Deutsche Bank said that dividend yields for equities in the S&P 500 index SPX were approaching record lows for the first time since 2000.
However, Jim Reid of Deutsche Bank says it’s not surprising that investors don’t appear to care. Businesses gradually began switching from dividends to share buybacks. As the post-war boom began to take shape in the late 1950s, dividend yields began to decline.
However, Reid noted that the 1980s saw a significant increase in buybacks, spurred by policies like President Ronald Reagan’s lower capital gains taxes.
More significantly, a 1982 Securities and Exchange Commission regulation amendment that established precise rules for businesses wishing to buy their own stock contributed to the practice’s successful legalization. Businesses were able to steer clear of possible charges of market manipulation as a result.
Over the past ten or so years, the trend toward preferring buybacks over dividends has really picked up speed.
Companies who choose to spend their profits back into their operations were rewarded more and more by investors as growth companies, like technology equities, thrived.
The technique seems to have been successful, based on the massive increases in U.S. stocks over the last two decades on a total return basis, Reid said.
Investors might eventually begin to miss their dividends, though. The bond market is currently offering some of the highest yields since the 2008 financial crisis for investors who are more concerned about income.
Even though share buybacks have been credited for contributing to the recovery in U.S. stocks after the early-April selloff, Reid listed a number of reasons why investors should be more cautious of them.
According to Reid, the dangers are as follows.
- Buybacks are more discretionary, and as such they can vanish overnight in a downturn. On the other hand, companies are typically more reluctant to cut dividends.
- Companies typically buy back more of their shares at market tops than market bottoms, Reid said. That means firms aren’t necessarily getting the best value.
- One consequence of buybacks is that they tend to inflate key metrics such as earnings per share, which could make companies look more profitable than they actually are.
- If they are used by executives to help meet earnings targets in the hopes of boosting their compensation, firms might allocate money to buybacks that might be better put to use by investing in the business.
The result? Currently, reliance on buybacks may not be an issue. However, that can change at any time.
Does a dividend yield that is close to a record low matter, then? Not when businesses have plenty of money and are content to buy back their own stock,” Reid stated.
However, it does raise the beta of the US market. Buybacks will cease much sooner than dividends in the event of a slump, potentially removing a crucial pillar of market support.
A few choices are available to investors who are interested in dividend investing. Value stocks with some of the highest dividend yields in the S&P 500 include Walgreens Boots Alliance Inc. (WBA), Ford Motor Company (F), and Altria Group Inc. (MO), according to FactSet data.
Another option is the ProShares S&P 500 Dividend Aristocrats ETF NOBL, which, according to the fund’s prospectus, monitors an index of S&P 500 companies that have raised dividend payments steadily for at least 25 years in a row.
