Monthly Archives: June 2018

Classic Entertainment


June 25, 2018

I love to watch old black and white film classics. Early Bogart or Jimmy Stewart movies have really stood the test of time. I am a sucker for financial classics too. They provide a surprising amount of entertainment.

The first time Charles Dow, and his statistician Edward Jones, calculated the Dow Jones Industrial Average (DJIA) was May 26, 1896. The 12 original component companies included names like American Cotton Oil Company, United States Rubber Company, National Lead Company, and American Tobacco Company. The initial DJIA value was 62.76.

Hard as it is to imagine now, America would have been viewed as an emerging market economy when the DJIA was first calculated. The incredible success of the US economy since 1896 has been the driving force behind the rise of the DJIA to today’s value of over 24,500! The modern notion of socially responsible investing was as remote for Messrs. Dow and Jones as the idea of color motion pictures. It was simply inconceivable at the time.

General Electric is the only modern company to have been a part of the index at the beginning. GE was out of the index for a time, but has been a continuous component since 1907. This past week, however, the index committee announced that GE was being replaced by Walgreens Boots Alliance. The change will take place this week.

GE has struggled recently and its share price has fallen to the low teens from over $30 in late 2016. New management is pursuing a restructuring strategy and investors have yet to be convinced the new plan will deliver the goods.

The Dow is a price weighted index as opposed to a market capitalization weighted index like the S&P 500, for example. This means that high priced shares have a disproportionate impact on the index relative to low priced shares. Dow component Boeing trades around $339 a share, for example, as opposed to GE which currently trades around $13. A one percent move in Boeing would have 25 times the impact of a one percent move in GE. In that light, it’s not surprising that GE is being replaced in the index.

Getting booted from the Dow is not always the curse it might seem. When AT&T was replaced by Apple, it gained 15% in the following year. When Hewlett-Packard was replaced by Visa, it gained 73% over the next year. When Alcoa was replaced by Nike, it gained 96% over the next twelve months.

As we all know, past performance is no guarantee of future success. That said, I’m sure a year of outsized performance is just the kind of movie the team at GE would like to see. As always, it will be interesting to see how things play out this time around.

Mike Masters


A Trillion Dollar Return


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.

Cam Simonds