Updates for KG Meyer, PC now that we are nearing the end of the summer. It has been an outstanding year so far for the markets in general. With December being what it was, yes the markets have made a good run of things so far for 2019. We are at or near all-time highs for all the major indexes from the Dow to the NASDAQ and yes the S&P 500 has gone through the roof. For all of these records highs, there is an area of the markets that does concern me a bit, and that is the amount mature, established companies pay in dividends and what seems to be wasteful spending on share repurchases.
Dividends
I just finished a book that is several years old but seems relevant today none the less. It was entirely about how mature; established companies were paying about 30% of their free cash flow as dividends to owners of the company. And that does still seem relevant if you look at the dividend yield on the S&P 500, which encompasses about 75% of the US markets. Now the dividend yield for the S&P 500 has been all over the spectrum from a low of about 1.1% in 2008 to about 13.8% in 1938. So where is it currently? Right now, the dividend yield is right at 1.85% which is too low for an index that is comprised of the largest 500 US companies and many that are mature with growth rates right at GDP levels of 5%.
If the economy is going so well and stocks are at all-time highs, why is it the dividend yield is so low? Until the 1990s, most companies that paid a dividend did so at much higher payout rates, 50% or higher compared to the current level of 30%. Yes, several S&P 500 companies have dividend yield much higher than the 1.85% average. To name a few, there is AT&T at 6.03% and Verizon at 4.28%. So how safe are these high yielding dividends? I am not going into that in this post but say it to suffice your need to do your analysis on any security you own, and dividend-yielding stocks are no different. And there are many technology companies in the S&P 500 that pay no dividends at all, approximately 80. And some of the largest companies in the index pay extremely low dividends and considering how much cash they generate it may not be the best use of shareholder funds. Consider that Apple has billions in cash reserves yet only has a dividend yield of 1.49%. Exxon Mobile, whose industry does generate lots of cash, but also is very cyclical, has a yield of 4.64%, meaning it may be using free cash flow to benefit shareholders.
When it comes to the S&P 500 over four-fifths of the companies, pay some form of a dividend. But is the dividend payout at the level it should be, or is there another use of free cash flow that is taking away from these companies paying us a larger dividend? Consider this, over a hundred years, the dividend yield has been around 4% and is now less than half the historical average. Why is that?
Share Buybacks
In the 1990s there appeared to be a shift away from companies paying a larger portion of their free cash flow to shareholders as dividend going from a percentage over 50% to one about 30% today. So, what happened to all the money that these companies made since the 1990s? Some of that money went to mergers and acquisitions that may or may not have been a good use of money depending on if the combined business was a successor more likely failure. Yes, there have been some extremely successful mergers, but many end up being extremely costly and turn into a negative for the buying company.
Which brings us to share repurchasing or buybacks, this use of shareholder funds is designed to decrease the number of shares available in the open market, thereby driving demand and the price up for any outstanding shares. And this would make sense if companies did the repurchasing when the market was strong as it is now. By buying in market conditions similar to what we have now, companies are paying high valuations for these shares that they are going to retire. It would make more sense to wait until the markets cool off before going into the markets to purchase shares when the prices are depressed. But it seems companies tend to buy when the economy and markets are strong because that is when they are flush with cash.
Another reason why share buybacks never work out the way a company intends in many instances is due to employees exercising stock options that were part of their compensation packages. By buying back the shares at the same time, employees are exercising options, it keeps the overall level of outstanding shares fairly constant and not becoming diluted due to the options. And if this is the reason for the buybacks it would be better if the company were upfront and transparent with their intentions. But in most cases, they state the reason is to add value to existing shareholders by decreasing the number of shares outstanding and then turning around and fulfilling options to employees that immediately places the number of shares right back where it was before the buyback.
If a company were interested in decreasing the number of shares available, it would make sense to perform a buyback, in theory, to increase per-share value. But for this approach to work, they must refrain from giving employees stock options or issuing new shares after the buyback is complete. And few companies have done this with any success though many have had success in keeping the number of shares outstanding level by using both methods.
How the Stock Market Operates
Over two years ago, I released my book, “How the Stock Market Operates” on Amazon, and it has done fairly well. Then a few months ago in conjunction with a narrator, I had the book converted to an audiobook available on Audible and iTunes. Since then, that too, has done extremely well for me. I am looking for people to give honest reviews for all my books but especially this book. I have several free audiobooks available in exchange for honest reviews on Amazon. If you are interested in receiving a free copy of “How the Stock Market Operates” send me an email at kirk@kgmeyerpc.com, and I will send you a link to the free audiobook. If you would like to purchase a physical copy of the book or a Kindle version, please visit https://amzn.to/2Yoowx3.
If you have any questions or would like to leave a comment, I always welcome those. If you need financial planning or learning how to maximize your Social Security benefits, please reach out to me at kirk@kgmeyerpc.com. To join our newsletter, please fill out the form below.
