Dividend Yields

MANY COMPANIES don’t pay dividends, so looking at dividend yields won’t necessarily tell you whether one stock is better value than another. But it can be useful in gauging how expensive the overall market is. As of mid-2019, the S&P 500 companies were yielding 1.9%. That’s an improvement over the 1.2% at year-end 1999, but well below the level of earlier decades. Yields stood at 3.5% at year-end 1969, 5.2% at year-end 1979 and 3.2% at year-end 1989, and have averaged 2.9% over the past 50 years and 4% over the past 100 years.

The market’s dividend yield has trended down partly because stocks have become more expensive over time and partly because companies have instead used their spare cash to buy back their own shares. Historically, total shares outstanding have grown almost every year, as employees exercise stock options and companies issue new shares to raise cash or finance acquisitions. But that’s changed in recent decades: Corporations have been big buyers of their own stock, and these share buybacks have roughly offset new issuance.

Buybacks are seen as a more tax-efficient way of returning money to shareholders, because the money is used to cash out investors who want to depart without saddling remaining shareholders with taxable dividends. Buybacks may also reflect the current century’s slow-growth economy. With fewer chances for profitable expansion, some companies have decided instead to use spare cash to repurchase shares.

Trouble is, companies appear to be terrible market timers. They aggressively bought back their own shares ahead of the 2007 stock market peak, slashed their buying during the market slump that followed and now, with stock prices up sharply over the past decade, they’re once again aggressively buying back shares. One explanation: Buybacks are driven less by companies’ belief that their shares are undervalued and more by a desire to offset the dilution caused by employees exercising stock options. The latter is more likely to happen during buoyant markets, as the options gain value along with rising share prices.

Will the buyback craze continue? It’s hard to know. Buyback programs are often quietly abandoned, while dividends seem like a surer thing, because companies are loath to cut their dividend. Knowing they have to pay a regular dividend can also be a healthy discipline for management, forcing them to be more careful in handling the company’s cash.

Meanwhile, for investors, dividend-paying stocks can provide a fairly reliable and growing stream of income—one that’s arguably superior to that generated by bonds and cash investments. Most bonds generate a fixed stream of interest, leaving investors vulnerable to inflation, while the income from cash investments can fluctuate wildly from year to year, along with changing short-term interest rates.

By contrast, over the 50 years through 2018, the dividends paid by the S&P 500 companies grew at an average 5.9% a year, comfortably ahead of the 4% annual inflation rate. Will dividends continue to be a source of growing income in this era of stock buybacks? Here’s one indication: Over the 15 years through year-end 2018, dividends paid by the S&P 500 companies grew 2.9% a year, versus 2.1% for inflation.

Next: Price-to-Book Value

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