Investing

Has the Endless Growth of Dividends and Buybacks Peaked?

Investors love dividends. They also love buybacks. Both are great ways that public companies return capital to shareholders. And investors have been the beneficiary of growing dividends and larger and larger stock buybacks for years. Still, there is a looming question now that the bull market is more than six years old. What happens when the day comes that companies just cannot grow their dividends and just cannot buy back stock at continued high rates?

24/7 Wall St. has grown concerned that investors will have a very hard time expecting the same sort of dividend and buyback growth that they have seen in the past few years. This is not meant to scare investors about whether companies can continue pay dividends. It is also not a prediction that buybacks are about to come to a screeching halt. What may be approaching now is that some of the endless dividend hikes and massive buybacks cannot be sustained.

With cash locked up overseas and with growth becoming ever harder to come by for the largest companies, a day will come when a large enough number of companies in the S&P 500 simply cannot keep growing their dividends and buying back stock. In fact, some companies already have begun to slow their dividend growth. When companies get to the point that they have to use 60% to 80% of their operating earnings, it gets increasingly harder to imagine that dividend growth can keep ramping up. Then consider what happens if the economy slows down or if the company has a bad year.

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In order to show this, 24/7 Wall St. has used some specific examples in key Dow and S&P stocks. These are far from insults to these companies, but the issues in them are meant to highlight some of the broader issues that could come into play in the months and years ahead.

One serious issue that plays into the equation is the balance sheets that investors see versus actual balance sheets that just include the U.S. cash balances. That overseas cash would get clipped at a very high rate if it was all repatriated at once. Also, companies are raising serious amounts of debt because of the low interest rate environment, and that debt is being used in many cases just to fund buybacks and dividends, a move that by and large leverages up balance sheets through time. What happens when interest rates rise and drive up the cost of borrowing? Will the higher debt servicing costs eat up the extra earnings that could have been used to keep growing dividends?

Another issue is that dividends have already reached high-yield levels. In fact, it was just a month earlier that we pointed out that over half of the Dow Jones Industrial Average outyielded the 30-year Treasury bond.

24/7 Wall St. has reviewed the specific examples of Apple Inc. (NASDAQ: AAPL), Exxon Mobil Corp. (NYSE: XOM), General Electric Co. (NYSE: GE), Wynn Resorts Ltd. (NASDAQ: WYNN), Procter & Gamble Co. (NYSE: PG) and many others in this review. Again, this is not meant to highlight shortcomings. It is meant to use examples of how the trends of the past five years might not be running endlessly higher in the five years ahead, or not at the same pace.

One of our first worries about endless dividend and buyback growth was in March, after we noted how Moody’s has warned that companies may be gutting their futures by too much focus on buying back stock and paying dividends rather than properly keeping stronger balance sheets. This was on the heels of a separate report from Standard & Poor’s, calling for 2015 to be yet another record year for dividends and buybacks. Again, this effort is not to see whether the dividend and buyback game is over, but whether the great trends of years past can be continued. In fact, we recently covered the greatest stock buybacks of all-times and all those companies were still active in buybacks.

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Apple Inc. (NASDAQ: AAPL) is now embarking on a massive buyback plan and a dividend hike. Our initial take was that the priority was too much on buybacks and should be more on dividends. Either way, Apple suffers the same problem as many great companies with huge global cash balances: its cash is largely overseas. Apple recently had to do another debt offering and one of the uses of capital was stated as helping in dividend and buyback payments.

Apple is the most profitable of all companies, but even with its cash balance of more than $190 billion, its dividend yield is still only 1.6%. Carl Icahn seemed too ambitious in his aim of getting Apple to $240 per share.

Exxon Mobil Corp. (NYSE: XOM) and Chevron Corp. (NYSE: CVX) have been great payers in the oil patch, as has Kinder Morgan Inc. (NYSE: KMI). The problem is that oil’s price drop will not be a boom town in the years ahead, even for the best-run oil giants. Exxon Mobil raised its dividend to $0.73 from $0.69, but rival Chevron kept its dividend static at $1.07 for the fifth quarter in a row.

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Kinder Morgan has raised its dividend handily, but when the company committed to the 10% payout hike per year, oil was much higher than even the recovery level seen now. Chevron also backed off of share buybacks. In addition, S&P just maintained its AAA rating on Exxon Mobil with a “stable” outlook, but what stood out at least a bit was that S&P moved the liquidity assessment to “adequate” from “strong” based on liquidity now expected to exceed uses by a ratio of 1.2 in the next 12 to 18 months.

