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The stock buyback boom has helped push the S&P 500 index to near all-time highs, but could the buyback bubble finally be ready to burst?
U.S. corporations announced some $180 billion in buybacks last quarter, which is the biggest slowdown since 2012.
What’s hurting the buyback boom is the fact that corporate cash flows are on the decline. For the first quarter, S&P 500 revenues are expected to fall for the fifth straight quarter. Meanwhile, profits for S&P 500 companies are expected to fall by over 3% both this quarter and the next.
Companies buy back shares when they think their stock is undervalued. However, with the S&P 500 near all-time highs, how can things really be all that undervalued?
Taking that a step further, most companies are actually bad at buying back their own stock. Some 66% of companies in the Dow Jones Industrial Average would have fared better buying into the S&P 500 index versus buying their own stock. This includes companies like Coca-Cola (NYSE: KO), American Express (NASDAQ: AXP) and Wal-Mart (NYSE: WMT) – all of whose buyback timing has been poor over the last decade, and whose repurchased shares have underperformed the S&P 500.
Buybacks are said to be great ways to return cash to shareholders, but they still can’t compare with dividends, which actually put cash in shareholders’ pockets.
While the short-term move in a stock price due to a buyback announcement is positive, the long-term impact is more uncertain. The answer is to stick with companies that opt to commit to returning actual cash to shareholders with dividends. More importantly, focus on companies with a history of dividend increases.
Here are the top three companies that haven’t gotten caught up in the buyback hype and have remained committed to their dividends:
No. 1 Way to Play the Buyback Bubble: Nucor Corp. (NYSE: NUE)
The first company on our list hasn’t been active with buybacks, but has a long history of dividend increases. Nucor has upped its dividend for 42 straight years and is paying a 3% dividend yield.
The company has a solid balance sheet and is a provider of various steel products. It also has an advantage over other steel producers, as its furnaces are less energy and labor intensive. To this extent, Nucor has been profitable in every year since 1966, except one.
The other beauty of Nucor is that it has strong control over raw material costs with its ownership of scrap metal processor David J. Joseph and a partnership in a natural gas drilling company.
No. 2 Way to Play the Buyback Bubble: Mercury General Corp. (NYSE: MCY)
Mercury is a $3 billion market cap property and casualty insurer. It pays a sizable 4.6% dividend yield – but more importantly, it has upped its dividend for 30 straight years.
The insurance market has proven to be steady and profitable. Mercury operates primarily in California and has a full line of auto insurance coverage. It also has operations in 13 other states.
The auto business accounts for nearly 80% of Mercury’s profits. Thus, the steady rise of auto purchases should continue to be a net positive.
No. 3 Way to Play the Buyback Bubble: Vectren Corp. (NYSE: VVC)
Vectren is a diversified utility company. It pays a 3.2% dividend yield and has an impressive streak of 56 consecutive years of dividend increases.
Vectren provides energy services to residential, commercial and industrial customers. In particular, it offers natural gas distribution and transportation services, plus electric transmission services. It owns coal-fired, natural gas or oil-fired, and landfill gas electric generating facilities. Again, like insurance, utilities are steady and profitable businesses.
The impact of buybacks appears to be more short-term. And those short-term benefits appear to be wearing off. A proven long-term strategy for rewarding shareholders is dividends. Look for stocks like the three above that have a long history of dividends and have avoided the buyback bonanza.
And while companies that pay consistent quarterly dividends and regularly increase their payouts generally outperform the broader market, a select group of companies also rewards shareholders with special dividend payments. Click here to access recently completed research regarding opportunities too often overlooked by income investors.