Dividends in 2018 – will they lose out to buybacks?

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By some measures, 2017 was a good year for investors in dividend-paying stocks.

According to S&P Dow Jones Indices, the average dividend increase for U.S. common stocks was 11.36% last year, up from 10.51% in 2016. And despite the high profile cut in GE’s dividend, only 445 issues decreased or omitted their shareholder payments in 2017 vs. 659 in the previous year. That’s a 32.5% reduction in cuts.

On the other hand, 2,642 issues had positive dividend actions (increases, extras, and resumptions) vs. 2,634 issues the previous year, a measly 0.3% improvement. The tiny improvement in this metric followed two consecutive years of lower positive dividend numbers.

And while the dollar amount of dividends has increased, yields have declined slightly because the market continues to rise. We now have the second longest bull market in modern history. (The longest ended with the dot-com bust in 2000.)

With the corporate tax cut in effect for 2018, some of the extra income of publicly traded companies may be distributed to shareholders as dividends. But if history is a guide, more of it will be directed to share buybacks. Based on S&P 500 data for the 12 months through September, about 56% of the cash spent on buybacks and dividends went to buybacks. Over the past decade, there has not been a single year in which the aggregate amount spent on dividends exceeded that spent on buybacks.

The argument in favor of buybacks is that dividends are immediately taxable while share repurchases tend to boost the value of stocks and that gain is only taxable when the investor sells. This is true, but left unsaid is that buybacks tend to benefit the managements that deploy them. By reducing the number of shares, buybacks boost the per-share earnings of a company. And since per-share earnings growth is frequently a metric used to determine executive bonuses, buybacks are popular with C-suite residents.

Given political uncertainties in Washington, a few executives might be tempted to share some of the additional corporate income this year via extra dividends. Extras have the benefit of not adding to shareholder expectations. An increase in the regular dividend, though not guaranteed in future years, tends to be built into investor forecasts. And while companies that cut regular dividends are punished in the market, those that simply don’t repeat an extra are not.

Extra dividends totaled 592 last year. Over the past dozen years, extras peaked in 2012 at 1,056. The reason for the big interest in extras that year was the pending expiration of low Bush-era income tax rates in 2013. That made it advantageous for some executives to propose extra dividends, particularly in companies where insiders held significant stock positions.

Take the case of Wynn Resorts, which in 2012 gave shareholders $7.50 a share in an extra dividend. That year, chairman and CEO Steve Wynn held more than 10 million shares of the company’s stock. His ex-wife, Elaine Wynn owned 9.7 million shares. Their combined take in extra dividends was more than $148 million, on which they owed taxes of about $22.2 million. Had the cash been salary or bonus, the taxes would have been close to $52 million.

The likely higher corporate income in 2018 could lead some companies to reward insiders with a bonus in the form of an extra dividend. And, of course, the small investors along for the ride will be told that the company’s generosity was for their benefit. A better outcome for the individual investor would be a boost in the regular dividend. Look for that mainly from companies that paid closer to the statutory rate under the old law.

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