June 18, 2018
Shareholders of S&P 500 companies are receiving an unprecedented level of payouts following a surge in dividends and stock buybacks. Recently S&P Dow Jones predicted that “total shareholder return” [which covers share buybacks and dividends] for the S&P 500 will exceed $1 trillion in 2018. A trillion dollars is a lot of money. To give you some idea of how much, a trillion dollars is the combined net worth of twelve Warren Buffetts, or over 15,000 Gulfstream G650 jets.
Let’s look in more detail at the two mechanisms companies can use to return their profits to their shareholders: dividends and share buybacks.
Dividends are cash payments that go straight to investors as cash payouts. As of early 2018, according to data from Standard & Poors, S&P 500 companies were returning about 40% of operating earnings to shareholders as dividends. The dividend yield (taking dividends as a percentage of S&P 500 value) was about 1.9%. When received, dividends are taxable to shareholders, though generally at a more favorable rate than ordinary income. Most are qualified dividends, taxed at a 15% rate for married joint filers earning less than $480,000.
Share repurchases, or buybacks, are a less obvious but equally powerful option. In a buyback, a company can choose to repurchase its own shares and reduce the number of shares outstanding. When future profits are spread across a smaller pool of remaining shares, each shareholder’s portion of the profit is enlarged. Rather than tangibly pushing cash into shareholders’ hands, buybacks tend to raise share prices. Recently, the companies comprising the S&P 500 have been buying back shares to an extent that represents about 45% of profits. The resulting buyback yield is about 2.3%. Adding together this buyback yield and dividend yield, S&P 500 shareholders receive a current yield over 4%.
These approaches to delivering shareholder return can each attract both praise and criticism. Critics of buybacks point out that the practice can be self-serving, as executive compensation is often linked to share price targets, and buybacks tend to be concentrated at times when the market is more expensive, costing more to buy back shares per unit of profit. Advocates of buybacks celebrate the improved control buybacks give shareholders over the timing of realizing taxable income, and point out that companies who buy back their own shares have tended to deliver higher total returns over long periods than stocks of companies who do not repurchase shares.
Investors seeking current income still prefer dividends, which can also be reinvested into other investments if investors so choose. From 1999, S&P 500 dividends have grown from $130 million to around $430 million today, averaging annual growth of about 6.5%. Buybacks have grown from around $150 million to $520 million over the same period at a similar rate of growth. At a point when past returns have been high and prospects for future returns may be more muted, investors should be pleased to remember these forms of return as powerful forces over the long run.