Investors love dividends. They also love buybacks. Both are great ways that public companies return capital to shareholders. And investors have been the beneficiary of growing dividends and larger and larger stock buybacks for years. Still, there is a looming question now that the bull market is more than six years old. What happens when the day comes that companies just cannot grow their dividends and just cannot buy back stock at continued high rates?
24/7 Wall St. has grown concerned that investors will have a very hard time expecting the same sort of dividend and buyback growth that they have seen in the past few years. This is not meant to scare investors about whether companies can continue pay dividends. It is also not a prediction that buybacks are about to come to a screeching halt. What may be approaching now is that some of the endless dividend hikes and massive buybacks cannot be sustained.
With cash locked up overseas and with growth becoming ever harder to come by for the largest companies, a day will come when a large enough number of companies in the S&P 500 simply cannot keep growing their dividends and buying back stock. In fact, some companies already have begun to slow their dividend growth. When companies get to the point that they have to use 60% to 80% of their operating earnings, it gets increasingly harder to imagine that dividend growth can keep ramping up. Then consider what happens if the economy slows down or if the company has a bad year.
In order to show this, 24/7 Wall St. has used some specific examples in key Dow and S&P stocks. These are far from insults to these companies, but the issues in them are meant to highlight some of the broader issues that could come into play in the months and years ahead.
One serious issue that plays into the equation is the balance sheets that investors see versus actual balance sheets that just include the U.S. cash balances. That overseas cash would get clipped at a very high rate if it was all repatriated at once. Also, companies are raising serious amounts of debt because of the low interest rate environment, and that debt is being used in many cases just to fund buybacks and dividends, a move that by and large leverages up balance sheets through time. What happens when interest rates rise and drive up the cost of borrowing? Will the higher debt servicing costs eat up the extra earnings that could have been used to keep growing dividends?
Another issue is that dividends have already reached high-yield levels. In fact, it was just a month earlier that we pointed out that over half of the Dow Jones Industrial Average outyielded the 30-year Treasury bond.
24/7 Wall St. has reviewed the specific examples of Apple Inc. (NASDAQ: AAPL), Exxon Mobil Corp. (NYSE: XOM), General Electric Co. (NYSE: GE), Wynn Resorts Ltd. (NASDAQ: WYNN), Procter & Gamble Co. (NYSE: PG) and many others in this review. Again, this is not meant to highlight shortcomings. It is meant to use examples of how the trends of the past five years might not be running endlessly higher in the five years ahead, or not at the same pace.
One of our first worries about endless dividend and buyback growth was in March, after we noted how Moody’s has warned that companies may be gutting their futures by too much focus on buying back stock and paying dividends rather than properly keeping stronger balance sheets. This was on the heels of a separate report from Standard & Poor’s, calling for 2015 to be yet another record year for dividends and buybacks. Again, this effort is not to see whether the dividend and buyback game is over, but whether the great trends of years past can be continued. In fact, we recently covered the greatest stock buybacks of all-times and all those companies were still active in buybacks.