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What’s Better: Dividends, Stock Buybacks, or Debt Reduction?
The term “shareholder value” can be applied to any actions taken by a company that are viewed to be positives to shareholders. Chief among them are stock dividends, share repurchases, and debt reduction. A while back, we took a look at a measure called “Shareholder Yield” that combined all three into one number so that you could compare how different companies stack up in terms of shareholder friendly policies.
In a perfect world, every company would be actively partaking in all three. But that’s simply not the case. So if forced to choose among them, which one really plays into an investor’s best interest over the long run?
Dividend payments are one of the absolute cornerstones of stock investing. In fact, when you get right down to it, anything that doesn’t pay you back in one way or another can’t even be considered an “investment”, at least in the strictest sense of the word. (But that’s a topic for another day.) Moreover, consistent payouts underscore a company’s cash generation capabilities, while dividend increases demonstrate management’s confidence in the future. (For a more detailed rundown on the many attributes of dividends, see “Yielding To The Allure Of Dividends”.)
Stock Buybacks are good for existing stockholders in that they reduce the total number of shares outstanding. Logic will tell you that, whatever value you place on a company, the fewer shares out, the more each share is worth.
Finally, debt reduction is usually a good sign. It means the company has its act together. It’s generating enough cash flow that it doesn’t need to depend on others to expand. And the bottom line, the less you owe, the lower your interest expenses.
It’s All Good, Right?
You would think all of these strategies would be universally viewed as positives, but each has its deterrents. Some argue that money paid out in dividends is cash that could be spent growing the company. This is technically true. But sometimes, growth opportunities are limited. Worse still, managements sometimes waste money on reckless expansion.
As for stock repurchases, sometimes companies (just like individual investors) will overpay for stocks, often just before a bear market sets in. Also, you often run across instances where buybacks are simply used to cover up stock-based compensation, yielding you a net change of zero. Finally, you’ll also find that some companies announce enticing buyback plans, and just simply never follow through.
Lastly, aspersions can also be cast on the act of repaying debt. This is usually brought up when borrowing rates are low, such as they are now. As the argument goes, why pay down debt at miniscule interest rates, if the money can be put to better use invested in something (most likely an acquisition) that will generate a higher return.
Now there’s a word you don’t usually hear bandied about when talking about investments. But it’s particularly applicable to our discussion. Dividends, buybacks, and lower debt can all be good for shareholders. However, the one quality that favors dividends over the other factors is that they actually put money in your pocket. The others don’t. All things being equal, lower debt and fewer shares outstanding should result in a higher share price. But things are never equal, and oftentimes the markets simply won’t agree with you, such as in periods of general market declines.
More to our point, dividend payments are yours to keep forever. To be sure, a company can suddenly declare a dividend cut or suspend payments altogether. But the company can’t announce that it has suddenly changed its mind and wants its money back on dividends already paid.
On the other hand, shares that were repurchased can just as easily be sold back to the market. In fact, looking at all the stocks in the Value Line Survey that have been trading for at least 10 years, the majority of companies have more shares outstanding at the close of 2011 than they did at the end of 2001.
The same goes for debt reduction. A tempting acquisition or expansion opportunity could pop up at anytime, and then it’s back to the bank (or bond and equity markets) for more funding. Again, looking at that same 10-year period, most companies had more debt outstanding at the end of 2011. Sometimes way more, reflecting the easy credit policies that pervaded the period.
And how did dividends fare during that run? Once more, the statistics are stacked in their favor, as far more companies increased (or initiated) payouts over the last ten years, versus the number that made cuts or eliminations.
Hitting The Trifecta
As hinted earlier, in a perfect world, shareholders would rather have companies that consistently deliver in all three departments, at least over the long term. Just considering the aforementioned trends in debt and shares outstanding, the chances seem alarmingly slim. So are there any stocks like that out there? Looking at all the names covered in the Survey that have traded since 2001 (and excluding financials and utilities), just a relatively small number of issues managed to clear all three hurdles. That is, fewer shares out, lower debt, and steadily rising dividends over the entire period ended December, 2011. It’s worth noting that, more often than not, the deal killer was higher debt.
So who are these “shareholder champions”? Among the top-yielding names are: Lockheed Martin (LMT, 5.0%), Leggett & Platt (LEG, 4.9%), Universal Corp. (UVV, 4.2%), Paychex (PAYX, 3.9%), Bristol-Myers Squibb (BMY, 4.3%), Raytheon (RTN, 3.8%), and Unilever PLC (UL, 4.2%).
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.