Over the past two quarters I’ve noticed a pretty big divergence in the strategy that companies are starting to follow. A large portion (maybe 70% or more of large caps) are on the “return cash to shareholders” trend, while fewer and fewer seem to be executing a growth strategy specific to their business. I see this as confirmation that the world is still strapped for demand because when a company doesn’t see a better use for the cash, meaning opportunities for investment and growth are pretty limited, they might as well return the cash to shareholders to do something more productive with it.
I’m concerned because returning cash to shareholders in the form of dividends and share buybacks is basically the flow-through model of telecom and utility companies where they pass the bulk of cash flow each year to shareholders. It’s not necessarily a bad strategy, just one that is heavily focused on annual income (yield) at the expense of future growth. You can tell a company fits this description if it consistently trades with a relatively high dividend yield.
As an investor it’s important to make sure your investments actually match your goals. This means if you’re investing in stocks because you need/want/expect growth, you should buy stock in companies that aren’t transitioning to this model. Companies that are transitioning are a much better fit for “income” oriented portfolios. These stocks have significantly outperformed bonds over the past few years and while that pace is sure to slow, I still believe they’re a better investment as a source of income than bonds.
Let’s look at Pepsi as an example, which I just bought some more of two weeks ago in “income” portfolios after they reported earnings and the stock dropped. Pepsi just boosted their dividend 15% and said they plan to buy back 4% of outstanding shares this year. By reducing the amount of shares outstanding this actually creates a 20% boost to the yield received next year. Rising income certainly blows away the fixed income of bonds.
Pepsi – 9 months
As for the companies still executing growth strategies, they’re becoming much harder to find and so few and far between that investors are bidding them up to pretty high valuations. This says that they’re having such a hard time finding good growth that they’re willing to “pay-up” for it at higher valuations which will almost always come back to bite you.
Both of these trends point to lower expected returns in the long-run, at this point, for stocks. But I guess we can’t be greedy. We’ve had a heck of a run over the past 5 years.
Thanks for following!
Nick
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