The two most common methods used by companies to return "excess" cash to their shareholders are dividends and stock buybacks – stock buybacks are currently favored.
S&P Indices data shows 305 S&P 500 companies purchased their shares in the first quarter of 2011 – at a cost of $89.8 billion. This compared to 270 company’s conducting buyback programs during the fourth quarter of 2010, 261 in the third quarter, 257 in the second quarter and 251 in the first quarter of 2010.
S&P 500 stock buybacks increased 21.6% to $109.2 billion during the second quarter of 2011 - there has been eight consecutive quarterly increases in stock buybacks.
"Companies returned to the $100 billion quarterly buyback level in the second quarter as they continued to match and control employee options, thereby protecting their earnings per share. At this point, companies are continuing to use buybacks to prevent earnings dilution from employee options, as well as shares used for dividend reinvestment programs. Few companies are venturing outside of the box to purchase additional shares, as was the common practice from late 2005 through mid-2007." Howard Silverblatt, Senior Index Analyst at S&P Indices.
Let’s consider why management might favor buybacks over one time special dividends, starting or increasing dividends:
- Management receives compensation - usually in the form of stock options - that is tied to the company stock price. The higher the stock price the more they make cashing out their options
- When a stock buyback occurs the short term implications on the stock price are positive. If a company’s stock is suffering from low financial ratios ie earnings per share (EPS) and price earnings ratio (PE) buying back stock can give them a temporary boost because they are based on the number of outstanding shares. Earnings don’t change but the EPS looks better because you’ve reduced the number of shares outstanding so management meets goals for profit growth and earn bigger bonuses
- Dividends may work against the stock price of a company by reducing the book value of the stock
- Managers do not immediately benefit from dividends as their options do not qualify for dividend payments
According to TrimTabs Investment Research companies announced $124 billion worth of stock buybacks in Q2 2011 while insiders used less than $2 billion of their own money to buy stock in the same quarter. This is one of the highest ratios of announced company share buybacks to insider stock purchases since the investment research firm began keeping records in 2004.
“We’ve never seen such a sharp contrast between what insiders are doing with their own money and what they’re doing with the money of the companies they manage. While insiders are willing to use corporate cash to try to support the value of their stock-based compensation, they don’t seem to think their stocks are attractively priced.
The ratio of announced stock buybacks to insider buying topped 70 in the first two quarters of this year.
They were by far the highest levels in our records. How many of the analysts and journalists, cheering the big buybacks, realize that the people rolling them out aren’t buying anything themselves?” Charles Biderman, CEO of TrimTabs
TrimTabs data shows that insider buying occurred at only six of the 30 companies with the biggest announced stock buyback programs this year - totaling $168 billion dollars. The insider buying at these six firms amounted to less than $10 million, which makes an announced buyback to insider buying ratio of 16,800 to 1.
According to istockanalyst.com, insider buying decreased by 50% the first week of December with insiders purchasing just $20.6 million of their stock compared to $41.01 million the week before. Selling increased during the same time period - insiders sold $926.4 million worth of stock compared to $558.9 million the week before.
The insider Sell/Buy ratio is calculated by dividing total insider sales in a given week by total insider purchases for the week. The ratio for the first week of December 2011 is 926.4/20.6 = 44.9. In other words, insiders sold very close to 45 times more stock then they purchased.
Oh, there ain't no rest for the wicked
Money don't grow on trees
I got bills to pay
I got mouths to feed
There ain't nothing in this world for free
“Ain't No Rest For The Wicked” Cage The Elephant
Consider:
- Reducing a company’s outstanding shares does make each dollar of earnings more valuable on a per share basis. Unfortunately shareholders will not benefit after a stock buyback program has been undertaken if companies fail to reduce their share count because they have issued new stock to replace employee stock options
- Stock buybacks are almost always initiated in good times – when stock prices are high. Stock buybacks do not happen in bad times when stock prices are low. Purchasing stock at inflated prices, paying a dollar for .50 worth of stock is not an effective use of cash and some companies borrow money to pay for their stock buyback programs
- According to Fortuna Advisors companies that spent the most on stock repurchases, over the last ten years, had a total shareholder return of 37 percent versus 127 percent for companies that spent the least. Spending money on stock buybacks can halt or delay development of new products, acquisitions, diversification and spending on new plants and infrastructure
- Stock buybacks are more tax efficient than dividends. But dividends drive shareholder returns – over the last 50 years 56 percent of returns from the stock market have come from dividends
- Dividends are the only form of returns on investment that shareholders achieve during bear markets
- Dividends are valuable indicators of whether or not a stock is undervalued or overvalued and dividends put a floor under a stock
- Dividends are flexible, they give investors options by allowing them to time, and direct, income flow to where they think the best investment opportunities are at any given moment
- Dividends are a predictable and reliable source of income in retirement, relying on stock buyback programs not so much
- Research has found that paying dividends increases earnings growth
- Companies that regularly pay dividends have imposed fiscal discipline on their managers. There’s no empire building, instead focus must be on improving the bottom line without sacrificing return on equity
- Stock buyback programs can be cancelled and most investors would not notice while dividend payments are highly visible to shareholders and cutting or eliminating a payment creates warning signals something is amiss
Conclusion
Knowing what we now know, in regards to current stock buyback programs and insider selling, is it any wonder that managers prefer stock buybacks as opposed to special one-time dividends, starting or increasing existing dividends?
Each companies share buyback program will have to be individually judged by their shareholders as to its worth – but with very few corporate insiders willing to put their own money where they are putting corporate cash and with heavy, long term insider selling taking place, perhaps existing shareholders and potential investors had better take a hard look at just what is happening.
Whether or not there is a relationship between buybacks and insider selling in the company you own, the bottom line is that share buybacks usually do nothing to create long term shareholder value and are never a match for a steady, and sustainable, dividend.
There are many studies, easily accessible online, that have shown that the companies with the most consistent, and quickly rising dividends have greatly outperformed the overall market.
For those in search of appreciating retirement income streams, or income in bear markets and times of uncertainty, dividend paying stocks – companies returning “excess” cash to shareholders in the most beneficial manner - should be on every investors radar screen.
Have you got a few good dividend stocks on your radar screen?
If not, maybe you should.
