Monday, August 28, 2006

US Stocks' Dividend Yield & The Hidden Devil

Recently I posted that as of the end of July, the US equity markets (S&P 500) were trading at a PE of 17.6x, Price/Book of 2.8x with a dividend yield of just 1.9%. International stocks trade at a PE of 15.9x, P/BV of 2.3x and a DY of 2.5%. Emerging markets stocks trade at a PE of 14x, P/BV of 2.3x and a more respectable DY of 2.5%. In effect, there is another point which I have failed to account for, which would bring the US markets' valuation closer to the other two. The hidden devil in disguise is stock buybacks. According to S&P, if you add in stock buybacks to dividends, the S&P 500’s yield jumps to 5.34 percent!

S&P says that companies in its 500 index have spent a stunning US$116 billion on stock buybacks in the second quarter, up 43 percent from 2005 levels and a stunning 175 percent from 2004. Thats about US$2 billion a day. Buybacks are similar to dividends - you are in effect returning money to shareholders, only thing is that instead of cheque in the mail, they reduce the float. Of course, as I have argued many times before, share buybacks only works IF you cancel those shares. That's the main reason why the so-many-buybacks in Malaysia does not work. You have to tell investors you are buying them, and then canceling them. If you buy on the pretext of redistributing them later or selling at a profit, that is not share buybacks. It does not work like that. The good thing in the US is that most share buybacks involve share cancellation as well.

The record US$116 billion in buybacks is the result of over 40% of the S&P 500 companies reducing their share count during the second quarter. The unprecedented expenditure on buybacks and the resulting share count reduction is having a material affect on both earnings-per-share and cash flow. Left unabated, this will eventually impact the supply of open market shares, and therefore the share price itself. With US bank accounts paying just over 4 percent, and bonds yielding not much more than that, the 5.34 percent buyback/dividend yield doesn’t look half bad.

The enormous buybacks also show something that’s been obvious to index watchers for some time: Despite relatively flat returns in the market, corporate America is swimming in cash right now, and they don’t know what to do with it. According to S&P, companies spent as much money on stock buybacks over the past twelve months as they have on capital equipment expenditures. Doing massive share buybacks is also a tendency to boost share prices by senior management as they have enormous options, and stand to gain from that strategy. It also points to the fact that corporate America is cash rich. But it also points to the fact that most companies find few reinvesting ideas.

Now the differentials between US equity, International equity and Emerging Markets equity does not look so bad at all. In fact with a dividend yield of more than 5%, US stocks still has a long way to go up. Look on the bright side, things good for US stocks, will also make other equity markets good.

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