Buybacks & Dividends – A Trillion Dollar Offer by Aranca Investment Research

Among the sectors, Information Technology with Apple continued to lead in Q1 15.

Since 1995, the S&P 500 buyback index has provided better returns than the benchmark S&P 500 index.

Corporate America’s performance in early 2015, along with the expected growth for full-year 2015, will continue to expand the capital return program to investors at an astounding figure of more than US$ 1.0 trillion.

NEW YORK – Aranca’s Investment Research practice, the global research and analytics company, today released its new report “Buybacks & Dividends – A Trillion Dollar Offer”.

Strong macro numbers, exceptionally low interest rates and a healthy recovery in profits after the economic crisis have made several S&P500 companies financially stronger. Ample cash reserves have increased their appetite for buybacks and dividends. Investors have welcomed both the payout strategies, with the buyback index significantly outperforming the benchmark over the past three years. The generous trend of strong shareholder returns is expected to remain robust in 2015, given the confidence among companies to pursue their business plans, supported by significant cash and stable economic recovery.

Strong Rebound In Buybacks And Dividends After Financial Crisis

Buybacks and Dividends Touch US$ 904 bn

S&P 500 companies continue to increase their shareholders’ payout, with strong rebound in buybacks as well as dividends since the financial crisis. Companies have spent nearly $2.3 trillion on buybacks since 2009, supporting the bull run in which the index has more than tripled during the period. In 2014, S&P 500 companies spent more than 90% of their earnings on buybacks and dividends.

In 2014, total expenditure on buybacks and dividends touched a record high of $903.7 bn, increasing from $787.4 bn in 2013. Buybacks represented a larger share of the total (61%), rising 16% Y-o-Y to $553.3 bn, little shy of its highest point in 2007 ($589.1 bn). However, this is higher than the low of $137.6 bn registered during the recession in 2009. On the other hand, dividends reached a record high of $350.4 bn in 2014 (up 12% Y-o-Y), indicating a healthy corporate America.

Buybacks for Q1 15 totaled $144.1 bn, up 8.7% from $132.6 bn in Q4 14, while dividends rose 0.8% to $93.6 bn, as cash-rich companies continue to reward stock investors. However, buyback participation slid marginally during the quarter, with fewer companies reducing their share count. In Q1 15, 299 corporations reported buybacks, down from 308 in Q4 14, although higher than 290 in Q1 14.

S&P 500 Companies – Dividends and Buybacks (US$ bn)

Buybacks & Dividends

Source:S&P Dow Jones Indices, Aranca Research

Information Technology Leads the Pack

Among the sectors, Information Technology continued to lead in Q1 15, with buybacks as a percentage of the total in Q1 15 remaining at 24.3%, marginally up from 24.2% in Q4 14. Apple continued to dominate, with nearly $7.0 bn of buyback activity during the quarter. Among other large contributors, Financials accounted for 15.6% of all the buybacks during the quarter, followed by Healthcare (14.5%), Industrials (14.0%), and Consumer Discretionary (13.3%, second best performer in Q4 14). This reflects the cyclicity in the sector.

Five of the ten sectors witnessed a sequential percentage decline in spending on share repurchases, led by the Energy sector. The Telecom sector was a surprise, recording the largest percentage increase on buybacks. Verizon Communications joined the buyback market, spending $5 bn during the quarter after registering $92 mn in Q4 14. This resulted in a total sector spend of $5.2 bn in Q1 15.

S&P 500 Companies – Sectoral Buybacks (US$ bn)

Buybacks & Dividends

Source:S&P Dow Jones Indices, Aranca Research

Some of the major spenders, which led to the increase in buyback expenditures in these sectors, are as follows:

Total Buybacks Over The Past Five Years

Information Technology Healthcare Consumer Discretionary Financials
Apple Inc. ($79.9 bn) Pfizer ($41.6 bn) Comcast Corp. ($14.3 bn) JPMorgan ($25.0 bn)
Microsoft ($43.3 bn) Johnson &Johnson ($29.4 bn) Twenty-First Century Fox ($13.9 bn) Wells Fargo ($23.7 bn)
Intel ($34.9 bn) Merck & Co. ($21.4 bn) General Motors ($12.7 bn) AIG ($20.0 bn)
Oracle ($34.2 bn) Gilead Sciences ($15.8 bn)

Shareholder Payout Remains Higher Than Business Investment

Are Increased Payouts Hampering Investment Opportunities?

As a contrarian, the question to be asked is whether corporate America is lacking investment opportunities that offer them higher returns on investment, which in turn is leading to increased investor payouts. In recent times, top managements have increased their engagement in financial engineering compared with business investments.

The right mix – Companies have not stopped or lowered their capex investments. In 2014, capital expenditures and R&D expenses by S&P 500 companies rose 8.6% and 10.4%, respectively. S&P 500 companies continue to follow a disciplined approach to capex and R&D expenses, along with several new product launches. R&D expense in 2014 stood at US$ 31.9 per share, up from US$ 21.6 per share in 2009. It is about setting the right mix; cash governance could be through reinvestment in the company, mergers & acquisitions, repayment of debt, or returning value to shareholders through buybacks or dividends. In one of the recent earnings call, Apple’s CEO Tim Cook stated that the buybacks reflect its strong confidence in what lies ahead; the company raised its dividend by 11% and boosted its buyback plan by $50 bn.

If a company has sufficient funds to ensure the operational and liquidity requirements of its business, effective cash management would directly or indirectly enhance shareholder value.

S&P 500 Companies – Capital Usage (US$ bn)

Buybacks & Dividends

Source:S&P Dow Jones Indices, Bloomberg, Aranca Research

Is Undervaluation Leading to Higher Buybacks?

Buyback plans are believed to indicate that a company considers its stock to be undervalued. Several activist investors advised Apple to increase its share repurchase plan, stating that the company remains “dramatically undervalued” despite the rally and that raising buybacks helps increase shareholder value.

Since the start of the rally after the crisis, the increase in price-to-earnings multiples has been a major driver of stock gains. The S&P 500 index traded at a trailing P/E ratio of 12.6x in 2011 compared with the current multiple of 18.2x. The current P/E ratio still remains shy of a two decade long-term average of 19.5x.

Overall, a company should have a good reason to believe its stock is undervalued. For a company, even after spending on capex and innovation, along with miniscule debt, still has billions of cash lying around – doing a buyback indeed makes sense.

Companies With Largest Dollar Buyback Programs Outperform S&P 500

Since 1995, Buyback Index Yields Better Returns Than the Benchmark

From an investor’s perspective,  the key is to earn the highest return on every penny invested in stocks, be it from business growth or share buybacks. Since 1995, the S&P 500 buyback index has provided better returns than the benchmark S&P 500 index. Since 2009, the S&P 500 buyback index has been increasing at an annualized rate of 23%, while the benchmark S&P 500 index has advanced at 15%.

The question to be asked whether buybacks and dividends are driving the markets higher? Yes, to an extent; they act as an accelerator to sustain the rally. Historically, both these payout strategies have worked

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