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If You’re Looking For Capital Growth, Avoid Dividends

Shareholder distributions, defined as total dividends plus gross share buybacks, amounted to $259.8 billion for S&P 500 companies at the end of the third quarter — the highest quarterly total of shareholder distributions in at least ten years. The second highest total was recorded back in April 2014 when distributions hit $252.2 billion.

For income investors, this is good news. Corporations are now returning a record amount of cash to investors — what’s not to like?

Well, as it turns out there’s a lot not to like, especially for those investors seeking capital growth, as a recent research report from Factset INSIGHT points out.

Dividends are rising

S&P 500 company dividend payments amounted to $103.3 billion in Q3, which was the third largest quarterly total in at least ten years. Dividends make up around 40% of cash distributions to investors. Year-on-year dividend payments to investors are up 10.9%. The total dividend payout for the trailing 12 months ending in Q3 was $410.8 billion, which marked the largest trailing-twelve-month payout in at least ten years.

At the sector level, Financials and Information Technology sectors were the most generous to investors. The Financials sector ended Q3 with dividend payments totaling $17.5 billion on a quarterly basis and $70 billion on a trailing 12-month basis. The Information Technology sector paid out $14.6 billion in quarterly dividends and $60.9 billion in TTM dividends. Tech giants such as Apple and Microsoft, along with banking giant Wells Fargo were responsible for the largest cash payouts to investors.

However, while the dollar value of dividends paid per share hit one of its highest levels in ten years during the third quarter, the year-over-year growth in dividends paid per share was the lowest rate seen since 2011. The S&P 500 TTM dividend per share was $42.46 for the third quarter representing 10.9% growth from the year-ago period, below the average YoY growth rate of 12.1% for the past eight quarters.

That being said, the energy sector saw a near 50% year-on-year decline in Q3 per share dividend payouts, and this decline skews the figures somewhat as the chart below shows.

Performance Spread Between Dividend Payers and Non-Dividend Payers

The most interesting finding of Factset’s study is the diverging performance of dividend payers and non-dividend payers on a total return basis relative to the S&P 500 Total Return Index. Since the end of April 2013, non-dividend payers have drastically outperformed their dividend-paying peers, a trend that’s been in place for the past two decades. Since the end of 1995 dividend paying stocks have achieved an excess weighted cumulative return of -52.8% relative to the benchmark, while non-dividend paying stocks saw a return of 88.3% relative to the benchmark. As shown in the chart below:

This return spread (141.1 percentage points) is the highest recorded since August 1999, when the spread was 149.8 percentage points.

Reinvestors vs. returners

The underperformance of companies that return the majority of their earnings to investors is not a new phenomenon. Indeed, a few months ago the Financial Times took a look at the findings of a white paper from the Credit Suisse Holt group. The white paper looked at the fortunes of “reinvestors” vs. “returners”, companies that returned the majority of their cash to investors vs. those firms that reinvested excess cash into operations.

From the FT:

“Historically, according to the Holt white paper, companies have deployed an average of 60 per cent of their cash flows in capital investment (whether organically or through M&A) and have returned 26 per cent to shareholders (12 per cent dividends and 14 per cent share buybacks). More recently, the capital invested has dropped to 53 per cent while cash returned to shareholders has increased to 36 per cent, with an increasing share going to buybacks.”

“The Holt paper follows the fortunes of “reinvestors” and cash “returners” and finds that the latter increase their sales by only 5 per cent per year over the ensuing five years on average. Reinvestors managed to grow sales at 19 per cent per year. So the critics’ picture of tired ex-growth companies, out of ideas for growth, and deciding to reward their shareholders to the detriment of the chance for economic growth, has at least something to recommend it.”

“Companies are getting less cash than they used to, they are not optimistic that they can invest it productively and so they are choosing to deploy it in a way that weakens the chances of sales growth in the future. Not encouraging.”

So, according to Credit Suisse’s data “reinvestors” have been able to grow sales three times faster than “returner” peers. In other words, if you’re looking for growth avoid “returners”.

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