These Dividends Are Bigger Than You Think

Dividends are great. They're a very visible, verifiable way for companies to share their profits with shareholders. And at the end of the day isn't getting a slice of the profits what being a shareholder is all about?

But many companies are reluctant to get too aggressive about raising dividends too quickly. Dividend aristocrats like Clorox (NYSE: CLX  ) and Coca-Cola pride themselves on their long, unbroken streak of dividend increases, and if they were to suddenly bump the payout significantly, it could make it more difficult for them to continue their streaks.

Even companies that don't have the aristocrat title recognize that many dividend investors like to have a dependable payout level and get pretty upset if the company has to cut the payout down the road. So it behooves these companies to keep their payouts at very maintainable levels.

As a result, many companies look for other ways to return additional capital to their shareholders. And sometimes, those ways can slip the capital past dividend-investors' noses without them even noticing it.

Yes, I'm talking about buybacks
I'll say right up front that in general I'm not nearly as fond of buybacks as I am of dividends. The primary reason is that companies just don't seem to be as disciplined about buybacks as they should be.

In an ideal world, all companies with extra cash would be ready and willing to buy back their own shares. However, in that utopia they'd only ever pull the trigger when their stocks were actually at an attractive buy point. In practice, it seems like a lot of companies like throwing extra cash at shares no matter what the price, and sometimes the timing of the buybacks doesn't make a whole lot of sense.

Take Comcast (Nasdaq: CMCSA  ) for instance. Back in 2007 when the company's stock was trading at an average price-to-earnings ratio in the 30s, it spent more than $3 billion on share buybacks. Over the past 12 months, with the stock trading at multiples in the mid-teens, the company spent just $1.3 billion on buybacks.

Perhaps management has a view on the value of the company that I don't, but it sure looks like it was buying a lot of stock when the price was high and buying a lot less when the price was much lower.

Big money coming your way
Of course there are definite advantages to share buybacks over dividends though. Chief among them is the fact that investors don't have to worry about dividend taxes. And when buybacks are conducted when a stock is undervalued, the value to shareholders can be significant.

Adding together the impact of dividends and share buybacks, we can uncover companies that are far more generous with shareholders than their dividend yield alone reveals.

Company

Dividend Yield

Combined Yield

Combined Yield (1 year ago)

Combined Yield (2 years ago)

United Technologies (NYSE: UTX  )

2.4%

4.4%

4.7%

5.2%

ExxonMobil (NYSE: XOM  )

2.9%

5.8%

12.2%

13%

Procter & Gamble (NYSE: PG  )

3.2%

6.3%

6.3%

7.5%

Baxter International (NYSE: BAX  )

2.4%

6.2%

6.7%

7.2%

Lockheed Martin (NYSE: LMT  )

4.2%

11.5%

10.2%

11.7%

Source: Capital IQ, a Standard & Poor's company, and author's calculations. Combined yield = Total cash used on dividends and share buybacks divided by total market cap over the last 12 months.

To be sure, an attractive combined yield doesn't necessarily mean that a particular stock is attractively valued. For instance, back in late August I argued the Procter & Gamble's isn't an overly attractive buy right now. Share buybacks also have much more "here today, gone tomorrow" potential than dividends, so there's no assurance that these yield levels will hold. For confirmation of that, just look at how much Exxon's distributions fell over the past couple years.

That said, looking at the numbers this way can give investors a different perspective on the generosity of many cash-rich companies.

Do you own a company that's particularly generous with its shareholders? Head down to the comments section and let us know why it's a must-own.

Interested in dividend stocks? Click here to check out a free Motley Fool report, "13 High-Yielding Stocks to Buy Today." 

Coca-Cola is a Motley Fool Inside Value pick. Clorox, Coca-Cola, and Procter & Gamble are Motley Fool Income Investor recommendations. The Fool owns shares of and has written covered calls on Procter & Gamble. The Fool owns shares of Coca-Cola and ExxonMobil. Try any of our Foolish newsletter services free for 30 days.

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.

Fool contributor Matt Koppenheffer owns shares of Coca-Cola, but does not own shares of any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookies were harmed in the making of this article.


Read/Post Comments (35) | Recommend This Article (108)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 05, 2010, at 6:26 PM, SJLATTY wrote:

    The only shareholders that benefit from buybacks are those who are ready to sell and possibly insiders with underwater options.

