Buybacks Decline Along With Earnings In Q4 2011

Standard & Poor's fourth quarter 2011 preliminary buyback report for the S&P 500 Index shows buybacks declined in Q4 along with reported earnings. Preliminary earnings were reported at $186.76 in Q4 2011 versus $206.08 in Q3 2011 and $187.67 billion in Q4 2010, while buybacks declined to $91.46 billion versus $118.41 billion in the prior quarter.

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S&P's Howard Silverblatt, Senior Index Analyst, notes,

“Companies appear to have finally gotten it right with average share prices declining 14.3% during the third quarter of 2011, companies poured $118 billion into stock buybacks (the most since the heydays of 2007), buying back shares at reduced prices. With depressed prices, companies were able to scoop up additional shares, which reduced the number needed for year-end employee options. In the fourth quarter, with share prices increasing an average of 11.2%, they pulled back.”

I would agree with S&P that it is better for companies to buyback shares at the lower prices reached in Q3 last year. However, this buyback volume can distort reported earnings per share and mask weakness in earnings growth. With fewer shares, earnings growth on a per share basis will be higher than actual corporate earnings growth. Bloomberg reports, the buyback activity reduced Standard & Poor’s 500 Index divisor, a measure of outstanding shares, by 0.6 percent last quarter, the first drop since March 2009.

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The Number Of Dividend Payers In S&P 500 Index At 12-Year High

In a dividend report released by Factset this past Friday, it is noted the number of dividend paying companies in the S&P 500 Index has reached a 12-year high. The report notes,

"The number of dividend-paying companies was 393 at the end of Q4 2011 (January 2012), which marks a 12-year high. Aggregate quarterly dividend payments amounted to $260.8 billion over the trailing twelve months. On a per-share basis, the aggregate figure was $26.78 per share, reflecting year-over-year growth of 16.1%. The Financials, Materials, and Information Technology sectors led all sectors in year-over-year growth on a per-share basis (40.0%, 28.4%, and 23.5%, respectively)."

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Interestingly, a majority (53.5%) of the companies in the technology sector now pay a dividend. This is up from only 17.9% in July of 2002, nearly 10-years ago. Is this a sign the technology sector is maturing?

We believe a primary reason for investors to look at a company's dividend practice is it provides insight into future expected earnings growth. And assuming a company is consistently growing its dividend at say a 10% rate, and all else being equal, that is, not borrowing to sustain the dividend growth rate and the payout ratio is not increasing, then the company's earnings are likely growing 10% as well. Over time the stock price should advance in line with the company's earnings growth rate. I am simplifying the analysis here as investors need to evaluate cash flow, etc. The Factset report, however, notes,

"a back test utilizing FactSet’s Alpha Testing application shows that stocks with the highest five-year compound annual growth rates in earnings per share have outperformed stocks with lower growth rates over fifteen years. However, the results for dividend per share (DPS) growth rates show a different relationship. Dividend paying stocks in the top quartile by DPS growth have underperformed the S&P 500 Total Return Index, while the lower three quartiles outperformed (emphasis added)."

If one removes the financial and health care sector stocks from the analysis, the top quartile dividend growers do exhibit the highest total return.

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The negative influences to the health care and financial sector are well know, the housing bubble and heath care reform legislation. So just looking at dividend growth and investing based on this can be treacherous. Investors certainly need to evaluate macro factors that can negatively (or positively) influence a sector or stock's performance.

Companies in the S&P 500 index are now paying dividends at a record level after J.P. Morgan's (JPM) recent dividend announcement. This was noted recently by Howard Silverblatt, S&P's senior index analyst. The below chart is for the period ending 12/31/2011 and includes preferred dividends.

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Lastly, given the level of cash on corporate balance sheets, and the still low payout ratio, future dividend growth looks promising.

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Certainly, the change in the tax structure for dividend payments might be a headwind as noted in a recent Wall Street Journal article, Will A Dividend Tax Hike Spoil The Party? ($); however, the discipline of using dividend growth in ones stock analysis can be rewarding for even total return investors.

Source:

Factset Dividend Quarterly (PDF)
By: Michael Amenta, Research Analyst, John Butters, Senior Earnings Analyst
March 23, 2012
http://www.factset.com/websitefiles/PDFs/dividend/dividend_3.12/

The Disconnect Between The Economic Data And Sentiment

Recent unemployment data released by the Labor Department continues to indicate the economy is adding 200,000 jobs per month. This has been the case for the last three months. What is interesting about the continued job growth figures is the GDP growth rate is suggesting a much lower rate of job additions. A recent article in the Wall Street Journal, Piecing Together the Job-Picture Puzzle ($), notes the level of job improvement over the last year would indicate the economy is growing at a 4-5% pace. This projection is based on a study by Arthur Okun and is known as Okun's Law. The Fed has opined on Okun's Law and the relationship between output and unemployment. Mish's Global Economic Trend Analysis site highlights a comment from Madeline Schnapp, Director of Macroeconomic Research at TrimTabs Investment Research:

"Something about the U.S. economy isn't adding up.

At 8.3%, the unemployment rate has fallen 0.7 percentage point from a year earlier and is down 1.7 percentage points from a peak of 10% in October 2009. Many other measures of the job market are improving. Companies have expanded payrolls by more than 200,000 a month for the past three months, according to Labor Department data. And the number of people filing claims for government unemployment benefits has fallen.

Yet the economy is barely growing. Many economists in the past few weeks have again reduced their estimates of growth. The economy by many estimates is on track to grow at an annual rate of less than 2% in the first three months of 2012. The economy expanded just 1.7% last year. And since the final months of 2009, when unemployment peaked, the economy has expanded at a pretty paltry 2.5% annual rate.

