In this low-interest rate environment, investors are understandably looking for stocks that pay meaningful dividends. However, many companies continue to use stock buybacks to return shareholder cash in lieu of dividends. For the quarter ended December 2010, S&P 500 companies bought back $86 billion of stock and paid out $55 billion in dividends.
Frankly, I'm generally not a big fan of buybacks and think dividends are a better deal for most individual investors. On average, companies tend to either buy back stock for the wrong reasons (e.g. artificially boost earnings per share, executive compensation, etc.) or at the wrong time.
If a company buys back its stock at good prices, that's wonderful, but so many companies are terrible value investors. Consider that in 2007, when the market was hitting record highs, S&P 500 companies bought back a record $589 billion versus $246 billion in cash dividends; in 2009, when the market was around its nadir, buybacks hit record lows.
It's hard to imagine a worse use of shareholder cash, except maybe if they had lit the cash on fire. Still, buybacks are here to stay, so investors need to know how to separate good buybacks from bad ones.
Meet the augmented dividend
When I spoke with NYU professor Aswath Damodaran in February, he suggested that in light of the buyback reality, investors should consider the "augmented" dividend yield, which combines the cash dividend yield and the stock buyback yield.
I've since applied the augmented dividend yield to my regular stock screens and focus on those stocks with a cash dividend yield higher than 3% and an augmented dividend payout ratio below 100%.
This helps reduce two problems I have with buybacks. First, with the S&P 500 yielding less than 2%, stocks yielding 3% could be trading in value territory, so the companies that are buying back stock now could be doing so prudently. Second, I prefer to see companies that can afford their dividends and buybacks and don't need to borrow to fund the programs.
Here are 10 companies that show up on my screen:
|
Company |
Dividend Yield |
Augmented Dividend Yield |
Augmented Dividend Payout Ratio |
|---|---|---|---|
|
ConocoPhillips |
3.7% |
9.0% |
72.0% |
|
Intel |
4.0% |
8.5% |
77.0% |
|
Northrop Grumman |
3.0% |
5.9% |
58.0% |
|
Cincinnati Financial |
5.7% |
5.9% |
71.0% |
|
Bristol-Myers Squibb |
4.6% |
5.6% |
88.0% |
|
Sysco |
3.4% |
5.0% |
89.0% |
|
Johnson & Johnson |
3.5% |
4.4% |
71.0% |
|
Wisconsin Energy |
3.4% |
4.3% |
72.0% |
|
Public Storage |
3.4% |
4.3% |
99.0% |
|
Genuine Parts |
3.5% |
4.3% |
67.0% |
Source: Capital IQ, a division of Standard & Poor's, as of June 27.
A number of these companies might show up on a dividend-focused investor's radar anyway. Intel, Bristol-Myers Squibb, and Cincinnati Financial already yield more than twice the market average and have been buying back stock, to boot.
On the other hand, based on the cash dividend yields alone, a high-yield investor may not get too excited about Northrop Grumman or Sysco, but when you include buybacks, both stocks yield more than 5%, making them much more attractive candidates.
ConocoPhillips may be on a few radars with its 3.7% cash dividend yield, but its net buyback yield of 5.3% makes it look even better. Going forward, however, Conoco's buybacks will largely be determined by energy prices and could thus be volatile.
One risk of the augmented dividend yield is that buybacks tend to fluctuate much more than dividends, so a good track record of buybacks is important. Northrop Grumman and Intel, for example, have bought back meaningful amounts of stock in each of the past five years.
Foolish bottom line
If you're looking for stocks that pay you back, be sure to include the augmented dividend yield in your research. Some stocks' cash dividend yields may be sufficient, but taking account of buybacks could make some stocks look even better, as long as those buybacks are employed properly and prudently.
