- S&P reports a 1.93% dividend yield.
- S&P also reports a 3.2% buyback yield.
- How long can a 5.14% combined yield last?
I have previously written articles concerning the SP-500's (NYSPY) measurement of operating vs. reported EPS and the justifed P/E ratio, and now we come to the sustainable growth rate of the S&P 500. This information is provided by the following formula:
Investors can find this information from the S&P on its website, just download the excel file "SP 500 Stock Buybacks" under the tab labeled "Additional Info." The information on this sheet provides both the amount of dividends and buybacks, and for Q1 2014 preliminary data was for a combined divided yield of 5.14% (rounded up).
One can see that the "Dividend Payout Ratio" should now be changed to the "Shareholder Payout Ratio," since both dividends and share buybacks are considered a return on/of capital to owners of the company. Hence, the formula changes slightly to:
SP only provides data up to the Q1, of 2014, as of July 23rd. It shows $81.96 billion in dividends and $159.28 billion in buybacks, for a combined total of $241.24 Billion in shareholder payout during Q1. Operating earnings were $243.76 billion and GAAP reported earnings were $221.64 billion. This means that 99% of operating earnings were paid to shareholders, in Q1 2014, and that an amazing 108.8% of reported earnings were paid out to shareholders.
Trivially, the term "(1 - Shareholder Payout Ratio)" reduces to either .01 (operating earnings) or -.088 (reported earnings). Now, in a sense, it does not matter what the "Return on Equity" is because of the multiplication of the second part of the equation.
|Return on Equity||10%||15%||20%||25%|
|Operating Payout (99%)|
|Reported Payout (108.8%)||-.88%||-1.32%||-1.76%||-2.20%|
What does this result in? The website of the formula link states:
The sustainable growth rate is a measure of how much a firm can grow without borrowing more money. After the firm has passed this rate, it must borrow funds from another source to facilitate growth.
If the S&P 500 were to somehow have a 25% return on equity, it could only have a sustainable growth rate of .25%, if the current payout rate to shareholders remained the same (99% of operating earnings). For an investor who believes that reported earnings are important, as I argued in my previous article, then companies would be forced to borrow or find other funds to expand growth, such as the amount they receive when stock options are exercised. But, if share buybacks are not made when options are exercised then the supply of shares increases and existing shareholder wealth is diluted. Therefore, most of the funds will come from more debt, and this should, in the long term, raise the cost of equity according to Modigliani & Miller proposition II theorem.
Bulls might say that Q1 was a "one off." OK, let's run the numbers with the average from the data available. The average from Q1 2008 through Q1 2014 was a 79.3% operating payout and 91.1% reported payout, but excluding Q4 2008 because of large skew from negative earnings. The results are as follows
|Return on Equity||10%||15%||20%||25%|
|Operating Payout (79.3%)||2.07%||3.10%||4.13%||5.17%|
|Reported Payout (91.1%)||.89%||1.33%||1.78%||2.22%|
We see again that in the "best case" scenario growth above 5.17% will be financed with more debt. If reported earnings are a more accurate measure of growing shareholder wealth, then the "best case" scenario here shows a cap of 2.22% on sustainable growth.
The implications of this are very astounding in my opinion. It shows that if the historical average rate of shareholder payout continues, then growth above mid, or even, low single digits has to be financed with more debt. "But, rates are low!" Yes, for the time being. However, they will not be forever and in the meantime the level of debt is increasing. Just as trees don't grow to the sky, corporate bond rates don't drop below zero. A company can't keep paying out more, in both dividends and share buybacks, than it makes in earnings in the long run.
P.S. Stay tuned for the implications to the justified P/E ratio.