|Forbes.com, Winter, 2012. This article was written with Oliver Pursche, the Co-Portfolio Manager of GMG Defense Beta Fund. It was part of a series of articles developed under an agreement with forbes.com to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site, forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.|
Yesterday, cable giant Comcast (CMCSA) increased its dividend 44% and announced a $6.5 billion share buyback. The stock responded well on a down day for stocks, up nearly 5%.
Noise on dividends and buybacks has reached an almost fevered pitch since Apple’s (AAPL) $100 billion cash hoard came to light. Accordingly, I thought some context and perspective on dividends and buybacks was in order.
Some advisors, brokers and investors believe that share-buyback programs are “always” a good thing. I am always distrustful of the word always, as it rarely seems to hold true. As with any other indicators, stock buybacks have to be put into context. Investors need to be careful and review many other pieces of information.
Foremost, at least from my perspective, investors should look at what will happen with the repurchased shares. In many cases, they are used as executive compensation and stock option programs; in other words, they are recirculated into the market.
Perhaps what can be inferred from the chart above is a tale of two companies. Take Alcoa (AA), one of the worst performing stocks among the Dow components over the last five years (Bank of America (BAC)–is the biggest loser, but let’s not pile on). Since 2006, venerable AA, buffeted by volatile commodity markets, has seen its revenue plunge from $30.3 billion in 2006 to 24.9 billion in 2011, while net income has been more than halved from $2.1 billion to about $810 million. The operating margin has declined by more than four percentage points from 17.8% to 13.2%.
By contrast, the best performing stock in the Dow, McDonald’s (MCD), has grown revenues over the same period from $21.6 billion to $27 billion, while net income has nearly doubled from $2.9 billion to $5.5 billion.
In 2007, Alcoa announced its intention to buy back as much as 25% of its own stock. While details about the number of shares purchased are sketchy–the company did not respond to questions about this before I posted–I think it’s safe to say that however many shares were bought, the action had little if any impact on the performance of the shares.
On the other hand, shareholders of McDonald’s, whose last share buyback was announced 10 years ago, were rewarded almost exclusively on the skills and expertise of its management. To wit, even after running its restaurants for 57 years, management still managed to wring significantly more profit out of them as the operating margin rose about nine percentage points, from just under 27% to just over 36% years, during the last five years.
What the data in the chart says with a little more clarity, is that share price return is more accurately predicted by a rising dividend. With the exception of Merck (MRK), DuPont (DD) and Kraft (KFT), all of the winners among Dow components have been with companies that have regularly raised their dividends. With the S&P 500 returning -0.84% on a compound annual basis over the last five years, the dividend raisers, as a cohort, have all delivered alpha.
As a result, it should not be surprising that over the long haul, companies that raise their dividends have significantly outperformed companies that have not, or reduced their dividend, as the chart below indicates. The share buybacks can add a tailwind to be certain. But investors need to keep in mind that changing the metrics on the income statement (and to some degree the balance sheet), cannot repair a business that is fundamentally not working at the moment.