Looking for Equity Income? Try Shareholder Yield
May 1, 2013
- Shareholder yield—a comprehensive measure of equity income—can be helpful in selecting stocks.
- Our research shows that a shareholder yield strategy tends to produce better returns than a dividend yield strategy alone.
- A shareholder yield strategy also may help investors find attractively priced non-dividend-paying stocks.
With the record low interest rate environment over the past few years, income-seeking investors have bought shares of nearly any high dividend-paying company.
But, as we noted recently, this pursuit of yield has caused many of these stocks to become expensive relative to their fundamentals. We also found that these highest-yielding stocks are more likely to cut their dividends than other dividend-paying stocks.
So where else can investors turn? Our research has shown that a strategy emphasizing shareholder yield—a more-comprehensive measure of equity income that includes both dividends and share repurchases—tends to produce more attractive total returns than those earned from just a dividend-yield strategy. Additionally, we've found that a shareholder yield strategy might help investors find attractively priced non-dividend paying stocks.
What's shareholder yield?
Shareholder yield is a measure of the total cash returned to the shareholders—the combination of cash dividends and share repurchases. With share repurchases, a corporation pays out cash to shareholders selling in the open market. The remaining shareholders benefit as their shares are now worth more.
Let's look at a simplified example to help explain the principles of share repurchases. Imagine that you already own one share of company XYZ that has 10 shares total outstanding. Company XYZ's market cap is $1,000,000 which means that each share is worth $100,000. XYZ's management team and board agree to buy back one share of their outstanding stock leaving nine outstanding shares. All else being equal, now that same market capitalization of $1,000,000 is spread across fewer shares (nine) which increases their value to $111,111 per share.
This simplified example does not imply that all share repurchases will increase an existing shareholder's value. It just demonstrates one scenario where share repurchases could increase a shareholder's value. Companies have also been known to destroy value by buying back their shares at overvalued prices.
How does the shareholder yield strategy perform?
To test shareholder yield as a stock-selection strategy, we first examined the performance of a hypothetical dividend-yield strategy and a share repurchase strategy separately. We then combined them to see if the share repurchase factor would have added any extra return.
To start, we divided the top 1,500 stocks in the US market by market capitalization into five segments based on a stock's current dividend yield or its share repurchase value. Using the current dividend yield measure, we first separated the dividend-paying stocks from the non-dividend paying stocks. The non-dividend paying segment constituted, on average, approximately 500 stocks from the top 1,500. For the stocks that paid a dividend, we divided them equally into five groups (on average approximately 200 stocks per segment) based on dividend yield. Group 1 contains the stocks with the highest yield while Group 5 holds the lowest-yielding stocks.
For the share repurchase value, we calculated the year-over-year change in shares outstanding. This value can be negative (net share repurchase) or positive (net share issuance). Using this measure, we divided the top 1,500 stocks in the US market by market capitalization into five equal segments (on average approximately 300 stocks per segment). The first segment (Segment 1) included all the stocks that had, on average, repurchased their shares. The next four segments were comprised of stocks that had increasingly greater number of share issuance, on average, year over year.
We formed our five buckets for the dividend and the share repurchase measure as of the end of each month from 1990 through 2012. We calculated the subsequent average 12-month return for each segment and then averaged these overlapping twelve month returns (276 returns) over the entire test period. The table below shows this hypothetical average 12-month return, the average dividend yield and the standard deviation of returns for each of these groups:
- Highest dividend-yielding stocks—stocks in top 20% of all dividend-paying stocks (Group 1 described above)
- Highest shares repurchased—stocks in Segment 1 described above
- Combination of the two groups above (the intersection of stocks from Group 1 from the dividend yield segments and Group 1 from the share repurchase segments)
- Overall stock universe—top 1,500 stocks in the US market by market capitalization
Hypothetical Performance of the Five Groups of Stocks from 1990 to 2012
|Strategy||Average 12-month return (1990-2012)||Average dividend yield||Standard deviation of 12-month returns|
|Highest yielding stocks— Group 1||13.1%||6.1%||17.5%|
|Highest shares repurchased— Group 1||15%||2.4%||33.1%|
|Overall stock universe||12.9%||2.7%||42%|
Source: Schwab Center for Financial Research as of December 31, 2012. These returns are simulated, historical results, calculated with the benefit of hindsight, and are not intended to be replicable by individual investors.
In analyzing these results, please note that they are indicative of the general tendencies of a large distribution of returns associated with historical dividend yield or share repurchase values.
Looking at the table, the share repurchase strategy appears to be a better stock-selection strategy than the highest dividend yielding strategy (outperforming it by close to 2% on average for past 12-month periods, 15% versus 13.1%), although with more price variability (i.e. higher standard deviation of returns).
There are two main reasons why a share repurchase strategy appears to work. When a company buys back its shares, the remaining shares become more valuable—like cutting a pizza into six slices instead of eight. In other words, the investors' ownership in the company increases on a percentage basis as we explained above.
The other reason has to do with what management may be signaling to the market. Buying back shares could tell the market that company management has a favorable attitude toward shareholders and an ability to generate profits that can be used to buy back shares.
Another insight drawn from the table is that the highest-yielding stocks surprisingly only matched the overall universe returns. Given their high average yield, you might expect their total return to exceed the market. However, dividend cuts and overvaluation may explain why this might not be the case.
