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Here’s another reason to shun the bright and new and stick to the tried and true.
Investors are always looking to get one-up on other investors. They are in constant search of the philosopher’s stones of valuation metrics – the one metric that continually leads to profitable investments.
The new metric of “shareholder yield” has gained currency among investors. Shareholder yield putatively measures the different ways “dividends” are paid to shareholders: cash dividend, share buybacks, debt reduction, reinvestment, and acquisitions.
My issue isn’t so much there is anything wrong with shareholder yield; it’s really that there is nothing new. Focusing on cash dividends paid to shareholders, buybacks, debt reduction, and how the business is run is what investors and analysts have done for decades, if not centuries.
What’s more, to say “yield” is misleading. The only yield that matters to investors at the end of the day is dividend yield. Everything else is simply a means to an end, and that end is the dividend. The value of any company is determined ultimately by the dividends – present and future – that will be paid to investors. There is no other “yield” to shareholders.
I generally like share buybacks when done continually and methodically, but they don’t in and of themselves generate a meaningful yield to me. What’s more, buybacks are not automatically winning strategies. Research from Fortuna Advisors, a firm that advises companies on creating shareholder value, shows that share buybacks actually deliver lower total shareholder returns for many companies.
Mergers and acquisitions are also notorious for destroying value. KPMG analyzed a large sample of M&As completed between January 2007 and July 2009 and showed that, in 44% of the transactions, the acquirer achieved either none or very little of the anticipated synergies.
I also frequently read that a dividend shouldn’t be paid if the company generates a high return on its internal projects. Therefore, the company should continue to plow all earnings back into the company. This line of reasoning, as persuasive as it sounds, has a couple of shortcomings.
For one, dividends, high returns, and growth are more positively correlated than most analysts and investors know. In a 2003 paper written for the Financial Analysts Journal titled “Surprise! Higher Dividends = Higher Growth,” asset managers Robert Arnott and Clifford Asness found what the title of their article states: Historical evidence strongly suggests that expected future earnings growth is fastest when current payout ratios are high and slowest when payout ratios are low.
How can this be?
The authors reason (persuasively) that cheap capital will always be available to companies that have a proven record of creating value. It doesn’t matter if the capital is externally or internally generated. Externally, there is no shortage of investors willing to provide the capital to grow a high-return business. In this regard, more debt leads to more value, not less value that that proponents of shareholder value lead you to believe.
To be sure, keep track of debt levels, M&A activity, returns on investment capital, but these matter only to the extent they generate earnings and cash flow that are paid as dividends. Dividend yield is the only yield that matters to investors.
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