation’s purchases).

While the “buyback yield” typically refers to the amount of cash per share that is paid to liquidating shareholders, the relevant yield is the increase in economic value the remaining shareholders receive from the corporation’s “share liquidation program”.

CEOs shouldn’t be judged on how much cash they give to liquidating shareholders (the “buyback yield”), but in how much resulting wealth appreciation the remaining shareholders receive from the transaction (which will depend largely on the price the CEO paid to buy out the least committed).

Rick Connor
Rick Connor
10 months ago

Mike, very interesting and informative analysis. Thanks

Mike Zaccardi
Mike Zaccardi
10 months ago
Reply to  Rick Connor

Thanks Rick!

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