One major benefit to owning high-yielding stocks is that their variability of returns has been significantly less than the overall market (standard deviation of 17.5% versus 42%). This means, you may have smaller swings in your returns—especially important during market declines.
In our study, combining the highest stock repurchase and dividend yielding strategies added extra return. Note that the highest yielding stock's average 12-month return increased from 13% to almost 15% when combined with stock repurchases. For investors looking for an additional edge in buying high-yielding stocks, employing shareholder yield may help to improve returns while still providing a relatively attractive dividend yield (5.5% on average).
Help with non-dividend-paying stocks
An additional and unexpected result from our research was how looking at share repurchases may help select non-dividend paying stocks.
The universe of non-dividend-paying stocks is primarily comprised of faster-growing companies that reinvest all their earnings back into operations. Some professional investors are prohibited from buying these stocks because they don't pay a dividend. Others often have difficulty identifying the more attractively priced stocks among these faster-growing companies. The results from our research appear to help both investor types.
Focusing on just the non-dividend-paying stocks in our top 1,500 stock universe, we used the stock's share repurchase value to divide this universe into five segments. The first segment (Segment 1) included all the non-dividend paying stocks that had, on average, repurchased their shares. The next four segments were comprised of non-dividend paying stocks that had increasingly greater number of share issuance, on average, year over year.
We then calculated the subsequent 12-month return for each segment at the end of each month from 1990 through 2012 and then averaged these overlapping 12- month returns (276 returns) over the entire test period.
In analyzing these results, please note that they are indicative of the general tendencies of the distribution of returns associated with the non-dividend paying stocks and the share repurchase values. Therefore, investors may not be able to replicate these simulated historical returns going forward.
The results of this test are summarized in the graph below. It shows the hypothetical average 12-month return to each of the five segments along with the overall average return to the non-dividend paying universe.
Note the relatively attractive total return earned by the stocks of companies buying back their shares (the "net share repurchase" segment). The stocks in our study had historically earned close to 18.7% on average for past 12-month periods, about 4.5% more than the average non-dividend paying stock return.
Another interesting finding was the underperformance of stocks issuing the greatest number of shares (approximately 4%). Fast-growing companies that fund their growth with heavy share issuance appear to do a disservice to their shareholders, as more outstanding shares dilute the share value of all shareholders.
Considering our findings, more growth-oriented stock investors might want to focus their attention on stocks of companies buying back shares while avoiding the stocks of companies heavily issuing shares to fund growth.
For income investors, expanding their definition of income beyond companies that just pay a dividend to companies that also return capital to its shareholders via share repurchases could allow them to widen their selection universe to include some faster-growing companies and potentially find better returns.
Source: Schwab Center for Financial Research as of December 31, 2012. These returns are simulated, historical results, calculated with the benefit of hindsight and are not intended to be replicable by individual investors.
What you can do
To pursue a stock selection strategy based on shareholder yield, will take some time and research. Below are some steps to help get you started. For additional help and information, contact a Schwab representative at 800-435-9050.
- For a dividend yield strategy, your first step should be to research dividend-paying stocks. To do this, go to the "Stocks Research" section of schwab.com, go to the "Screener" tab, select the drop-down menu for "Basic Criteria" and click on "Dividend Yield." Here, you might want to consider stocks with dividend yields in the range of 4 to 6% and then select "View Matches."
Then, to narrow down this list, take a look at a stock's repurchase history. To find repurchase information, go to "Stocks Research," enter a ticker symbol and then the "Statements" tab will appear. Next, under the shareholder equity section of a company's balance sheet, find the difference in common shares outstanding between the most recent quarter and the same quarter a year earlier. Give preference to the high-yielding stock of a company that's been buying back its shares over the past 12 months. Companies with a reduction in shares outstanding historically have been more attractive candidates to purchase.
- In choosing among more growth-oriented stocks that might not be paying a dividend, consider the stocks of companies that have been buying back shares over the past 12 months. See step above for instructions on how to find this information. Also, avoid stocks that have had large net share issuances over the past year.
- Use Schwab Equity Ratings® to help identify potentially better-performing stocks within either an income or higher-growth universe. Our research has shown that high dividend-paying or high growth stocks that are A- or B-rated by Schwab Equity Ratings collectively outperformed similar stocks historically by at least 5% on average for the next 12 months. We have also found that A- and B-rated stocks have historically been twice as likely to buy back their shares.
For more on the research behind Schwab Equity Ratings and how to use them, read Schwab Equity Ratings® Foundations and Managing a Stock Portfolio Using Schwab Equity Ratings.
Schwab Equity Ratings® are assigned to approximately 3,000 of the largest (by market capitalization) U.S. headquartered stocks using a scale of A, B, C, D and F. Schwab's outlook is that A-rated stocks, on average, will strongly outperform and F-rated stocks, on average, will strongly underperform the equities market over the next 12 months. Each of the approximately 3,000 stocks rated in the Schwab Equity Ratings universe is given a score that is derived from several research factors. The assignment of a final Schwab Equity Rating depends on how well a given stock scores on each of the factors and then how that stock stacks up against all other rated stocks.
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Past performance is no guarantee of future results.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
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