Exxon Shareholders: Stop Whining About Dividends

| About: Exxon Mobil (XOM)

Exxon (NYSE:XOM), as the modern version of Standard Oil of New Jersey, is often referred to as the Granddaddy of Big Oil in allusion to its longevity. Standard Oil of New Jersey and General Electric (NYSE:GE) are the longest tenured Dow Jones Industrial Average component stocks, with inclusions dating back to 1928. Over the years, Exxon has maintained the business DNA of John D. Rockefeller, as it relates to conservative, yet bold management that translates into high return on equity. Preserving capital to reinvest back into the business has remained an Exxon core value that does date back to Titan Rockefeller.

In more recent times, a $10,000 investment made into Exxon on January 17, 1994 would have purchased 615 shares of stock at a split-adjusted $16.25 per share. Today, the initial $10,000 investment would have grown to roughly $61,500 worth of ExxonMobil stock that would, of course, offer an expected pay out of $1,549.80 in annual dividends. Still, long-term Exxon shareholders should evaluate management as a trusted capital allocator, instead of a nanny who simply doles out fatter dividends each year.

Big Oil Current Dividends

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Financial managers are largely tasked with the assignment of making decisions between returning cash back to shareholders and reinvesting cash back into the business. Equity owners, of course, arrive at the negotiating table with slightly divergent investment goals. Conservative income investors often prefer that stable corporations kick back out the majority of their free cash flow as dividends. Alternatively, growth investors welcome that corporations reinvest the majority of capital back into the company. Growth investors are willing to gamble that business expansion from reinvested capital and share price appreciation will exceed that of inflation and competing investments, over the long-term.

Over time, real dividend yields (initial investment / dividend payment) on a well-managed business may dramatically exceed those available out of a particular asset class, because the growth corporation operates with means to aggressively scale up annual dividend payments. Financial risks, of course, arise through the mismanagement of shareholder capital. At worst, shareholder value will collapse towards zero, and owners will receive no dividends, in exchange for their investment. Big Oil managers make capital allocation decisions between upstream exploration and production projects that may take decades to pay off and refining operations that convert crude oil into gasoline, jet fuel, and automobile lubricants. In years past, integrated oil companies would also retail gasoline. Today, most service stations are owned and operated by independent franchisees. Gas stations and convenience stores are relatively low-margin businesses.

For now, ExxonMobil remains best of breed within the oil patch. Exxon managers often target annual return on equity goals above 25%. Exxon ROE has led the industry for several years, despite the fact that Irving bought out XTO for $41 billion in stock in 2009, at the top of the natural gas market. Still, Exxon correctly offers the lowest dividend payout, as it is the best capital allocator within Big Oil. Interestingly, ConocoPhillips (NYSE:COP), Chevron (NYSE:CVX), and Exxon shares have dramatically outperformed those of Royal Dutch Shell (NYSE:RDS.B), and British Petroleum (NYSE:BP), over the past decade. Going forward, the inverse relationships between dividend yield, return on equity, and total returns are likely to hold serve within the oil patch. ExxonMobil is still alpha.

Stock Buy Backs Versus Dividends

All investors, of course, are very well familiar with the idea of total returns. Total return calculations account for capital appreciation, dividends, and taxes. For now dividends are classified according to ordinary and qualified dividends. Ordinary dividends are taxed at ordinary income rates that range between 10% and 39.6%. Single filers reporting taxable income of less than $36,250 may receive tax-free qualified dividends. From there, wealthier investors may find that their qualified dividends may be taxed at 15% or 20% rates. Dividends qualify for special tax treatment after investors own stock for more than 60 out of the 121-day holding period surrounding the ex-dividend date. The American Taxpayer Relief Act of 2012 largely extended the original terms of the Jobs and Growth Tax Relief Reconciliation Act of 2003. Going forward, all investors may be subject to higher tax rates, in concert with ongoing "tax the rich" rhetoric.

Management decisions to either reinvest shareholder capital back into the business, or buy back shares effectively allow for tax deferral. Rather than paying up front and annual taxes on dividends, investors can time when to take profits and pay capital gains taxes. For now, long-term capital gains are either tax-free, or taxed at 15% rates. Alternatively, short-term capital gains are taxed at ordinary income tax rates. An investor must hold Exxon stock for longer than one year, before selling out of the position for long-term capital gains. In any event, stock buybacks that support capital appreciation are a more tax efficient means to reward shareholders than are dividend payments. 200-300 additional basis points in annual total returns may calculate out to hundreds of thousands, if not millions, of dollars over the long term.

Over the past several years, Exxon has routinely returned more than half of its operating cash flow back to shareholders. Of this amount, Exxon has returned approximately two thirds of the capital back to shareholders through stock buy backs. ExxonMobil generated $34.7 billion in operating cash flow through the first nine months of 2013. This cash flow from operations did trickle down to $8.1 billion in dividend payments and $12.7 billion in stock buy backs. In 2008, Exxon actually ramped up its buy back program to purchase $32.0 billion in stock amid the housing bust and credit crisis. That year, Exxon shares did decline to a multi-year low of $54.71, despite the company having generated $59.7 billion in cash flow from operations. In all, Exxon has spent $113.9 billion in cash to purchase a net 1.1 billion shares outstanding between 2008 and Q3 2013. Exxon stock has gradually approached $100.00 per share through this time frame. Exxon has not blown cash to buy expensive stock at the top of the market.

Exxon closed out 2007 with 5.5 billion shares of common stock on the books. According to back-of-the envelope calculations, Exxon stock buybacks may have helped improve earnings per share and share price appreciation by 20%, over the past five years. Again, shareholders may defer taxes upon these capital gains. For now, shareholders should immediately stop wasting time whining about nominally meager dividend payouts, and start backing up the truck to purchase Exxon stock as a long-term holding.

As of September 30, 2013, Warren Buffett and Berkshire Hathaway (NYSE:BRK.A) traders had built out a $3.4 billion position within ExxonMobil stock.

Disclosure: I am long XOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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