Many mature companies with large hoards of cash are doing shareholders a disservice by disbursing cash for stock buy backs and/or just letting the cash accumulate, rather than paying out these amounts as cash dividends. Companies fitting this profile include Microsoft (MSFT), Cisco (CSCO), Intel (INTC) and IBM (IBM). In today’s ultra low income yield environment it makes little sense to buy back ones own stock and/or hoard excess corporate cash. Disbursing these funds as cash dividends would provide shareholders with significantly better overall returns than the dismal investment returns posted by these companies in the last 5+ years.
The market yield on U.S. Treasury securities at 1-year constant maturity, quoted on investment basis has declined precipitously since 2006 as follows:
- 2006 - 4.94%
- 2007 - 4.53
- 2008 - 1.83
- 2009 - 0.47
- 2010 (09-1) - 0.26
With such low rates there is no rationale for hoarding excess cash or buying back shares, when it is clear that such actions do not improve stock price performance.
Microsoft Corp. (MSFT) – The company commenced paying cash dividends to shareholders in February 2003, starting at $0.08 per quarter. They added a onetime special cash dividend of $3.00 per share in November 2004. The quarterly cash dividend has been increased periodically with the most recent quarterly dividend amounting to $0.13 on August 17, 2004. From 07-01-05 through 06-30-10 total cash dividends paid to shareholders amounted to $20.411 billion, which works out to be an average of approximately $0.44 per share each fiscal year (based on average shares outstanding in the five fiscal years ended 06-30-10).
During the same five fiscal years ending June 30, 2010, MSFT repurchased 2.825 billion of its common stock shares at a cost of $79.937 billion or an average of approximately $28.30 per share. Based on the September 13, 2010 closing price of $25.11, this indicates that stock buybacks in the last five fiscal years was not a good investment for Microsoft and its shareholders.
In the same five fiscal years ended June 30, 2010, the company issued a total of 783 new Microsoft shares (for employee purchases, stock options exercised, acquisitions etc). Thus, the company on a net basis repurchased 2.042 billion common stock shares (net of new common shares issued) in the period from 07-01-05 to 06-30-10.
I calculated an estimated dividend amount, using the assumption Microsoft paid it shareholders additional cash dividends, rather that using the cash for share repurchases in the five years ended 06-30-10. Assuming all newly issued shares (783 million shares) came from common stock repurchases (2.825 billion shares) in the five year period, then the net total amount expended for share repurchases (net of new stock issued) was about $57.3 billion or $5.35 per share. If the amounts expended for net share repurchases (average of $1.07 per share each year) were used to pay common stock cash dividends, and added to actual dividends paid (average of $0.44 per share each fiscal year), this would result in an average annual common stock dividend about $1.50 per share in the period 07-01-05 to 06-30-10.
I have little doubt Microsoft shares would be trading higher today than $25.11 (closing price on 09-13-10), had they used the funds for share repurchases to pay additional cash dividends to shareholders in the 5 years ended 06-30-10. Paying additional cash dividends of $5.35 over five years would have gone directly to shareholders. I believe Microsoft wasted the expenditures for share repurchases, which arguably resulted in little or no benefits to shareholders based on the company’s stock price performance in the past five fiscal years. An average annual dividend of $1.50 per share equates to a yield of 6% at the current price of $25.11. This is significantly higher than Microsoft’s actual dividend yield of just under 2% over the last five fiscal years ending June 30, 2010. An annual dividend of $1.50 would provide a yield of 5% if the stock price is $30.00. I believe Microsoft shares would immediately trade in the $30’s (and remain there) if the annual dividend were raised to $1.50.
It is evident that Microsoft’s share price is no longer correlated with such fundamentals as its operating results, PE ratios, operating margins, consensus estimates of future sales and earnings, returns on equity etc., etc. The market is sending a loud and clear message that it does not respect a mature company, which continues to accumulate excess cash or uses cash to buy back its own shares (regardless of how good the company’s operating results).
