Stock prices have been supported by high dividends and buybacks. But this may be ending, and if so, multiples will fall, potentially leading to a correction. And this is before the Fed moves their benchmark rate.
Over the past several years, there have been two primary sources of upside for the stock market: trillions in corporate buybacks, as companies themselves engaged in record repurchases of their own stock, often at price indiscriminate levels in a bid to not only raise the stock price but also the stock-linked compensation of management , and a similar amount of dividend payments which in a time of negligible yields, became one of the main drivers for buyers to scramble into the “safety” of dividend paying stocks. Collectively these account for an unprecedented amount of payouts to shareholders.
Today, Barclays’ head of equity strategy Jonathan Glionna quantifies just how much corporate cash flow has and will be used to fund these payouts.
Glionna finds that in aggregate the companies within the S&P 500 are returning a record amount of cash to shareholders through dividends and buybacks. Since 2009 dividends have increased by more than 100%, reaching $98 billion in the most recent quarter. Meanwhile, gross buybacks have tripled and Barclays forecasts that they will reach $600 billion in 2016. In fact, buybacks plus dividends could surpass $1 trillion in 2016, for the first time ever.
Just like Goldman Sachs, Glionna says that “we believe the substantial increase in distributions is one of the primary justifications for the gains in the price of the S&P 500 during this business cycle (Figure 1).
However, this unprecedented surge in distributions may be coming to an end and as Barclays puts it, “alas, nothing continues forever. The growth rate of payouts, which has averaged 20% since 2009, will all but disappear in 2017, in our opinion.”
While companies have “taken advantage of a recovering economy and generous credit market to enhance both dividends and buybacks” for six years, they may not be able to push them higher much longer.
And here is a fascinating statistic: over the last few years payouts have exceeded earnings for the S&P 500, which is rare. It almost happened in 2014, when the total payout ratio was 99%. In 2015, it did happen. It will happen again in 2016, based on Barc estimates, as net income is likely to be less than $900 billion against $1 trillion of dividends and buybacks. Prior to 2015, companies in the S&P 500, in aggregate, had paid out more than they earned only six other times during the last 50 years. It has never happened more than two years in a row (Figure 2).
In addition, cash outflows for dividends and buybacks have been exceeding cash flow from operations after capital expenditures. We discussed this in The end of financial engineering? (February 29, 2016), which highlighted the S&P 500’s growing reliance on the investment grade credit market to cover its cash flow deficit. Based on our measure, companies in the S&P 500 have spent more than they generated in free cash flow every year since 2013.
The kicker: Glionna estimates that non-financial companies in the S&P 500 have a cash flow shortfall of more than $115 billion per year (Figure 3). In other words, companies will spend promptly send every single dollar in cash they create back to their shareholders, and then use up an additional $115 billion from cash on the balance sheet, sell equity or issue new debt, to fund the difference.