    Buybacks do not increase revenue or benefit the balance sheet. There is no benefit to the ongoing shareholder. A higher P/E ratio does not make the shareholder any wealth.

    I would not buy a stock where I am bidding against the corporations "buy" position; I would be bidding against myself.

    Buybacking Shares is just that: BS.

  • Report this Comment On October 05, 2010, at 6:57 PM, timeinthewind wrote:

    Buffett likes buybacks more than dividends as they increase shareholder value (through the eventual per remaining share price increase) w/o any tax hit (unless you sell) vs dividends which are taxable events. Mary Buffett and David Clark wrote about Warren's perspective: "Since shareholders have to pay income tax on the dividends, Warren has never been too fond of using dividends to increase shareholders' wealth..... A neater trick that Warren loves is to use some of the excess money that the company is throwing off to buy back the company's shares. This reduces the number of outstanding shares -- which increases the remaining shareholders' interest in the company -- and increases the per-share earnings of the company, which eventually makes the stock price go up."

  • Report this Comment On October 05, 2010, at 6:58 PM, jm7700229 wrote:

    I'm afraid I'm with SJLATTY. If I'm not getting any cash in the buyback, what is the direct benefit to me? If the company has a dollar in cash, or a dollar in treasury stock, what is the difference? I can't spend either dollar. Buybacks should occur, of course, when the company has more cash than it can efficiently use without diluting earnings. By reducing shares outstanding, the price may go up, but theoretically holding the cash does the same thing. I'm afraid I don't get it. Maybe someone can explain it to me?

  • Report this Comment On October 05, 2010, at 7:01 PM, jm7700229 wrote:

    I just read @timeinthewind's comment, and again I don't understand. Dividends and capital gains are both taxed at 15% (at least until we get Obomaed), so the only difference is in timing: I can choose when I take the gain rather than needing recognize the dividend real time. Again, if someone can explain, I'd certainly appreciate it.

  • Report this Comment On October 05, 2010, at 7:28 PM, pkluck wrote:

    Dividends will most likely be taxed at ordinary income beginning 2011 while Capital gains will be taxed at 20% only if you sell. Throw in obamacare tax of 3.8% for dividends and you're looking at a top dividend tax rate of 45+ %. Buy back stock and the stock price goes up but no tax until you sell then at 20%. Seems like the better deal.

  • Report this Comment On October 05, 2010, at 8:13 PM, Glycomix wrote:

    According to Mary Buffet, Warren Buffett's former daughter-in-law who writes about Warren's investing methods, buybacks is one of the ways Warren Buffet used to avoid tax while increasing the value of his holdings.

    http://www.amazon.com/New-Buffettology-Techniques-Investing-...

    Contributors timeinthewind covered how it works and 'pkluck' above covered why.

    My question is simple. How do you discover which companies are doing buybacks?

    Are there free websites or do you have to subscribe to a premium service such as valuline as Mary suggested. Does another premium service a better value in quality/price? If premium services are better, which do you recommend fellow readers?

  • Report this Comment On October 05, 2010, at 8:53 PM, garno53 wrote:

    If you want a growth stock with grat dividends you go with the proven winner "MO"..Tobacco will always sell,regardless of the US Government warnings and Lawsuits,which includes the outrageous Settlements "thrown out there" (with Frivilious Lawsuits)..The US dosen't make this stock: THE WORLD economy will continue to Demand the Products..Good or Bad,it's probally the "secound" illeagal/Legal proffession in society..You decide ,but "MO" is there for the long-haul and they run a business for their shareholders.That's capitialism,or most important supply side economics !!!.

  • Report this Comment On October 05, 2010, at 9:01 PM, Rollerofthedice wrote:

    I totally disagree with your posture on buybacks. You assume that the market is completely rational, and furthermore that price moves after a buyback can be linked directly to it. These just are NOT the reality! Buybacks may be good, or bad, but they are in NO WAY equivalent to dividends from the investor's perspecrtive.

  • Report this Comment On October 05, 2010, at 9:32 PM, 11x wrote:

    When a company buys shares back, all the remaining outstanding shares become more valuable. Take for instance a company with this disposition in 2000:

    Earnings of $10

    Shares outstanding: 100

    Earnings per share: .10

    PE Ratio: 10x EPS.

    Price per share: $1.00

    in 2001, the company again earned $10 and spent the entire earnings on buying shares back.It could buy 10 shares. Now there's 90 shares outstanding.