Exxon is considered one of our top 10 stocks for the next decade, and Kinder Morgan was a runner-up. With low commodity prices, at least the oil patch leaders are not suffering the 84% dividend cut like Freeport-McMoRan

What about General Electric Co. (NYSE: GE)? It is a conglomerate that has been very eager to raise its dividend to get back to the peak days. The $0.23 dividend of today compares to a peak of $0.31, and now with all that is going on with massive buybacks after financial asset sales, repatriated cash from overseas, a coming completion of the Synchrony Financial (NYSE: SYF) spin-off and the rest, it looks like investors are likely to have to wait until late in 2016 or after for dividend growth to resume.

This is certainly no slam against GE, on the surface, and we even once opined that GE would be able to get away with saying that its dividend was unofficially higher after it exits so much financial dependence operations. GE is also one of our 10 companies to own for the next decade. It just may take some time for all the dust to settle and the buybacks to be further along — and hopefully more earnings growth as an industrial and post-financial conglomerate — before GE investors can expect serious dividend hikes to resume.

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Wynn Resorts Ltd. (NASDAQ: WYNN) recently had to cut its dividend. While we warned that Wynn could be among several at-risk dividends, we frankly cannot blame the company for cutting the dividend at all. Casino stocks live in booms and busts, and they just cannot always continue a boom-time dividend when they run into business headwinds. These companies do not want to see their credit metrics go south, and casinos sometimes need to save cash for a rainy day.

Using a casino may not seem like a fair comparison to broad dividend cuts, particularly if we think it was OK for them to cut their payouts, but they are one of the top casino and event destinations for Las Vegas and internationally.

Procter & Gamble Co. (NYSE: PG) may have raised dividends for years and may be a great brand. After all, it dates back to the 1800s, and its recent dividend raise was the 59th consecutive year it raised the payout. The problem here is that P&G raised its dividend by only 3%. That may be because P&G already yielded over 3% at the time, because there is only so high that companies really have to go in a yield. P&G is in the process of jettisoning dozens of lower growth brands.

P&G has a massive currency headwind, with a strong dollar that just comes right off the top line and bottom line. Now sales are expected to be down 3% or 4%, and organic earnings growth could be an issue, depending on how its restructuring goes.

Macy’s Inc. (NYSE: M) is another example of dividend and buyback growth that is being used either by the success of the past or by increased leverage ahead. The king of mall-based department stores recently raised its dividend by more than 10%, from $0.3125 to $0.36, after earnings fell to $0.56 from $0.60 per share. This sounds like enough earnings per share coverage on the surface, but Macy’s also boosted its buyback by $1.5 billion, a move that leaves a total of $2.1 billion available for buying back common shares. With earnings having declined and a prediction of a mere 2% in comparable sales growth (and 1% total expected sales growth), imagine what happens to dividend growth and buybacks if things do not go as planned. The issue is not the most recent quarterly number, because annual earnings per share guidance was offered at $4.70 to $4.80 per share, but it is the lack of growth and the sensitivity that large department stores have to economic growth and slowing trends.

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Macy’s is very well run and it may not have to stall on the dividend growth immediately, but any more disappointing economic trends on retail sales or consumer spending habits could crimp the company’s ability and desire to shovel billions back to shareholders.

Then there is the case of rising dividends in telecom and utilities.

AT&T Inc. (NYSE: T) and Verizon Communications Inc. (NYSE: VZ) are both being hampered by a four-way price war among wireless carriers. The DirecTV (NASDAQ: DTV) acquisition by AT&T (if approved) may help support much more dividend growth. After all, DirecTV is one-fourth the size of AT&T, and it now pays no dividend, leaving some $5.1 billion in operating income and $2.76 billion in net income (2014 figures) that can go toward dividends ahead.

Utilities have been great performers, almost to the point that investors had turned to utilities to be their replacement investments for certificates of deposit (CDs) after their yields went to 0.2% or so. But now utilities frequently yield less than 4% when they used to yield over 5%. What happens there when interest rates rise, and when their substantial borrowing costs rise?

If investors want to focus on exchange traded funds (ETFS) rather than just individual stocks, they might be able to avoid some of the individual issues. Still, these would not be immune to market pressure or if there is pressure on companies regarding dividend growth and continual stock buybacks. ProShares S&P 500 Dividend Aristocrats (NYSEMKT: NOBL) and Vanguard Dividend Appreciation ETF (NYSEMKT: VIG) are two leaders for dividend growth in ETFs, and the PowerShares Buyback Achievers ETF (NYSEMKT: PKW) and AdvisorShares TrimTabs Float Shrink ETF (NYSEMKT: TTFS) are the leaders for stock buyback ETFs.

24/7 Wall St. is not calling this the end of dividends. It is also not the end of stock buybacks. That being said, there are concerns brewing that will require some serious underlying issues to change for the rate of dividend growth and endless buyback expectations. A coming interest rate hike cycle from the Federal Reserve is only one small piece of a much larger puzzle when it comes to dividend and buyback expectations ahead.

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