Last year's Buyback/Dividend Growth Portfolio represented the combination of what I consider to be compelling attributes; companies that both increase their dividends, and continue to buy back their stock. It is not a new idea, but it is one that has not been widely accepted by the industry.
In fact it may be a bit controversial, and theoretically makes no sense on two fronts. First, you could make the argument that paying dividends is a waste of capital given the fact that it is taxed twice; once as profit to the payer and second as dividends to the receiver. Capital that could be retained by the company essentially flows to the government when shareholders pay taxes on their dividends. Secondly, buying back stock could theoretically mean that the company has nothing better to do with those funds, that it could not earn higher returns by reinvesting it in the business. Combining these two bad ideas should make for a really bad idea. But in my experience, it can actually create value for shareholders.
Last year's "experiment" in building a buyback/growth portfolio contained some fairly stringent criteria:
- Minimum Market Cap: $2 billion
- Minimum dividend yield: 2%
- Reduction in shares outstanding 3-year average of 5% or more
- Minimum 5-year dividend growth of 5% or more
Thirteen months later, not enough time to prove the concept, but a decent start, the portfolio of fourteen qualifying names is up 27%, outperforming both the S&P 500 Index (+16%) and Russell 2000 Index (+21%). All but one name, Harley Davidson (HOG) -22% is in positive territory. The big winners so far are Boeing (BA) (+100%), Valero (VLO) (+90%) and Kohl's (KSS) (+68%).
The portfolio's current yield (2.7%) is not quite to the level of the current 10-year treasury bond yield (3.07%), but is decent nonetheless. However, more importantly, at least for this concept, all fourteen names have raised their dividends over the past year.
In terms of buybacks, all but one name, Timken (TKR) , also reduced shares outstanding over the past year. TKR had quite a run of buybacks, reducing shares outstanding by about 20% between 2012 and 2017. According to the company's most recent earnings call, it may buy back shares in the coming year, based on the strength of free cash flow, but did not commit.
Overall, however, buyback activity among names in the portfolio has been strong over the past year. On average, these companies reduced shares outstanding by about 4.6% over the past year. Legg Mason (LM) was the leader here, buying back nearly 10% of its shares. That did not translate into any material gains, however, as shares are up about 8% since portfolio inception.
Whether there is true validity in this concept remains to be seen; I am certainly a believer, but also need to see how it would play out in a down market. Capturing more than 100% of the market upside, while having the ability to limit the downside by falling less than the benchmark in a down market would be the true test here.
