Shareholders get antsy when they see a lot of unutilized cash languishing on a company’s balance sheet. A common (and probably correct) attitude among investors is that, if the company’s cash cannot be deployed profitably toward expansion or investment, then it ought to be returned to the shareholders who can make better use of it.
In the first part of this study, we presented an overview of companies’ two principal methods of effectively returning those retained profits to shareholders: dividends and share buybacks. We covered their relative consistency, outcomes and tax implications, in addition to a brief history of the rise of buybacks as an alternative to dividends.
In this research note, we conclude our discussion with an assessment of the comparative performance of stocks with hefty (and consistently growing) dividends, and those with high share buyback ratios. In so doing, we attempt to present the relative merits and attractiveness of these two cash disbursement methods in a more general context.
Ultimately, we seek to arm investors with the tools and information they need to make intelligent decisions about these types of stocks.
Let’s get back into it.
Building a comparison
At this point, we hopefully have a fairly coherent understanding of the differences between dividends and share buybacks. We should be able to conclude, then, that the relative attractiveness of the two cash drawdown methods is based on investors’ individual needs, financial circumstances and risk profiles, ceteris paribus.
While we could end our discussion now in the realm of theory, it is far more worthwhile to pursue this investigation into the real world. That leads us to the final question: How does the real-world performance of the top dividend stocks compare to that of stocks with the highest buyback ratios?
Thankfully, this question is not particularly hard to answer since there are already indexes that track the performance of these two groups of stocks: the S&P 500 Dividend Aristocrat Index and the S&P 500 Buyback Index. The former index is composed of those companies that have raised their dividends every year for at least 25 consecutive years, while the latter consists of the 100 companies with the highest buyback ratio over the four preceding calendar quarters.
Head-to-head in a bull market
Comparing the returns of these two indexes between 2008 and 2017, we find the buyback stocks won by a moderate margin, posting an annual return of 12.6%, compared to dividend stocks’ 10.4%. That is still quite close.
While the S&P 500 Buyback Index beat out the S&P 500 Dividend Aristocrat Index over the course of 10 years, both did very well. Of course, solid returns were to be expected, given the time horizon comprised nearly the full span of a lengthy bull market. Thus, comparing them against each other tells just part of the story. We must also compare their performance against the market as a whole.
As it turns out, both indexes outperformed the full S&P 500 over the same period by a considerable margin. The broader index returned just 7.8% annually between 2008 and 2017. Buyback stocks may have narrowly pipped dividend stocks over a decade, but both beat the stock market quite unambiguously.
Head-to-head in a bear market
While we have a general answer to the question of comparative performance over the past decade, it still does not tell the full story. The final piece of the puzzle is to assess performance in other market circumstances. Given we may be teetering on the brink of a new bear market, it is worth taking a moment to consider how these indexes hold up in a downturn.
In the last recession, the dividend aristocrats fell 43.6%. That may seem pretty bad out of context, but it looks much more decent when set beside the buyback index’s 53.3% drop during the same correction. Indeed, buyback stocks actually fared ever so slightly worse than the full S&P 500 Index, which fell 53.1%.
The relative underperformance of buyback stocks is understandable in light of the recession’s economic realities. While a precipitous drop in the share price may theoretically present an opportunity to conduct stock buybacks on the cheap, most companies prefer to assume a defensive posture in times of uncertainty. They may think about doing a buyback on a depressed share price, but most will hold their fire until the crisis is in the rearview mirror. Strong dividend stocks, on the other hand, will keep paying out regardless of the economic conditions (most of the time, anyway).
Verdict
To wrap up our two-part discussion of the relative merits of dividends and share buybacks, we must reflect on the various factors outlined above and in the first part of this study.
While the buyback index pipped the dividend aristocrats over the course of a decade, that outperformance is somewhat mitigated when the declines of the last recession are also taken into account. Buyback stocks’ comparatively nasty reversal of fortunes during the last recession makes it nigh impossible to declare a clear winner on performance alone.
Ultimately, we must conclude both methods have merit, with the final assessment boiling down to the particular profile and preferences of each individual investor.
A final word to investors
Every individual is different, and thus the relative calculus must vary widely. Perhaps that is not the most satisfying conclusion in the world, but it is an honest one.
Investors considering investing in stocks of either type should review their needs and appetites carefully. Hopefully, this note can help them refine their thinking a bit.
Disclosure: No positions.
Read more here:
- Dividend or Share Buyback: Which Is Better for Investors? Part 1
- Is Buffett-Style Value Investing Making a Comeback?
- Was Apple's Share Buyback Binge a Mistake?