    Next year again it earns $10, or .11 per share. The stock still trades at 10x earnings, or 1.10 per share. It buys back 9 shares. That leaves 81 shares outstanding.

    Next year again it earns $10, or .123 per share. The stock trades at 10x earnings, or, 1.23 per share. It buys back 8 shares (this is all it can afford at this point). That leaves 73 shares outstanding.

    Next year again it earns $10, or .137 per share. The stock now trades at 1.37 each because of this. I could go on, but you get the point.

    This example was a company that had no growth in earnings and traded at 10 x earnings. 10 x earnings is a low number but the reality is there are quality companies trading at these low levels right now. Each time a company buys shares back, the remaining shareholders have a bigger piece of the company and will have a higher EPS. There is no reason to be against share buybacks and it's silly to think shareholders don't get anything out of it.

    However I do agree with the author; companies do tend to buy shares back when the economy is good and stocks are trading at high PE multiples, and stop or reduce share buybacks when they are cheap in a recession, and sometimes will issue shares when they are cheap(!). Basically corporate management is prone to the same behavior "Wall Street lemmings" we hear about so much and are told to avoid being.

  • Report this Comment On October 05, 2010, at 9:59 PM, TerryHogan wrote:

    On the tax issue:

    If you hold shares in a taxable account and a dividend is paid, you are taxed that year. If an equivalent buyback occurs, you decide when you want to sell, take your capital gains, and then pay your resulting tax. If you plan on holding forever (a la Warren) then you never pay taxes (okay, your estate will).

    However, I would agree that corporations are usually poor timers when it comes to buybacks. I would much rather a special dividend, that way there is no future expectation of maintenance.

  • Report this Comment On October 05, 2010, at 10:28 PM, tomunc wrote:

    I am NOT a big fan of buybacks. In many cases they could just be additional shares that will be awarded in the future to directors at a discounted price, something that we all just really love. Top executives exercising their options for about 20% of the current share price and selling them immediately for an 80% profit. What's not to love about that?

  • Report this Comment On October 05, 2010, at 10:33 PM, LakeEffect wrote:

    At one time, buybacks could be considered a reasonable use of excess capital. Today, more often than not, they are used to offset the dilution caused by excessive stock options awarded to employees. The former is in the shareholder's best interest, the latter is not. For that reason, it pays to be skeptical when a company's announces a buyback.

  • Report this Comment On October 05, 2010, at 10:44 PM, TMFKopp wrote:

    Great comments. Thanks all for reading and for the thoughts.

    I just want to highlight 11x's comment above -- that describes perfectly why buybacks can be desirable. In short, they reduce the number of total shares outstanding so more profit accrues to each share held.

    The key, as some have already pointed out, is that management properly values the stock and does the buybacks at the right time. As investors ourselves, we know that we can get more value out of $1 by buying a stock worth $1.25 when it's selling at $1. Likewise, we're worse off when we spend $1 on a stock really worth $0.75.

    The same holds for buybacks. When a company's stock is worth $1 and it's selling for $0.75, shareholders benefit when the company buys back shares. When a company's stock is worth $1 and the company is buying back shares at $1.25, management is squandering shareholder capital.

    The perverse thing about share buybacks is that companies tend to do them when they're swimming in cash. Most companies end up swimming in cash when times are good. When times are good, stocks tend to be fairly- or over-valued. On the flip side, they end up with less cash when times are bad and shares are beaten up, and therefore can buy back fewer shares when shares are cheap.

    Be on the lookout for managers that up dividends or hang onto cash during good times and then ramp buybacks when the stock falls. That's the manager you want allocating your company's capital.

    Matt

  • Report this Comment On October 05, 2010, at 10:53 PM, TMFKopp wrote:

    @Glycomix

    "My question is simple. How do you discover which companies are doing buybacks?"

    Two suggestions off the top of my head.

    1) Go to news.google.com and search "buyback" and permutations of that. Right off the top I can see that Chevron, Washington Post, GameStop, TI, and Tyco have some buyback action going on.

    2) Go to caps.fool.com. Look up a particular ticker you're interested in. Click the "Statements" tab and then the "Cash flow" tab. In the "Cash flow used for financing activities section" there's a line titled "Repurchase of capital stock." Those are your buybacks. You can also measure them on a net basis by backing out the capital stock issued.

    Also, keep your ears open during the upcoming earnings season. Companies LOVE to talk about share buybacks when they announce earnings.

