- S&P 500 dividend payout ratios are near historical lows, because share repurchase expenditures are high.
- A majority of S&P 500 companies repurchase shares. Only undervalued companies should repurchase shares, implying this level of repurchasing is unreasonable.
- If shareholders of S&P 500 companies want to see dividend payout ratios increase, they should be more critical of share repurchase plans.
Since the 1980s, S&P 500 and other U.S. companies changed how they return value to shareholders.
Why are dividend payout ratios across U.S. companies at historical lows?
Since the 1960s, S&P 500 companies have cut dividend payout ratios by about half. Some possible explanations are the changes in taxes on qualified dividend and long-term capital gains and the growth of the information technology sector. Another possible explanation for low dividend payout ratios is the growth of share repurchase plans. I will make a case for repurchases.
Current expenditures on share repurchase plans match that of dividends. According to my data compiled from S&P Dow Jones Indices, S&P 500 companies' expenditures on share repurchase plans were greater than expenditures on dividends in 2010, 2011, and 2012. In the S&P 500 over this three-year period, the average repurchase expenditures per year were $316 billion, while the average dividend expenditures per year were $234 billion. Buybacks didn't always measure up to dividends. Before the 1980s, share repurchase plans were basically non-existent.
According to data compiled from Compustat by Grullon and Michaely's (2002) in their paper Dividends, Share Repurchases, and the Substitution Hypothesis the expenditures on share repurchase plans began growing across global exchanges after the 1970s. Their data was compiled of U.S. exchanges and consisting of 134,646 firm-year data points, excluding data from banks, utility, and insurance companies.
In their data, expenditures on share repurchase programs relative to total earnings increased from 4.8 percent in 1980 to 41.8 percent in 2000. As is expected, repurchases plans experience only a slow incline before the 1980s. After 1982, we see growth in expenditures on share repurchase plans. In their study, Grullon and Michaely (2002) mention that in 1982, Rule 10b-18 was adopted by the Security and Exchange Commission providing "Safe Harbor" from the liability for manipulation under section 9(a)(2) and Rule 10b-5 in the Securities Exchange Act of 1934. Before 1982, companies repurchasing shares could be charged with illegally manipulating their share price. Below, is the kind of provision from section 9(a)(2) that was likely deterring companies from repurchasing shares:
It shall be unlawful for any person, directly or indirectly, by the use of the mails or any means or instrumentality of interstate commerce, or of any facility of any national securities exchange, or for any member of a national securities exchange to effect, alone or with one or more other persons, a series of transactions in any security registered on a national securities exchange or in connection with any security-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act) with respect to such security creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.
I believe that the phrase, "raising or depressing the price of such security," was the kind of statement that kept companies in fear of repurchasing their shares.
Before the 1980s, companies had one convention to deliver value to shareholders, the dividend. This is why we see dividend payout ratios above 50% and sometimes 60% in the S&P 500 before the 80s. It's different now, as according to the Factset Buyback Quarterly (June 18, 2014) over 350 S&P 500 companies are repurchasing shares with $535.2 billion in expenditures over the last 12 months.
Currently, the dividend isn't the only or even primary convention used to deliver value to shareholders, but I am not saying that I support the current levels of share repurchases in the S&P 500. Shareholders seem accepting of these plans, citing reasons such as tax efficiencies without questioning the incentives of management and without a strong understanding of the mechanism of value delivery.
If the only reason for a company to repurchase shares is because shares are undervalued, then I start to think. If a majority of S&P 500 companies are repurchasing shares, is it possible for the majority of S&P 500 companies to be undervalued? I highly doubt that. If shareholders of S&P 500 companies want to see their dividend payout ratios increase they need to question their managements' decision to repurchase shares. For some companies these plans may be valuable, but not for a majority of S&P 500 companies. For the portion of S&P 500 companies with overvalued shares, issuing a first or larger dividend is the better option for returning value. This is where it is up to the shareholder to question whether or not the shares to be repurchased are actually undervalued.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.