Lower dividend growth rates ahead? The good times are coming to an end for dividend investors; that’s what Barclays believes anyway.
Equity investors have had it good over the past seven years. According to a report out yesterday from Barclays’ US equity strategy analysts Jonathan Glionna and Eric Slover, CFA, since 2009 total payouts to shareholders, which includes dividends and buybacks, have increased by 20% per year for the S&P 500. After this growth, the duo is estimating that total payouts for the S&P 500 will reach $1 trillion for the first time during 2016. This figure will include approximately $400 billion in dividends and $600 billion in gross share repurchases.
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The scale of payout growth in the S&P 500 over the past few years should not be underestimated. Indeed, total payouts stood at just $500 billion per annum during 2010 so over the past six years returns to shareholders have doubled.
Unfortunately, Jonathan Glionna and Eric Slover do not expect this growth to continue. In fact, the duo expects payout growth to slow to a halt during 2017 and may even contract in the foreseeable future.
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Companies have been able to increase their investor payouts during the past six years by…taking on more debt.
Over the last few years, payouts have exceeded earnings for the S&P 500, which is rare. The net payout ratio was 99% of earnings for 2014 and payouts exceeded earnings during 2015. For 2016 according to Barclays’ estimates net income for the S&P 500 is on track to come in at less than 0 billion against trillion of dividends and buybacks. For comparison, according to the research from Barclays’ equity strategy team, before 2015, companies in the S&P 500 had paid out more than they earned in only six other times during the last 50 years. It has never happened for more than two consecutive years.
Companies are relying on the debt markets to fill the gap between income and cash returns to investors. According to research from the Barclays duo, companies in the S&P 500 have spent more than they generated in free cash flow every year since 2013. The estimated cash shortfall of non-financial companies during this period is more than 5 billion per annum.
Equity investors have stepped up to fill some of the cash gaps. Over the past 12-months, the S&P 500 has issued approximately billion of new equity in aggregate. The rest of the cash gap has been filled with roughly trillion of debt during the last three years.
Leverage ratios were low coming out of the financial crisis, but after this debt splurge, ratios are not low anymore. In fact, Barclays highlights the fact that the median ratio of debt-to-EBITDA for companies in the S&P 500 (excluding financials) was just 1.53x in 2010. Now it stands at 2.33x, the highest point in at least 20 years. The total ratio of debt-to-EBITDA for the S&P 500 (rather than the median ratio) has reached 2.56x, excluding financials.
For this reason, Jonathan Glionna, and Eric Slover believes the S&P 500’s payout splurge will come to an end this year. What does this mean for investors? Here’s the advice of the Barclays analysts:
“The low-interest rate environment has spurred incremental demand for yield, and we expect companies to respond to this by focusing on dividend growth. The consequence should be a decline in buybacks. Buybacks are not generating the outperformance they once did and forward indicators such as the number of buyback announcements have been suggesting a fall. For 2017, we forecast dividend growth of approximately 5% and a modest reduction in buybacks, although we note a wide range of potential outcomes.”
“We believe it is going to become more difficult to find companies that can rapidly grow dividends and buybacks. Therefore, we recommend focusing on sectors that still have the capacity to grow payouts.”
By Rupert Hargreaves
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