How can an economy that is growing so slowly produce such big declines in unemployment?

TrimTabs thinks the problem lies in the heavily massaged BLS employment data and the highly suspect BEA personal income data.

That said, withholding tax data is also messy and not a perfect measure either, but no matter what I do with the data, I can't get to 200,000+ jobs unless a huge percentage of the workforce is suddenly working for McDonalds."

Recently, a number of consumer sentiment releases have turned negative. Last week's University of Michigan consumer sentiment index fell to 74.3 versus 75.3 in the prior month. Expectations were for an increase to 76. Additionally, the IBD/TIPP Economic Optimism Index declined to 47.5 versus 49.4 in February. This decline was the the index's first since August of last year. Readings below 50 indicate consumer pessimism. Both sentiment reports highlight gasoline prices as a prime contributor to the weaker sentiment figures.

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TechnoMetrica's (TIPP) president, Raghavan Mayur, notes, "There is a basic disconnect between the media and the American public," he said, adding that coverage of the jobs picture has been too positive. "It's like there are two realities in this country. The report noted that 87.2% of those survey in the poll expect gas prices to top $4 over the next three months and 37.1 expect gas prices to reach over $5. It should be noted that all three of the components of the index worsened. The three components consist of:

• The Six-Month Economic Outlook: a measure of how consumers feel about the economy’s prospects in the next six months.
  

• The Personal Financial Outlook: a measure of how Americans feel about their own finances in the next six months.

• Confidence in Federal Economic Policies: a proprietary IBD/TIPP measure of views on how government economic policies are working.

There certainly seems to be a disconnect from much of the reported economic data versus consumer/business sentiment.

Unlocking The Risk Associated With Stock Concentrations

Various techniques are available to investors in order to customize an effective approach to reducing a concentrated investment. Investors must continually evaluate the investment landscape, concentrated position risk, opportunity cost, time horizon and taxable consequence related to concentrated holdings. We recently prepared a report titled, Unlocking Concentrated Risk (PDF), that we feel is timely for investors as the market and individual stock prices have increased significantly since the market lows in September of 2011.

Is The Consumer's Financial Condition About To Worsen?

The consumer is the one important key to economic growth as they account for nearly 70% of GDP. Recent data does show consumer balance sheets have been improving based on the Fed's Financial Obligation Ratio.

From The Blog of HORAN Capital Advisors

Even consumer loan charge offs at commercial banks continue to show significant improvement.

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The water on the fire though is the fact consumer delinquencies have recently turned higher. Is this a precursor to a less robust consumer spending environment? The fact gasoline prices have been on the rise as well is likely to reduce the cash available to consumers for discretionary spending.

From The Blog of HORAN Capital Advisors

Markets Retrace Significant Amount Of Losses Since Financial Crisis

The Chart of The Day charting service provides a graphic look at the market recovery for various indices since the financial crisis trough in March 2009.

"For some perspective on the post-financial crisis rally, today's chart illustrates how much of the downturn that occurred as a result of the financial crisis has been retraced by each of the five major stock market indexes. For example, the Dow peaked at 14,164.53 back in October 9, 2007 and troughed at 6,547.05 back on March 9, 2009. The most recent close for the Dow is 12,980.30 -- it has retraced 84.5% of its financial crisis bear market decline. As today's chart illustrates, each of these five major stock market indices have retraced over 78% of their financial crisis decline. However, it is the S&P 400 (mid-cap stocks) and the tech-laden Nasdaq that have recouped all the losses incurred during the financial crisis and currently trade higher than their 2007 credit bubble peak."

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Chart of the Day

Risk On Trade Not Kind To Dividend Payers This Year

The dividend paying stocks in the S&P 500 Index have significantly lagged the performance of their non paying counterparts. The payers return in February and YTD have totaled 3.84% and 8.92% respectively. The non-payers on the other hand have generated February and YTD returns of 5.55% and 14.19% respectively.

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Source: Standard & Poor's

One could say the market has been in a "risk on" mode this year and at least since the end of September last year. As we discussed this in our 4th Quarter Investor Letter the "risk on" "risk off" trade has been a common discussion item of late. Investors that desire to track the "risk on" and "risk off" cycles of the market are now able to follow the newly issued exchange traded notes with tickers "ONN" and "OFF". As the below charts show, these ETRACS notes came into existence in late 2011. Until the last few trading days, these indexes have shown the market has been mostly in a "risk on" mode. The question becomes whether the "risk off" trade exhibited over the last two to three trading days is one that will be sustained. If so, the dividend payers might regain some of the ground lost to the non-payers.

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Investor Equity Fund Flows Indicate They May Be Late To The Rally

Mutual fund flow data appears to indicate investors have been late to allocate additional funds to equities in spite of the strong equity market advance since the end of September last year. As the blue bar in the below chart indicates, monthly net flows into equity mutual funds has been negative in spite of the continued advance in the market.

From The Blog of HORAN Capital Advisors

The below chart shows the same data with flows accumulated on a rolling one year basis. Historically, when equity flows have been negative, the equity market returns have not been favorable. During this most recent period though, equity returns have been extremely strong in the face of the negative equity fund flows.

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Not until this past month have equity fund flows turned positive. The biggest beneficiary of flows though has been fixed and money market funds.

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Source: ICI

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From a contrarian standpoint, and taking into account only the fund flow data, investors don't seem to have thrown in the towel and piled into equities.Maybe this market continues to climb the proverbial "wall of worry" until we see investors capitulate and plow into equities.