Canadian investors love dividend stocks. But income seekers should look beyond a company's dividend yield to other factors that can enrich – or impoverish – shareholders.
Share repurchases represent one such factor because they are another way to effectively send money to shareholders.
In ideal circumstances, a company will buy back its own stock when it trades at a bargain price. It will also resist the urge to shower managers with stock options, issue additional shares at low prices, or pay too much when acquiring other businesses. Companies don't always live up to the ideal in practice, though.
While share repurchase plans are usually announced with a great deal of fanfare, far fewer are acted on. One way to keep track of a firm's progress is to calculate its buyback yield, which is equal to the percentage decrease in its share count over the course of a year.
For instance, Canadian Pacific Railway reduced its share count from 161.3 million on June 30, 2015, to 148.4 million on June 30, 2016. As a result, its buyback yield at the end of June was a hefty 8 per cent.
Buying stocks based on dividend yield or buyback yield leads to different results. Money manager James O'Shaughnessy studied both in his book What Works on Wall Street. He sorted large U.S. stocks each year by yield into 10 equal groups called deciles and tracked their returns over time.
He found that large U.S. stocks with the highest dividend yields (top decile) outperformed the market by an average of 1.2 percentage points annually from 1927 through 2009. More impressively, stocks with the highest buyback yields beat the market by 3.3 percentage points annually over the same period.
There was also an impact at the other end of the spectrum. That is, large stocks with low dividend yields (bottom decile) trailed the market by 1.2 percentage points annually. Those with low buyback yields did particularly poorly and underperformed by 3.6 percentage points annually. The low-yield results offer a cautionary tale for investors.
In more practical terms, many U.S. investors like to follow the famous Dogs of the Dow approach, which was first popularized by money manager Michael O'Higgins. A Canadian variant, "Beating the TSX," was advocated by retired professor David Stanley in a series of articles that appeared in the Canadian MoneySaver magazine over the years.
The idea is to start with an index of large stocks like the S&P/TSX 60. All of the stocks in the index are sorted by dividend yield and the 10 with the highest yields are purchased. They're then held until the following year when the process is repeated.
The strategy has been quite successful and it usually points investors to big banks and utilities. This week is no exception because the highest dividend yields in the S&P/TSX 60 are offered by: Inter Pipeline, Power Corp. of Canada, CIBC, Pembina Pipeline, National Bank of Canada, BCE, Emera, Shaw, Telus and Bank of Nova Scotia. (In the interest of full disclosure, I own a small amount of many of the stocks mentioned herein.)
Following a similar strategy but using buyback yield results in a different list, according to data from S&P Capital IQ, which reveal that the top stocks in the S&P/TSX 60 by buyback yield are: Canadian Pacific Railway, Dollarama, Metro Inc., Canadian Tire, Magna International, Gildan Activewear, Thomson Reuters, Agrium, Canadian National Railway and Loblaw.
It turns out that the high-dividend-yield stocks didn't buy back many of their shares over the last year. Of the 10, only Telus, CIBC and Bank of Nova Scotia sport positive buyback yields.
On the other hand, three of the top 10 dividend payers have deeply negative buyback yields. The laggards are Emera, Pembina Pipeline, and Inter Pipeline. Dividend investors might want to think twice before loading up on them.
While stocks with generous dividend yields often prove to be wonderful investments, investors should be mindful of firms that have a habit of issuing a lot of shares because they tend to lag the market.