    Matt

  • Report this Comment On October 06, 2010, at 4:15 AM, aamcadams wrote:

    I don't like them for two reasons

    1) Already mentioned, no discipline in repurchase.

    2) Are they "buying" them back, only to award them to themselves? [In that case considering the lax timing of the purchases aren't they buying high with my cash?]

  • Report this Comment On October 06, 2010, at 4:19 AM, wrkdiver wrote:

    It just seems to my simple brain that tin your Comcast example the ratio of money spent to stock p/e is pretty close to the same, if you get what I mean.

  • Report this Comment On October 06, 2010, at 8:46 AM, MarkoPilgrim wrote:

    Quick question: Are corporations able to claim a buyback as an income deduction or are the buybacks done with after-tax dollars?

  • Report this Comment On October 06, 2010, at 10:06 AM, TMFKopp wrote:

    @wrkdiver

    The ratio you're looking at doesn't really matter that much. Yes, when a company's stock is more expensive they're going to need to spend more money to buy back the same number of shares as when the stock is cheaper. However, the point is that when the stock is expensive, the company really should be disciplined about simply buying back fewer shares.

    @MarkoPilgrim

    As far as I know, it's all after-tax dollars.

    Matt

  • Report this Comment On October 06, 2010, at 11:14 AM, gimponthego wrote:

    This is my first year delving into the wild and wooly world of dividends! So far, so good. I'd anticipated an easy buy, hold and get paid..unaware of the ex- T-minus 3, etc. However, after learning a few valuable lessons, things have worked nicely with NLY, MO, and several others. If I can learn to pull a rabbit out of a hat, anyone can...and I strongly suggest you do so. Especially, if you're retired as we are.

    Debt free doesn't hurt..at 65 I can say life is great as long as you do your own DD and research. "Advisers, Brokers and Funds" are things I avoid like the plague, IMO. Happy trading and Investing! Johnny/San Antonio

  • Report this Comment On October 07, 2010, at 2:23 PM, Piddlepuppy wrote:

    11x makes me think of Auto Zone. They don't pay a dividend, but they are buying back around 5% of their stock (announced in August I believe). I've seen critical comments about the company, but over 35% of the stock is insider owned.

    I'm not sure if they pay a dividend or not.

  • Report this Comment On October 07, 2010, at 5:40 PM, mikecart1 wrote:

    Article is misleading. No way in the world am I going to trade set dividend stocks to those with lower dividends and "possible" buybacks.

  • Report this Comment On October 08, 2010, at 9:14 AM, gimponthego wrote:

    Can someone please tell me when MO pays it's dividend. I know it's shortly. Thanks, Johnny

  • Report this Comment On October 08, 2010, at 12:07 PM, grindelsa wrote:

    I recently bought 3 stocks just for the dividend income. They are NLY, PM, and T. That is a REIT, a tobacco company, and the phone company. I immediately put stops at a level I felt would protect my core investment. In the six weeks I have owned them they have gone up almost 5% invalue all together (the REIT is lagging the other two). So far I am happy with my investment.

  • Report this Comment On October 08, 2010, at 12:09 PM, timeinthewind wrote:

    Even if you are not a "never sell", Buffett-like investor, there is a lot to be said for controlling the timing on taxes. My aspiration is to be semi-retired in my 50's. At least in theory, my tax rate will be much lower on a semi-retirement income than it is right now (and will be next year if the Dems get their way). All else being equal, buybacks are better than dividends for me as I don't need current income from stocks and if I sell some in my 50's to supplement a more modest income I'll have lower taxes than if I have to pay tax on dividends now. I also be living in a state with no state income tax which will save me money compared to where I live now.

    All that said, all is not equal and due diligence still matters. Buybacks aren't something to predict and angle for, they are a good result of a good business investment. Pick the right companies first and foremost but if it is a tie, the one with a history of buybacks and share price growth looks better to my situation than the one paying dividends.

  • Report this Comment On October 08, 2010, at 1:13 PM, MBRECRUITER wrote:

    MO should pay dividend 10/10/10 Bought MO 9/27/02 up 174% and 234% on dividend reinvest AND, it spun off PM up 141% and 208% on dividend reinvest AND it spun off KFT up a paltry 106% and 157% on dividend reinvest. (seems people like smokin more than eatin;^) I'll take the surety of dividends any day over the maybe of buybacks.

