Living in a big city, I don’t drive very often. It’s usually more efficient to take public transportation. So when I got in the car alone on a sunny day, music turned up, I remembered how fun it is to just drive. One particular song came on where I heard the lyrics more crisply than I ever have. It was a braggy, uplifting hip-hop song and the specific line was about living “up.” I wondered why I had never listened more closely to that line and, moreover, why it resonated with me in the moment.
I think, without giving TMI, it’s because I’m trying lately to approach life from an “up” perspective — to stay optimistic in the midst of so much uncertainty in the world. So in the same vein, I’ve thought about this perspective for investments, too. Cash is a more obvious way to at least stay certain about what you have (before inflation of course), but are there other aspects to investing that can help — while things are uncertain? The short answer is that everything comes with a risk. But the longer answer might look at the benefits some shareholders receive by simply being invested, in the form of cash flow. Specifically, dividends and stock buybacks.
First, what are they: Well, backing up, there are two main ways companies may provide benefits to their investors:
A company may reinvest the income they earn back into the business to create greater growth in the future. Eventually, if those investments by the company work well, their shareholders should benefit through an overall greater value.
There are also times that a company will decide they want to distribute a portion of their income back to shareholders (or are obligated to due regulatory requirements, like in real estate investment trusts, aka REITs).
Distributing income is most well-known in the form of a dividend. This usually is represented on a cents or dollar per share basis, so how much you receive is based on how many shares you own. Often, people will quote a dividend yield, which takes that dollar amount and divides it by the stock price. For example, if a company’s annual dividend is $2.00 and it’s trading at $100 per share, its dividend yield is 2%. Thus, the greater the dividend, the greater the dividend yield. However, in the short term, if stock prices go up, dividend yields can fall unless dividends are increased. They are often declared on a quarterly basis and paid out to investors within a month of the “record date”. An important aspect of this is that once a company decides to pay a dividend, they’re sort of committed to these payments indefinitely. This doesn’t mean they can’t, or won’t, cut it or stop paying one… but they try not to since investors expect them to continue. If they do cut it, it’s usually a sign the business is not doing well (since they can’t afford to pay a dividend). On the other side, companies that consistently increase their dividend payments are generally considered higher quality.
So what types of companies tend to pay dividends? Here’s an outline of the average weighted dividend yields for the sectors of the S&P 500 Index as of February 28.
Stock buybacks, on the other hand, are a little different. Instead of giving cash directly back to shareholders, the company uses earnings (or other cash) to buy shares back from its investors. In a sense, it’s paying investors for their shares — so they are providing cash in its place. In another sense, the company is also reducing the number of shares that are out in the world. This means that everyone owns a little more of the company per share and theoretically, this should increase the value of the shares. Warren Buffett recently referred to this in his shareholder letter.
Something I’ve written about in several past pieces has been the rise of interest rates in the last year — and its impact on security valuations, housing values, among many other things. Stock buybacks are another area that may see an impact. This is because for most of the 2010s, interest rates were historically very low. Many companies took advantage of that and borrowed very cheaply — sometimes without a specific business purpose in mind. Instead, many borrowed to buy back their own stock. This not only meant corporate debt increased (albeit at inexpensive costs), but also that the number of shares out in the world fell, supporting stock values.
Here are cumulative stock buybacks by sector of the S&P 500 Index since 2009 (this is double the amount, on average, from 1999 to 2005):
Now that interest rates are much higher (the 10-year Treasury rate averaged 2.5% in that decade vs. close to 4% today), it’s natural to expect support for stock buybacks may wane. Will this be another natural headwind to stock values (at least in tech)? Perhaps not for those companies that always maintain decent cash balances. But it’s something to consider in analyzing investments and the market as a whole.
Despite this, and in line with staying “up,” there are many companies focused on living within their means — controlling their costs and growing — while still potentially sharing income with their investors. Certainly, these criteria were something my team and I looked at closely last year when evaluating stocks and believe it’s still not a bad place to start when looking for long-term investment opportunities.
Dividends are not guaranteed and must be authorized by the company’s board of directors.