Except for the fiscal year ended June 30, 2009, which included a severe economic decline from October 2008 to March 2009, Microsoft posted year over year increases in operating results in the five fiscal years ending June 30, 2010. By the end of the five year period, sales grew by +57% to $62.5 billion in the year ended June 30, 2010 from $39.8 billion in the fiscal year ended June 30, 2005. Similarly, net income advanced by +53.1% when comparing the fiscal year ended June 30, 2010 (net income $18.76 billion) with the year ended June 30, 2005 (net income $12.254 billion). Earnings per share rose +87.5% from $1.12 in the fiscal ended June 30, 2005 to $2.10 in the year ended June 30, 2010. The higher percentage increase in earnings per share was because of share repurchases made in the last five fiscal years ending June 30, 2010, which reduced the diluted shares outstanding from 10.906 billion on June 30, 2005 to 8.927 billion at June 30, 2010. Analysts are projecting additional growth in the future with consensus estimates of Revenue of $68.08 billion and EPS of $2.36 for the FYE 06-30-2011 followed by Revenue of $73.22 billion and EPS of $2.64 in the FYE 06-30-2012.
For more detailed information about Microsoft’s operating data, balance sheet info and other metrics for the five fiscal years ending June 2005-2009 and for the four quarters in the fiscal year ended June 2010 click here.
Despite the good results achieved by Microsoft in recent years, and estimates of continued growth in the future, MSFT’s share price performance has been dismal. As of June 30, 2010 the shares were trading at $23.01 versus $24.84 on June 30, 2005. The market message is loud and clear that it does not respect the Board of Directors decisions to repurchase MSFT shares and hoard its large war chest of cash and other investments, which totaled $44.5 billion on June 30, 2010. That cash hoard amount is after paying out close to $80 billion for share repurchases in the last five fiscal years.
What rationale is there for making share repurchases instead of paying out such amounts as cash dividends to shareholders? The share repurchases did increase EPS growth but it is evident that the market cares little about this and instead views share repurchases as a negative consequence of poor decision making by the Microsoft Board of Directors.
If the BOD's rationale for buying back shares is to shrink the size of the company, it is not a wise way to achieve such a goal. Microsoft has five operating segments: Windows & Windows Live Division; Server and Tools; Online Services Division; Microsoft Business Division; and the Entertainment and Devices Division. If the company wants to get “smaller” they should spin off to its shareholders one or more, or a combination of operating segments. Spinning off separate entities should result in more efficient and creative segments that would be free to grow unencumbered by the bureaucracy, which is an inevitable consequence of all “Bigness”, whether it is a government or a business. It would also enhance shareholder value since the sum of the individual parts should be greater than the whole.
Microsoft’s Board should also consider whether it makes sense to have a hoard of cash and investments that totaled $44.5 billion on June 30, 2010. Based on its history of generating consistent and growing operating cash flow ($24.073 billion or $2.70 per share in the FYE 06-30-10 vs. $16.605 billion or $1.52 per share in the FYE 06-30-05) there seems no good reason to hold such a sizeable cash hoard. Does anyone on the Board really believe that Microsoft would be worse off if they had only $20 billion in cash and investments instead of $44.5 billion (and distributed the balance of the hoard to its shareholders). Based on the company’s current size, I seriously doubt that MSFT could effectively employ the excess cash hoard to increase the performance of Microsoft’s stock price (other than by paying out the funds as a special cash dividend to shareholders).
In summary, the Microsoft Board of Directors should take their heads out of the “Cloud” long enough to do what is best for the shareholders (owners) of the company by: increasing the regular annual cash dividend to $1.50 per share; discontinue share repurchases (except to cover any newly issued shares); distribute their excess hoard of cash ($15 billion to $25 billion) as a special cash dividend; and spin off to shareholders one or more or a combination of its operating segments. The latter suggestion (spinning off operating segments) might be difficult to implement by an entrenched hierarchy and bureaucracy, but the other policies are very doable.
We have a long position in MSFT and therefore won’t go into such detail about other mature companies, who are penalizing their current share price by engaging in share repurchase programs and/or hoarding cash instead paying such amounts as cash dividends to shareholders.
