The Dow Can't Afford to Pay You Any More

Investing in stocks is risky business. That's why it's always nice to find a company that makes a habit out of rewarding you for taking on that risk of ownership. When everyone thinks about how stocks reward us, they think about dividends, but share repurchases are another huge way companies effectively return money to shareholders.

Not all dividends and share repurchases are created equal, though. Sometimes a company is holding back, and other times they're spending more than they can afford and will probably have to restrict future generosity. To figure out where everyone's favorite index, the Dow Jones Industrials Average (INDEX: ^DJI  ) , stands on this spectrum, I looked at all the cash each component has returned through both vehicles over the past five years, and I divided it by the total earnings of all the companies over the same period.

She's giving you all she's got, cap'n!
Given that the Dow yields 3% on average, below its historic mean, and that we've seen record corporate profits coming out of the recession, it's tempting to think companies are holding out on us, but that's not the case on the Dow.

On average, the Dow has returned 91% of its earnings to shareholders over the past five years. Complain as we may about companies that don't reward us enough, that's not bad. While there is technically a little room left for more handouts, it's about as high as we can reasonably expect.

A penny earned is two spent
Looking at specific companies reveals some surprising results. In what seems like typical reckless Wall Street fashion over the past few years, Bank of America (NYSE: BAC  ) has paid out 151% of its earnings to shareholders. That figure is mostly due to big dividends and share repurchases in 2008 and contrasts with big losses in later years that caused the payout to climb above 100%. You'd think that with cutting its share repurchases in 2009, running the numbers again by looking at just the past three years may yield a more conservative figure, but that's not the case. Looking at it that way, the payout actually climbs to more than 400%. Really confidence-inspiring to think that these are some of the financial architects of the modern world, isn't it?

But B of A isn't even the worst offender over the past five years. That honor goes to Alcoa (NYSE: AA  ) , which has paid out 306% of its earnings over that period. To make it clear, that means  Alcoa has paid out three times as much as it has earned over the past five years.

These trends are clearly unsustainable -- and it's not just B or A and Alcoa, either. More than 40% of Dow stocks paid out more than they earned over the past five years.

Who does it right?
On the flip side, Caterpillar (NYSE: CAT  ) doled out a conservative 54%. That's interesting to me, because Cat is regarded as one of the riskier Dow stocks right now -- yet here we  see prudent cash management with room for upside. Then again, considering the cyclicality and capital-intensive nature of its business, it makes sense why Cat would need to keep more in-house.

General Electric (NYSE: GE  ) has a better track record than most. It returned a still handsome but far more sustainable 88% of its earnings over the past five years. To do so, the company put a leash on share buybacks, making about 75% of its purchases over the past five years in 2008 alone and then dialing back sharply.

You could argue that GE should have bought back a few more shares when they were trading at dirt cheap 2009 levels, but when you're looking at investing in a company over the long term, it's more important that it's able to sustain those payments than anything else. In addition, 2009 was a time of such high uncertainty and weakness inside GE that having kept money in-house to shore up GE Capital will probably pay more outsized gains over the long run than some timelier share repurchases.

There is a better way
With the Dow yielding 3%, but paying out almost everything it has, it's unlikely we'll see things go even higher. But you can still get huge yields elsewhere -- yields that could get even bigger. Check out our list of nine rock-solid dividend stocks. You can learn about the companies that made the cut -- including some great non-Dow names -- by reading our totally free special report.

Austin Smith owns no shares of the companies mentioned here. The Motley Fool owns shares of Bank of America and has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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