Record Dividends and Buybacks:
Good for Business?
Companies in the S&P 500 stock index paid out roughly $200 billion in
dividends and a record $315 billion in share repurchases to shareholders in
2005. 1,2 According to Standard & Poor's, that's up more than
30% from the previous year's record.³
To put this hefty $515 billion figure in perspective, consider that it
would amount to nearly $1,700 per U.S. citizen and would pay off last year's
federal budget deficit with $180 billion to spare.4
Here's a look at why corporate shareholders are seeing the recent flood of
dividends and buybacks, and what the trend could mean for investors,
corporations, and the economy as a whole.
Through dividends, a company can distribute a portion of its profits
directly to investors. When a company repurchases its own stock, it reduces
the number of outstanding shares by buying them back, which potentially drives
up earnings per share and leaves investors with a bigger slice of the profits.
The recent generosity on the part of American corporations is a by-product
of record profits. Deep corporate cost cutting, prompted by the previous
economic downturn and subsequent bear market, led to rapidly improving balance
sheets once the economy improved.5
The payouts should have been relished by stock market investors, who
accepted relatively flat share prices in 2005, especially now that dividends
are taxed at a lower rate (at least through 2008 under current tax law).6
However, some economists worry that the trend could have negative economic
overtones, particularly if companies with staggering cash reserves don't find
profitable ways to reinvest for future growth.
Others perceive higher dividend payouts as an attempt at friendlier
corporate governance, meant to restore confidence after episodes of accounting
scandals. The return toward historical levels is significant, but not
complete. Dividends now constitute about 32% of payers' profits, compared with
the historical norm of about 54%.7
As for buybacks, they could prove to be a smart long-term investment on the
part of companies, but only if shares are purchased at an attractive price and
the stock is truly undervalued relative to performance.8
Dividends and buybacks together translate into tangible benefits that
investors can appreciate. And if the impressive payments lead to increased
consumer spending, or push up stock prices as dividends are reinvested in the
stock market, then the overall economy may benefit as well.
1) The Wall Street Journal, January 22, 2006
2) USA Today, January 5, 2006
3-8) The Wall Street Journal, November 28, 2005
