Dividends Aren't Enough: Natural Gas Pipelines

I love cash. As an investor, nothing makes me happier than a company that returns money to shareholders, rather than spending it recklessly on a CEO's pet projects or an ill-fated acquisition. Historically, investors have often looked at a stock's dividend yield to identify these shareholder-friendly enterprises. But I prefer a slightly different metric -- one proven to further maximize investor returns.

A 2007 study in The Journal of Finance suggests that investors should also factor net share repurchases into the equation, through a metric called the net payout ratio. According to the authors of the study, this ratio not only identifies companies that are paying back investors, but also predicts future equity returns better than the dividend yield.

Let's crunch the numbers
To find the net payout yield, start by adding up all the cash the company spends on both dividends and share buybacks. Next, subtract its share issuances. Finally, divide the resulting number by the company's current market cap.

The ratio that you end up with represents the percent of each invested dollar that a company is returning to shareholders. This simple calculation handily allows us to adjust for shares issued through employee stock options and other forms of shareholder dilution. Some companies will spend a lot of money buying back shares just to counteract the dilutive effect of their stock compensation programs, without creating any value for shareholders.

Here are the net payout yields for a few companies in the natural gas distribution industry:

Company

Net Payout Yield (TTM)

Dividend Payments (TTM)

Net Share Repurchases (TTM)

Market Cap

Kinder Morgan Energy Partners (NYSE: KMP  )

(0.2%)

 $880

 ($919)

 $20,822

Enterprise GP Holdings (NYSE: EPE  )

4.3%

 $291

 $0  

 $6,727

ONEOK (NYSE: OKE  )

3.5%

 $182

 ($21)

 $4,598

Energy Transfer Equity (NYSE: ETE  )

6.2%

 $479

 $0  

 $7,747

Source: Capital IQ, a division of Standard & Poor's. Payout yield is author's calculation. All dollar figures in millions. TTM = trailing 12 months.

It's also interesting to look at the emphasis that each company puts on dividends versus stock buybacks:


How powerful is this payout?
Based on the analysis above, Enterprise, ONEOK, and Energy Transfer all look like potential buys for investors searching the natural gas utility industry for a stock with a solid net payout yield. As you can see from the data above, these companies have made a strong commitment to returning cash to shareholders.

Keep in mind that this data only looks at trailing-12-month numbers, so it does not correct for recent changes in a company's dividend or buyback policy. While dividends tend to remain fairly stable, share buybacks can vary substantially from year to year. Investors should also look at a company's dividend payout ratio to make sure the dividend is sustainable, and examine historical buyback patterns to ensure that the buybacks aren't a one-time event. If you can build a diversified portfolio with a few of these high yielders, healthy returns -- and plenty of cash -- are likely to follow.

Motley Fool Hidden Gems analyst Jeremy Myers does not own shares of any company mentioned. ONEOK is a Motley Fool Income Investor recommendation. Try any of our Foolish newsletter services free for 30 days. The Motley Fool has a disclosure policy.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.


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  • Report this Comment On October 24, 2010, at 11:48 AM, pscalare wrote:

    I believe the analysis is flawed,especially in the case of MLPs. MLPs tend to distribute all available cash to general and limited partners (as per their partnership agreement). So in order to grow assets they need to either issue additional debt or issue new shares. The analysis method you espouse penalizes the issuance of new shares but ignores the issuance of debt. MLPs will use either method of raising capital, depending on several factors, including the cost and availability of capital. In the case of MLPs look carefully at distribution growth. This can vary widely.

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