Cisco Systems, Inc. (CSCO) - The company has not paid any cash dividends to shareholders and currently has no plans to do so in the future. In the five fiscal years ending July 2010 they repurchased 1.631 billion of its shares paying out $37.931 billion, or an average price of $23.26. At the end of fiscal July 2005 the share price was $19.15. Sales in the FYE July 2005 totaled $24.8 billion with EPS amounting to $0.87; and Cash and Investments amounted to $16.055 billion. By way of contrast: at the end of fiscal July 2010 the share price was $23.07 and has declined to $21.26 on 09-13-10. Sales in the FYE July 2010 totaled $40.04 billion (+61.4% higher than fiscal 2005) with EPS amounting to $1.33 (+52.9% higher than fiscal 2005); and Cash and Investments amounted to $39.861 billion (+148.3% higher than at the end of fiscal 2005). Additionally analysts are estimating decent growth in future sales and earnings for fiscal years ending in July 2011 and July 2012.
For more detailed information about Cisco’s operating data, balance sheet info and other metrics for the five fiscal years ending July 2005-2009 and the four quarters in the fiscal year ending July 2010 click here.
Had CSCO repurchased just enough shares to cover all new stock issues (for acquisitions, employee purchases, exercise of stock options, etc) during the five fiscal years ending July 2010, they could have used the remaining stock repurchases funds ($13.6 billion) to pay cash dividends to shareholders. Additionally there was a cash buildup of $23.8 billion from the end of July 2005 ($16.055 billion) to the end of July 2010 ($39.861 billion). Thus, shareholders could have been paid cash dividends totaling approximately $37.4 billion or just under $6.00 per share (average annual dividend rate of approximately $1.20) over the five year period ending July 2010.
Does John Chambers and the Cisco Board believe the current stock price would be $6.00 lower today had this shareholder friendly program (paying cash dividends) been implemented instead of the actual stock repurchases made in conjunction with a cash hoarding policy? A 5% annual cash dividend yield over the last five fiscal years surely would have resulted in Cisco’s shares trading higher than its current stock price. Additionally, long term investors would have been rewarded with an additional $6.00 per share in cash dividends. While most eminent CEO’s and Boards of Directors give lip service to the mantra “enhancing shareholder value” I don’t believe Cisco has accomplished this by repurchasing their shares, hoarding their cash and electing not to pay cash dividends to shareholders.
IBM bought back 525 million of its shares at a cost of $52.528 billion. If it assumed the only share repurchases made were to cover newly issued shares (for acquisitions, employee stock purchases, stock options exercised etc.) then IBM could have paid out additional cash dividends of $33.5 billion or approximately $20.36 per shares (about $4.00 per share annually) in the five year period ended December 31, 2009. Based on IBM's historical fundamentals and anticipated future results, I think it is a safe bet IBM shares would be trading higher than its current stock price had the expenditures been for cash dividends rather than share repurchases. Also, the shareholders would have benefited by getting additional dividends of approximately $20.00 per share in the five years ended December 31, 2009.
For more detailed information about IBM's operating data, balance sheet info and other metrics for the five years 2005-2009 and the first two quarters in 2010 click here.
Intel bought back 1.179 billion of its shares at a cost of $26.975 billion in the years 2005-2009. If it assumed the only share repurchases made were to cover newly issued shares (for acquisitions, employee stock purchases, stock options exercised etc.) then INTC could have paid out additional cash dividends of $16.673 billion or approximately $2.67 per shares (about $0.53 per share annually) in the five year period ended December 31, 2009. Based on Intel's historical fundamentals and anticipated future results, I believe INTC's shares would be trading higher than its current stock price. Additionally, the shareholders would have benefited by getting additional dividends of approximately $2.67 per share in the five years ended December 31, 2009.
For more detailed information about INTC's operating data, balance sheet info and other metrics for the five years 2005-2009 and the first two quarters in 2010 click here.
Two companies that have paid out large cash dividends to stockholders (yields of 5% to 6%), avoided hoarding their cash and have not made large share repurchases, are Verizon Communications Inc. (VZ) and At&T Inc. (T). I believe the stock price performance of these two companies, in relation to their historical and projected future fundamentals, has exceeded the stock performance of companies that made large share repurchases and/or hoarded excess cash in recent years.
Disclosure: Author is long MSFT, no positions in the other stocks mentioned