A recent study by Reuters found that corporate America is increasingly keen on one particular way to return money to shareholders: Simply buy back an enormous amount of stock.
The study points out that stock buybacks have reached unprecedented levels, and revealed the following startling fact:
“In fiscal 2014, spending on buybacks and dividends surpassed the companies’ combined net income for the first time outside of a recessionary period, and continued to climb for the 613 companies that have already reported for fiscal 2015.”
Dividend stocks are no longer the flavor of the day. Buyback stocks are all the rage.
But, as Reuters notes, the buyer should still beware. That’s because while major share repurchase plans can boost stock prices in the short run, they can backfire when purchases are poorly timed or when the company finds itself unable to adequately invest in its own growth.
One particularly revealing part of the Reuters analysis examined the top 50 non-financial U.S. companies — ranked by total amount spent on stock repurchases since 2000 — and graphed the ratio of buybacks and dividend payments compared to profits over the years.
And while the overall trend to spend rather than invest is troubling, there were five dividend stocks on the list that caught my eye, for all the wrong reasons.
Here are five companies overspending on buybacks and dividends at the expense of long-term shareholder value (at least as far as I see it):
5 Buyback-Happy Dividend Stocks to Ditch: Lowe’s (LOW)
Value of Buybacks & Dividends (FY 2015): $4.7 billion
Net Income: $2.7 billion
Buybacks & Dividends as a % of Net Income: 175%
It’s hard to argue that a series of aggressive stock buybacks and a stable dividend payment have been bad for Lowe’s (LOW) shareholders.
Investors in the home improvement retailer are sitting pretty right now, with shares up nearly 12% in the last year. Since stagnating in fiscal 2013, revenue grew at a 5% clip for two consecutive years, and is projected to do about the same in this fiscal year.
That’s all well and great, but if the housing market softens — remember, interest rates are almost certainly rising before year-end — things won’t be quite as rosy.
At that point, shareholders may very well be lamenting the ill-timed (and overenthusiastic) stock buyback rather than cheering it.
5 Buyback-Happy Dividend Stocks to Ditch: Time Warner (TWX)
Value of Buybacks & Dividends (FY 2014): $6.6 billion
Net Income: $3.8 billion
Buybacks & Dividends as a % of Net Income: 173%
“Those who do not learn from history are doomed to repeat it.” And, like an overplayed episode of Seinfeld, Time Warner (TWX) is playing out a tired theme we’ve seen all too often before.
Specifically, Time Warner has a nasty habit of stupid buybacks.
In 2006, it paid $14.5 billion to shareholders via share buybacks and dividends, despite making only $6.6 billion in net income … in other words, it returned 2.2 times what it made that year to shareholders.
In 2007, Time Warner was at it again: $7.1 billion paid out on a $4.1 billion profit, for a ratio of 171%.
What happened then? TWX went from $70 in 2007 to less than $20 per share (split-adjusted) in March 2009, at the trough of the markets.
In fact, TWX is a case study on why you shouldn’t aggressively buy back shares for short-term, illusory gains. It had to execute a 1-3 reverse split in 2009 to make its shares look more attractive to investors, and only in the last year did it begin trading above that $70 level, taking a full 7 ½ years to recover.
One should be especially skeptical of Time Warner’s dubious share buyback strategy given the irreversible trend towards cord-cutting we’re seeing today.
5 Buyback-Happy Dividend Stocks to Ditch: Home Depot (HD)
Value of Buybacks & Dividends (FY 2015): $9.5 billion
Net Income: $6.3 billion
Buybacks & Dividends as a % of Net Income: 150%
What is it with home improvement retailers and their exuberant buyback policies?
Home Depot (HD) faces the same systemic risks that Lowe’s does if the housing market takes a break, and recently it has been doubling down on how hard it’ll feel the pain if that happens soon.
Fiscal year 2014 and FY 2015 were Home Depot’s two most egregious years of overspending on buybacks and dividends since fiscal 2008. Its last two fiscal years saw the company return a combined $20.3 billion to shareholders through buybacks and dividends, despite reporting just $11.7 billion in profits.
Naturally this sort of spending is financed by debt, and total long-term debt at HD has spiraled from $9.5 billion at the end of fiscal 2013 to $16.3 billion at the end of the most recent quarter.
Home Depot’s long-term debt-to-equity ratio is currently 2.3, an uncomfortably high level for risk-conscious investors to stomach.
5 Buyback-Happy Dividend Stocks to Ditch: Caterpillar (CAT)
Value of Buybacks & Dividends (FY 2014 ): $5.9 billion
Net Income: $3.7 billion
Buybacks & Dividends as a % of Net Income: 158%
Caterpillar (CAT) doesn’t always blow its wad on share buybacks and dividends, but when it does, it does so in style. Last year’s 158% ratio was the highest in the 14-year period measured by the Reuters study by a decent amount.
In 2009, it divvied out about $1 billion to shareholders on net income of about $900 million for a ratio of 115%, but for 11 of the last 14 years Caterpillar has managed to prize profits over dividends and buybacks.
CAT has historically been a little more conservative than some of its peers in the study, which is why it’s concerning to see it spending so freely nowadays. A payout ratio of 67% indicates the dividend isn’t exactly facing an existential threat, but continued buybacks may not be the best allocation of capital.
Especially if the global commodities and mining markets don’t improve soon and China’s slowdown worsens.
5 Buyback-Happy Dividend Stocks to Ditch: Kimberly-Clark (KMB)
Value of Buybacks & Dividends (FY ): $3.2 billion
Net Income: $1.5 billion
Buybacks & Dividends as a % of Net Income: 209%
Last but not least, consumer goods giant Kimberly-Clark (KMB) is returning loads of cash to its shareholders despite not raking in anything close to that in net income. 2014 was the most disproportionate in that respect on record, and nothing but 2007 (the market top) comes close.
What’s worrisome is that sales have been stagnating for years, and revenue is expected to advance just 1.8% in 2016. That’s less than the historical 2% to 3% pull we see from inflation, and seeing as KMB owns a portfolio of brand-name personal product lines like Cottonelle, Kleenex, Huggies and Depend, the company should be able to raise prices year after year and continue to charge a premium over generic competitors.
Considering more than 50% of its revenue comes from overseas, KMB is also fighting the headwind of the strong dollar, a macroeconomic force Kimberly-Clark can’t do anything about.
With its largest customer Walmart (WMT) increasingly looking to suppliers for more favorable pricing as it raises wages for employees, now isn’t looking like the best time to take a new position in KMB.
As of this writing, John Divine did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @divinebizkid or email him at email@example.com.