Did American International Group Make a Huge Mistake By Ignoring Its Dividend?

Source: AIG.

It's always nice when you come into some extra cash, but finding the best use for it can sometimes be a troublesome endeavor. With American International Group's (NYSE: AIG  ) recent sale of its International Lease Finance Corp. to AerCap, the insurer found itself with $2 billion in proceeds. But did adding the funds to reinforce its current share repurchase plan make the most sense for shareholders?

Burning a hole in its pocket
There's been a lot of speculation surrounding the uses for the $2 billion in proceeds AIG received from its sale of ILFC -- and now we know where it's going: share buybacks. The insurance behemoth's board of directors announced last week that it had approved a $2 billion increase to its current buyback authorization, resulting in $2.12 billion available to purchase shares. The company has already spent $867 million on share repurchases this year.

But with a so-so 0.9% annual dividend yield, some shareholders may be discontent with management's focus on reducing outstanding shares. Let's take a look to see which distribution methods really serve AIG shareholders best.

A little dividend math
If AIG applied its current authorization toward dividends instead of buybacks, it has two options: It could pay out a one-time special dividend of $1.45 per share, which is 3% of the company's closing share price on Wednesday of $54.78; or it could devote the funds to quarterly dividends, which would allow for 11 quarters of doubled payouts ($0.25 per share versus current $0.125).

Despite the appeal of doubling its payout to shareholders, the cautious approach of AIG's management toward its dividend payments hardly jives with setting up a commitment to continue the $0.25 quarterly payout once the current surplus of cash runs out -- since decreasing the dividend after those 11 quarters would hurt its share price -- so we'll ax that option.

Though special dividends are one-time items, they usually aren't included in dividend yields, but we want to gauge the company's payouts to shareholders. So, if we look at the special dividend option, AIG's 2014 dividend yield would jump to 3.6% -- not bad, but it's just for this one year.

Does that one-time boost in payouts beat the benefits of repurchasing shares?

More purchases through share buying
In short -- no.

As of Wednesday's close, AIG's stock trades at a 31% discount to its book value. By focusing on share repurchases, the insurer's management is able to reduce the number of outstanding shares by 2.7% (assuming the entire authorization is used) at a big discount to its internal valuation.

The company's buyback yield (repurchases/market capitalization) hits 3.8%, including the $867 million of shares already purchased during the first quarter. On its own, the buybacks already pose a greater return to shareholders on their own than a special dividend, but when you add in the 0.9% yield from regular dividend payments, AIG's shareholder yield for 2014 could hit 4.7%.

Other benefits
Thanks to the discounted share price, AIG is able to return more value to its shareholders through its share repurchase program. On top of the yields for this year, the potential share buybacks provide longer-term benefits for both AIG and its investors. Investors will see positive results from the buybacks in three ways:

  • Ownership gains: With the number of outstanding shares on the decline, you'll own more of the company without having to shell out more of your own money.
  • No taxes: A special dividend would be heavily taxed, whereas the ownership gains you receive from buybacks are not.
  • EPS growth: Thanks to the share repurchase, EPS will be boosted, which can be a big attraction for new investors -- potentially leading to higher share prices (aka, gains for you).

For the insurer, the buybacks reinforce its balance sheet and may actually make paying dividends easier as higher earnings are paid out to fewer investors.

Right choice
Investors may like more cash on hand, but the renewed emphasis on share repurchases from AIG's management actually serves its shareholders better than providing a special one-time dividend or taking the risk of increasing quarterly payouts from sales proceeds instead of true operational growth.

The opinion battle over which capital distribution method is superior for investors will continue on, but for now, AIG and its shareholders are best served by management's big share repurchase strategy.

Looking to beat AIG's dividend?
Here's your chance to pocket big dividends. Over time, dividends can make you significantly richer. And guess what? The big banks are laggards when it comes to paying dividends. So instead of waiting for a cash windfall that may never come, check out these stocks that are paying big dividends to their investors RIGHT NOW. Click here for the exclusive free report.


Read/Post Comments (0) | Recommend This Article (2)

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.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2992524, ~/Articles/ArticleHandler.aspx, 9/19/2014 12:04:17 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 17,300.54 34.55 0.20%
S&P 500 2,012.95 1.59 0.08%
NASD 4,587.62 -5.80 -0.13%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

9/19/2014 11:48 AM
AIG $55.27 Down -1.06 -1.88%
American Internati… CAPS Rating: ****

Advertisement