Corporate America's Unhealthy Love for Buybacks and Dividends

We noted earlier this year that dividends and buybacks had consumed all profits and more since 2004. This is not healthy given that growth should be at least partially funded out of retained earnings, given the ephemeral nature of capital markets.

This trend continued into the third quarter of this year.

Three numbers, courtesy of Howard Silverblatt of Standard & Poor’s, shed some light on what companies did with their cash during boom times:

Over the last four years, since the buyback boom began, from the fourth quarter of 2004 through the third quarter of 2008, companies in the S.&P. 500 showed:

Reported earnings: $2.42 trillion
Stock buybacks: $1.73 trillion
Dividends: $0.91 trillion

As a group, every dime they made, and more, went to shareholders. Roughly $2 went to shareholders who sold out for every $1 that was paid in dividends to shareholders who held on to their shares.

Ideally, companies would be buying back debt and stock now. However, over the past five years, companies tapped the capital markets not only to fund all capital expenditures but also to fund buybacks and share repurchases. Now, capital markets are under extreme duress and companies are having to pay usurious rates of interest to fund operations.

It sure would be nice if corporate America had more financial flexibility amidst the worst credit crisis in 75 years.

Comments

[Tom Armistead:]

This has been particularly distressing in the case of certain financial firms that have bought shares back at premium prices, only to be compelled to raise additional capital under adverse conditions. They bought their own stock high and then sold it low.

Now, with share prices at record lows, many of these same companies are conserving capital at a time when they could be creating serious shareholder value.

The experience of the past year suggests shareholders should take a jaundiced view of management that hasn't got anything better to do with extra capital than to squander it propping up share prices.

2008 Dec 29 07:50 AM

[CLH:]

Growth certainly makes no sense during a time of contraction. Seems to me companies were right.

2008 Dec 29 07:51 AM

[farmer448:]

But you needed stock buy backs so the options granted to management did not cause share dilution.

This is just another problem generated when finance/accountants run companies. Many actions are taken that only help the books one time but complicate a business.

Maybe Finance and Accounting courses should teach the KISS principal.

2008 Dec 29 09:06 AM

[Rob Viglione:]

Policy drives markets. Federal policies encourage this sort of capital treatment. Think subsidization of debt through interest write-off on income, and tax advantages in share buy backs.

Government should not be distorting markets by influencing how firms treat capital.

2008 Dec 29 10:06 AM

[k45:]

Are share buybacks actually reducing the number of shares, or just picking up the excessive number of options granted to management? Of course, it varies from one company to the next.

I'm a believer in dividends. It's good to get some hard cash for your investment money, just like one would if they invested in a private company and received part of the income stream. Cash in hand is real, pumped up stock prices are just paper gains which can easily disappear.

The OP is right, many companies (with poor management?) bought their own stock at peak prices. Foolhardy.

2008 Dec 29 10:47 AM

[L Boyd:]

I'm not sure I follow the logic here? How is taking (what will prove to be) precious cash to buy back stock at inflated values, only to have have to sell shares at whatever they can get (significantly lower prices), in many cases simply for working capital needs, a good strategy? While it may have been better than funneling that cash into capex for no apparent reason, I suspect most did it because they saw no other alternative and wanted to give positive signals to the market; after all everybody else was doing it. The short term, quarter to quarter, time horizon of the Street is very much to blame.

On Dec 29 07:51 AM CLH wrote:

> Growth certainly makes no sense during a time of contraction. Seems
> to me companies were right.

2008 Dec 29 11:37 AM

[jackooo:]

If it doesn't pay a dividend, I don't buy it!!!

2008 Dec 29 12:12 PM