Dividends and Share Buybacks Could Fuel High “Total Yield”

“A good capital allocator gets that balance right,” says John Tobin, a portfolio manager at Epoch Investment Partners, referring to company management teams.

Wolfe Research recently screened for companies with total yields of at least 7%, through a combination of dividends and buybacks. Wolfe also threw in some measures of quality, screening for stocks with low leverage, or debt ratios, and weeding out companies that had experienced negative earnings-per-share (EPS) revisions over the past 90 days.

Companies that passed Wolfe’s test included
Bristol Myers Squibb
(ticker: BMY), with a total yield of 9%;
Prudential Financial
(PRU), at 7.9%; and
KLA
(KLAC), at 7.8%.

Chris Senyek, chief investment strategist at Wolfe Research, says he likes total yield because it can “tilt you toward growth stocks over purely value companies, which are more characteristic of dividend yield.”

Corporate executives often tout buybacks as a way of returning capital to shareholders. Ideally, buybacks prop up EPS by reducing total shares outstanding. But companies that issue loads of stock options to executives may buy back shares simply to prevent dilution as those options expire and more stock hits the market. And EPS can still be diluted with large buyback programs in place.

“We like to hear management teams say they at least buy back stock to offset the dilution as part of a compensation program,” says Tobin. Senyek uses net repurchases, taking into account stock-based compensation, to help avoid that issue.

Among the companies that showed up in the Wolfe screen, most tilted toward buybacks over dividends.
AutoZone
(AZO), for instance, recently had a total yield of 10.7%, according to Wolfe, but all of it came from buybacks, since the company doesn’t pay a dividend.

Conversely, the total yield for Prudential Financial, a large insurer and asset manager, is more evenly distributed: its dividend supplies 4.7%, and 3.2% comes from buybacks.

Another consideration is that buybacks tend to be less secure than dividends, which companies usually only cut under deep duress. And this year isn’t looking great for buybacks.

Goldman Sachs
forecasts that S&P 500 buybacks will total $869 billion, down about 10% from $965 billion in 2022, due to what it expects will be flat earnings amid a tougher economic environment. In contrast, Goldman expects S&P 500 dividends to increase by 5% to $633 billion.

One other pressure point may be a new 1% federal excise tax on share buybacks. It took effect in January and could “slow buyback activity on the margin,” according to Goldman. President Biden has called for raising that tax to 4%, though it’s unlikely to pass Congress with Republicans in charge of the House.

Buybacks can be tricky for other reasons. Companies can overpay for their stock, buying when prices have risen well above what the fundamentals justify. Dividends tend to be a far more dependable source of capital return to shareholders, says Savita Subramanian, equity and quantitative strategist at BofA Securities.

“Companies have a lot more flexibility in terms of increasing or decreasing their buybacks,” she says. “It isn’t as consistent, and it doesn’t seem to be as much of a signal of commitment to shareholders.”

Scott Chronert, U.S. equity strategist at Citigroup, points to another difference between these two ways to return capital to shareholders. “Buybacks are a longer-term tailwind, but they are harder to measure in the shorter term,” he says, adding that a dividend “is much more tangible.”

Still, Ben Snider, a senior strategist at Goldman, likes total yield for its holistic picture of a company’s capital return policy, rather than looking at a dividend in isolation. Total yield, he says, may reflect the fact that “more-profitable companies have more capacity to do things like dividends and buybacks.”

For investors interested in the framework, one option is the $274 million
iShares Core Dividend
exchange-traded fund (DIVB). The ETF tracks the
Morningstar
US Dividend and Buyback Index, making it a proxy for total yield. It has an expense ratio of 0.05% and yields 3.2%.

The ETF’s top holdings include
Oracle
(ORCL), which yields 1.5%;
Broadcom
(AVGO), 3%;
Exxon Mobil
(XOM), 3.2%; and JPMorgan Chase (JPM), 2.8%. All four companies have been buying back billions of dollars of their own stock.

The fund has returned 5.2% this year, putting it in the middle of the pack for Morningstar’s large-cap value category. Its three-year annual return of 10.6% ranks in the top 25% of peers, and its five-year annual return of nearly 11% beats 95% of its rivals.

Tobin points to
Apple
(AAPL) as an appealing stock for its total yield. While its dividend yield is only 0.6%, the payout grew by 5% last year and 7% in 2021. In the fiscal year that ended in September, Apple repurchased $89.4 billion of its common stock, bringing its total yield to more than 4%.

Tobin also likes
PNC Financial Services Group
(PNC), a regional bank based in Pittsburgh. Its stock yields 3.7%. Add about $3.6 billion of stock buybacks last year, and the total yield gets even higher. PNC should earn $14.82 a share this year, according to consensus estimates, up 7% from 2022.

“There are different ways for a company to return capital to shareholders, who are the owners of the business,” says Tobin. “It doesn’t just have to be a dividend.”

Write to Lawrence C. Strauss at lawrence.strauss@barrons.com