Trillion-Dollar Payout May Mean Peak Largesse for U.S. Investors
(Bloomberg) -- U.S. companies are on pace to spend a record $1 trillion on buybacks and dividends in 2016. It’ll be a tough record to top.
A total $600 billion in share repurchases and $400 billion in dividends will be doled out by S&P 500 Index members by the end of the year, the biggest combined payout in history, according to strategists at Barclays Plc. Gravy like that is getting tougher to sustain as corporate profits suffer a six-quarter slump and cash levels begin to dwindle.
As a result, fewer companies in the third quarter upped their dividend -- and more are tapping the debt market to sustain their buyback programs, data from S&P Global Inc. and JPMorgan Chase & Co. show. For U.S. stock investors, it means a key pillar of the 7 1/2-year-old bull market may be tipping over.
“That’s been pretty important in keeping the valuations where they are today,” said Bill Schultz, who oversees $1.2 billion as chief investment officer of McQueen, Ball & Associates Inc. in Bethlehem, Pennsylvania. “Part of the implications would be that you wouldn’t have such an aggressive upward support for stocks than you’ve had in the past.”
Dividends and share buybacks have played an integral role in the rally since 2009 as low interest rates fostered an environment ripe for corporate borrowing. Money remained cheap, and the prospect of regular cash outlays drew investors to equities from income-generating assets like bonds.
Companies ramped up their outlays so much that the amount they’ve spent on buybacks and dividends has eclipsed their reported earnings for six consecutive quarters, the longest stretch since a two-year long period beginning in 2007, according to BNP Paribas SA.
Now the data suggests they may be running out of steam. U.S. companies increased dividends by a net $6 billion in the last quarter, down from $10 billion a year ago, according to S&P Global. At the same time buybacks may contract next year, Barclays said.
“What we’ve seen since 2011 is an extraordinarily high growth in shareholder distributions that is likely to slow back to longer-run levels,” Stewart Warther, an equity and derivatives strategist at BNP, said by phone. “Financial conditions have tightened somewhat and as a result companies are looking to reassure bondholders and looking for potentially organic growth that could be the catalyst for distributions.”
Companies won’t curtail buybacks without a fight. In the face of shrinking margins and less cash, they continue to fund distributions with borrowed money. In the past 12 months, 34 percent of repurchases were paid for through new debt issues, compared with 22 percent last year, according to JPMorgan.
The dip in buyback announcements won’t be the start of a larger trend, researchers at the bank said in an Oct. 17 note. Buybacks that are already completed are a better indicator of a company’s willingness to spend cash, and persistently low rates will enable companies to take on more leverage, wrote the team led by Dubravko Lakos-Bujas.
For now, shareholder distributions have swelled to a bigger portion of the cash available to pay them. On an absolute basis, payouts in 2015 reached the highest ever and accounted for a larger chunk of operating earnings than any period since 1994, apart from a stretch from 2008 to 2009.
Slipping cash levels are putting a dent in the funds available to sustain shareholder remuneration at record amounts. After more than six quarters of growing levels of free cash flow, S&P 500 companies said the metric for corporate efficiency shrunk in the third quarter, according to data from Pavilion Global Markets.
“Weaker economic growth together with higher leverage ratios across U.S. large caps will erode already weakening free cash flows, making capex, dividends and share buybacks more difficult to sustain,” the team at Pavilion wrote in a note to clients Thursday. “Indeed, free cash flows, which are less vulnerable to accounting wizardry than earnings, have begun to contract.”