The US dividend culture appears to be shifting, but is it really sustainable alongside a multibillion-dollar binge of share buybacks and low investment?
The S&P 500 dividend payout ratio – the amount of earnings paid in distributions – has been creeping upward to 34.5 per cent over the past couple of years.
It remains far below its long-term average of 49 per cent, and the FTSE All Share, which currently pays out 47 per cent of its earnings.
JP Morgan US Equity Income lead manager Clare Hart believes the dividend train is just getting started, with more companies paying larger proportions of earnings to shareholders. However, the sheer level of margin eked out by US companies on top of massive share buybacks and minimal investment in future revenue growth is giving some managers pause for thought.
When US dividends are added to share buybacks, the total returned to shareholders last year was about $915bn, or 95 per cent of earnings, according to Dow Jones
More S&P constituents currently pay dividends than at any time before 1997, with 423 handing out regular distributions. Eight companies started paying dividends last year, while 375 dividend increases were reported.
While those dividend payments are encouraging, they are not the only method of returning profit to shareholders.
Share buybacks have become endemic in the US. Some 3.2 per cent of market capitalisation was bought back in the US in 2013, compared with 1.5 per cent in Europe, according to the JPM Long Term Capital Market Return Assumptions report.
Hart says American companies have large cash holdings and record levels of profitability, allowing them greater freedom to allocate capital.
The US has delivered strong ret-urns over the past few years and investors can expect “reasonably good” performance over the next year too, Hart says.
JP Morgan analysts estimate US earnings will grow 5 per cent this year, taking the total to $124bn. However, Thomson Reuters data released last month indicates that first-quarter earnings are likely to be flat, which would make it the worst quarter since September 2009.
That is driven by the halving oil price and its ramifications for oil majors and energy services companies. At the time of writing, the S&P 500 was 2.1 per cent down year-to-date.
Hart says JPM’s analysts have already moderated their expectations to account for the oil price slump.
“The stronger US dollar and sluggish growth in Europe and Asia have also contributed to a more subdued outlook,” she admits.
“But fundamentally US profits are exceptionally strong, with margins at records and still rising, and until this economic cycle ends we don’t see that changing.
“Strong profits and cashflows should encourage continued stock buybacks, higher dividends and
Despite its bumper growth, the US economy remains mid-cycle, she argues.
“At times, investors get caught by measuring market advances in calendar years and not where we are in the economic cycle.”
Premier senior multi-asset manager Simon Evan-Cook says the team’s funds have avoided the US for some time on valuation grounds.
It is impossible for dividends, share buybacks and capital investment to increase at once unless there is the earnings growth to fund it, he says. He agrees dividends are likely to rise in the long term toward their average as demographics shift in America.
“Equities have been the servants of babyboomers, and for the past 35 to 40 years they wanted capital growth and that’s what they’ve given,” Evan-Cook explains. “But now, that cohort is approaching retirement and it is more inclined to demand income, which will flow through to a greater dividend culture.”
Evan-Cook remains nervous about the US market because of its weighty valuations as well as its high number of buybacks.
“Aside from valuation, the level of share buybacks is my single largest concern with the US market at the moment. It’s almost at the point of making them the marginal buyer of themselves.”
The lack of capital investment also bodes ill for future revenue growth, he adds. “They just have not been spending the money on research, renewing equipment, whatever it is, to pay for share buybacks.”
Old Mutual Global Investors head of multi-manager John Ventre says dividends are likely to rise, but that it would be a stretch to call it “real dividend growth”.
“You have to be careful investing on that premise because the US market doesn’t price itself on dividends, it prices itself on earnings,” Ventre says. “Dividend growth in the US is a little bit of a shell game, it’s not a
sign of improving health like it is in other places.”
He agrees share buybacks have become too rampant, especially as companies are usually bad at timing their purchases. “Typically there is one pot to fund dividends and buybacks and capital expenditure, and I don’t see much chance of companies changing their views on capex.”
For years US companies have been battling to boost margins above all else, he explains.
“And that’s been working in that the market has been rewarding them for it, but the issue is: where’s that future growth coming from?
“Corporates are kind of in a trap right now, where the market essentially rewards a lack of capex because people want to buy high-margin businesses or businesses where margins are improving, which is not good from a long-term investor’s position.”