    If you really like high yeild with minimum risk, look at JH closed end funds. HPI bought 8/03 -17% up 65% with dividend reinvest-trades at .40 discount to NAV. BTO bought 4/20/09 up 34% and 32% with dividend reinvest and it trades at 1.90 discount to NAV XBTOX. Look at the historical yields on just those two JH C/E funds

    Later!

  • Report this Comment On October 08, 2010, at 2:16 PM, DESERTKAT42 wrote:

    Once again Dave is touting the big dollar stocks, there are great ones out there that are under 10.00 like a canadian stock YLWpF canadian yellow pages. pays .065 pr month with a stock price of $5.44. even with the 15% tax to canada that is still a net income of 12% and it is cash in my pocket that I can spend - not look at on a balance sheet. It also increases my portfolio value buy allowing me to expand and buy a diverse array of stocks. Come on Dave get it down where the working guy can make some money as well. and there is lots of it out there.

  • Report this Comment On October 08, 2010, at 2:18 PM, donknipe wrote:

    'Just returned from a month in Europe and I can tell you it's SMOKIN!

    Bought PM immediately upon my return.

  • Report this Comment On October 08, 2010, at 4:06 PM, altruria wrote:

    I prefer dividends because I do most of my investing in a roth IRA where there is no tax. I prefer the money whereby I can deploy it, rather than shrinking the outstanding shares which may or may not affect the share price. I know in theory that fewer shares boosts EPS but smetimes it is used as a tool to keep earnings from stagnating or slipping.

  • Report this Comment On October 08, 2010, at 5:16 PM, jmweese wrote:

    I have long heard the argument for share buybacks but in the end how do those who strongly support share buybacks answer this question: how do share buybacks pay for my groceries every month?

    As a dividend lover, I invest with the goal that in retirement my dividends will either be my income or supplement it. My prinicpal will remain the same and, hopefully if I do my due diligence, my dividend payments will keep rising every year. But what do share buybacks do for me? To convert those into cash, I will have to sell my existing shares (thus reducing my principal) and what if I must buy groceries in a huge down market (like Sept. 08 through March 09)?

    I would offer the following link concerning share buybacks: http://www.dividendtree.net/opinion/does-share-buyback-retur...

  • Report this Comment On October 08, 2010, at 7:29 PM, cgscouten wrote:

    Agree with jmweese. Buybacks typically pay off management, not ordinary shareholders. Look for a dividend in dollars not a mirage.

  • Report this Comment On October 08, 2010, at 8:30 PM, ativana wrote:

    Try AGNC, GOL, SB all of them pay dividends above 5%.

  • Report this Comment On October 10, 2010, at 2:14 PM, lbjack wrote:

    I think making a buyback part of a "combined yield," as the author does, is a bit facile.

    In principle, growth and income are mutually exclusive. You either pay out your earnings or reinvest them. Income investors are not interested in growing their stock's price but in growing or at least maintaining the dividend. A company that attracts capital as a dividend play breaks faith with its investors by reinvesting in the form of a buyback. (Of course reinvestment in the business is necessary to maintain viability.)

    As someone has said regarding Buffet, if you want to buy stocks just to put them away and collect the dividends, then the only benefit of price growth is to your estate, which has its own merit. Of course, most gains are worth an awful lot of dividends, but to realize them you have to reduce your shares, thereby reducing your income.

    Another thing to consider is that a dividend is compensation for tying up your capital. You can make far more by using that capital to make a business, but win or lose, there goes a good part of your life. And life is short. If you can raise the capital for $5K/mo. in dividends, then you have yourself a nice wad of walking-around money.

    By the way, AGNC is too good to be true. (I have some. Silly me.)

  • Report this Comment On October 11, 2010, at 12:33 PM, stephenbfool wrote:

    complete rubbish. this speaks such volumes about the ignorance of the author, who probably heard those fairy tales in finance 101 bus. school.

    the editor should get rid of such guys.

  • Report this Comment On October 11, 2010, at 3:31 PM, MJH1959 wrote:

    11x wrote that the company was earning $10 every year for multiple years in which case you don't want to be owning shares in that company as its total earning should be rising. Try the same calculations with say half of the earnings paying dividends and half buying back shares and an increase of total earnings of say 5 or 10%. That seems like a winner. Earnings per share go up because of the buyback and because of growth also you dividends go up for the same reasons.

  • Report this Comment On October 12, 2010, at 3:58 PM, Don5757 wrote:

    Any opinions on BPT's 7-8% Dividend?

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