The following is a guest post from Ben Carlson at A Wealth of Common Sense. Ben writes about personal finance, investments, investor psychology and using your common sense to build wealth.
Shareholder Yield: A Better Approach to Dividend Investingby Mebane Faber, answers one of the most often asked questions in investing today – “Where do I find yield”? Academic research on the topic of dividend investing is fairly well-known at this point (especially to loyal Dividend Ninja readers). Dividends make up a large portion of the total returns for stocks over the long-term. By some estimates reinvested dividends account for more than half of total returns in the stock market.
Unfortunately, the number of companies that pay dividends on a consistent basis has decreased in the past few decades. Companies have also decreased the amount that they pay to shareholders.
In the 1970s and 1980s the dividend yield on the S&P 500 averaged over 4%. The average yield since 2000 on the S&P has hovered around 2%.
One of the biggest reasons for this trend is the fact that companies are using their cash flows in different ways to increase shareholder value.
Increasing Shareholder Value
There are three main techniques that companies can use to increase shareholder value through the use of cash flows: (1) Dividend payments, (2) Share buybacks or (3) Debt repayment.
The book Shareholder Yield: A Better Approach to Dividend Investing by Mebane Faber takes a deeper look into each of these different strategies. Shareholder Yield has some great historical information on dividends and their effect on the stock market. This is a thorough and well researched book.
There’s also some background information on why more and more companies have decided to make the switch to share repurchases over dividends. Companies now spend more money on share repurchases than the amount of cash flows paid out as dividends, so it makes sense to see if those companies have been adding value through these buybacks.
The first part of the book was tasked with figuring out if there was a difference in stock performance between companies that utilized each of the three measures to increase shareholder value. The author took a look at the three different strategies and actually found similar stock return results from each.
What’s the Best Measure of Yield?
Over a 30 year period, stocks with the highest dividend yields (represented by the top quartile of all dividend paying stocks) returned over 2% more per year than the market over that period. The risk-adjusted returns were much better than the market as well.
Buying companies with the highest net buyback yield had very similar return numbers as these stocks also beat the market by over 2% in the 30 year period. It’s interesting to see that increasing EPS numbers through buybacks had a similar result as issuing dividends.
The last way to improve shareholder value is by paying down debt. This makes sense since cash flows and financing costs can be freed up to be used elsewhere in the business. Companies that had the highest net debt paydown yield also beat the market by over 2% a year in the same time frame.
Faber wanted to know what would happen if you fused each of these three metrics together in what he termed shareholder yield. Shareholder yield is defined as dividend yield + net buyback yield + net debt paydown yield.
When all three value added activities were used to find the stocks with the highest shareholder yield, the strategy beat the market by over 4% over the same 30 year period. So shareholder yield was the clear winner over simply looking at companies with the highest dividend yields, share repurchases or debt repayments individually.
Takeaways For Dividend Investors
The two alternate approaches don’t put income in your pocket, so dividend investors may be reluctant to look at these other yield measures.
At the very least, this book should expand your investing universe as a dividend investor. It could open you up to a number of interesting new names that you may have missed by only looking at companies on a dividend yield basis. Those companies that have a high net debt paydown yield could also be future candidates for paying solid dividend yields when the debt is fully retired.
Even if you don’t decide to use this new yield metric, this short book (it’s only about 50 pages) is worth your time. It’s full of stats and gives a really great historical perspective on dividends. The breakout of data about how much dividend paying stocks provide in total returns in both bubble and bust markets was especially interesting.
Also, the increased relevance of share buybacks and why they are now so prevalent is very important for understanding today’s markets.
If you don’t want to figure out how to calculate this new yield measure, Faber has a list of websites that allow you screen for the highest shareholder yield. For those interested in a diversified approach to using shareholder yield, Faber has created an ETF (ticker: SYLD) that puts this strategy into practice.
You can buy Shareholder Yield: A Better Approach to Dividend Investing on Amazon for about $5 (Kindle version). It’s well worth it for those interested in dividend stock investing or those that would like to learn more about the factors that influence shareholder value.