For those investors that follow or own Boeing (BA) stock, we are getting an opportunity to see in real time the real-world advantages of dividends over buybacks. As many of you probably know, Boeing announced during the second week of December that the quarterly dividend would increase 50% from $0.485 to $0.73 per share, which was Boeing management's way of saying to shareowners, "Yeah, we should have been giving you more than 4.5% dividend increases these past five years."
The other part of the announcement is that Boeing will be buying back $10 billion worth of its own stock. The announcement is not as eye-popping as it superficially sounds; the buyback will start in 2014 and run through 2017, and it only adds a little under $1 billion to the buyback share authorization that the company created in 2007.
The good news about the Boeing announcement is that the new dividend is well supported. At a new annual rate of $2.92 per share, the current dividend will only consume 50.34% of Boeing's normalized profits generated over the course of 2013 ($5.80 per share).
Furthermore, the dividend will likely have a good amount of room to grow over the next four or five years because Boeing's business is entering a golden age of production over the next few years. The Dreamliner headaches of the past couple of years will no longer be the shadow overhanging the company's stock. When you tally up the upcoming production of its 737, 767, 777, F-15, C-17 cargo carriers, submarine communicators, and business jets, you will see that Boeing is currently sitting on a backlog of almost five-thousand pieces of machinery that the company will build in the next 4-5 years.
I had always thought that General Electric's (GE) $220 billion backlog was one of the most impressive things I'd ever seen in business, but as I've started to study Boeing, I have found that Boeing's backlog of well over $300 billion in aircraft and other construction is one of the best arrangements of guaranteed profits in corporate America. Boeing essentially has an informal license to print money as fast as it can build its machinery because the product demand is so substantial. This is good news on the dividend side; in addition to the 50% dividend increase, the substantial backlog of production over the next few years puts Boeing in a position to give shareowners dividend increases of 8-11% over the next five years or so.
The problem is that Boeing is falling into the trap of buying back its own stock at precisely the most inopportune time as its stock becomes more expensive. Since January, Boeing's stock has increased 80%, making this an ineffective time to start retiring giant blocks of the company's stock. In relation to normalized profits of $5.80 per share, the current price of Boeing stock at $136 per share represents a valuation of 23.5x earnings. While this is not an all-time high, it is nevertheless higher than what usually constitutes Boeing's fair value range.
Over the past fifteen years, Boeing has traded between 14x and 18x earnings in each of the following years: 1999, 2000, 2001, 2002, 2007, 2008, 2010, 2011, and 2012. Because Boeing is somewhat cyclical and its earnings periodically collapse significantly (for instance, profits per share fell from $2.82 in 2002 to $1.00 per share in 2003, thus prompting Boeing's valuation to cross the 30x earnings mark). But those figures aren't useful in trying to determine where Boeing ought to trade in a normal environment, because P/E analysis is not all that useful for making future decisions when profits are sliding at the bottom of the economic cycle and the P/E figures get distorted because they don't reflect the pent-up profit that appears as soon as the business cycle turns.
The take-home point is that Boeing would be performing a valuable service for shareholders if it bought back its stock when the valuation was lower than 14x earnings, or about $81 per share. It would be performing a decent service for shareholders by repurchasing stock as long as it falls within the zone of fair value, which would be any price below $104 per share or so.
But that is not what Boeing is doing here. They are going to buy back $10 billion worth of stock at a starting price of $136 per share, which means it is effectively going to destroy 30% or so of shareholder value with its $10 billion buyback program. The time will come when Boeing's valuation will revert to the 14-18x earnings range in the next few years like it always has, and the shareowners will be left wondering why Boeing management thought it was a good idea to buy back the stock when it traded at 23.5x earnings. In effect, Boeing will be taking $10 billion worth of shareholder cash and converting it into $7 billion worth of value in the form of a reduced share count.
With the 50% dividend hike, the shareholders get to be the beneficiary of Boeing's business performance. As the profits continue to grow due to the $300+ billion backlog, the owners of Boeing stock will continue to receive nice chunks of change added to their checking accounts. This allows you to take the profits and do with it what you see fit. But this $10 billion buyback does not seem like a wise thing to commence after an 80% increase in the stock price over the past twelve months. Boeing's valuation is about 30% or so above the high end of where it has traded these past fifteen years, and that is why it is unfortunate to see Boeing's management decide that $135 is a good price to start retiring stock. The only saving grace will be if profits spike unexpectedly in 2014 and 2015, or if the share price comes down in the next few years to make the buyback more effective.