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Dividends: What the Bank Giveth, the Bank Now Taketh Away

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No, the headline above is not goofy, and I presume it did get your attention.

In a concise and suitably critical piece, Floyd Norris of the New York Times tells us that the corporate dividends paid in the seemingly good years depended far more on bank largess than was widely realized. And as credit is being reined in, so to will dividends be, as a direct result of more stringent lending decisions.

From the New York Times:

“Dividends don’t lie.”

Chalk up the death of another Wall Street cliché.

In the late bull market, dividend payments provided one of the seemingly strongest arguments for the bulls. Maybe earnings numbers could be manipulated, but dividend payments required cash. If the company had the cash to hand out, you could be confident the earnings were real.

It was a lie.

Yves here. Admittedly, Norris’ articles typically are more column than journalism, but I feel like applauding when someone at the Grey Lady decides not to mince words. Back to his piece:

It is now becoming clear that the great news on the dividend front from 2004 through 2006 was not an indication of solid corporate performance; it was just another sign of lax lending standards. Lenders who willingly handed out money to homeowners with bad credit were even more generous to corporate borrowers.

Now the situation has reversed. The quarter just ended had the worst dividend news for American companies in half a century, and this quarter could be even worse. Many corporate boards review annual performance and decide what to do about the dividend during the first two months of each year, and it is not likely to be a happy time.

Until those meetings are completed, buying stocks for their high dividend yields may be risky….

Companies appeared to be flush with cash during those days [2004 through 2006], but some of that was a mirage stemming from optimistic accounting, particularly at banks. In other cases, the cash was real but it did not stay in corporate treasuries very long. Wall Street was preaching the doctrine of shareholder value, and corporate America bought shares back at an unprecedented rate.

From the fourth quarter of 2004 through the third quarter of 2008, the companies in the S.& P. 500 — generally the largest companies in the country — reported net earnings of $2.4 trillion. They paid $900 billion in dividends, but they also repurchased $1.7 trillion in shares.

As a group, shareholders were paid about $200 billion more than their companies earned over that four-year period. Suffering investors who held onto their shares during the 2008 plunge may want to reflect on the fact that investors who were dumping shares got roughly twice as much of the money as the loyal holders did.

As a seasoned investor said at the time, “Why should I invest in companies if they aren’t willing to invest in the business of their business?”

You can read the article in full here.

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25 comments

  1. Anonymous

    Because leveraging was so cheap for so long, management was susceptible to charges of fiduciary breach if it actually chose to invest internally using retained earnings.

    IOW, if the cost of capital was 4% but the external (for shareholders investing elsewhere) ROI was 8%, then the fiduciary duty to shareholders would have called for borrowing the capital and divesting the retained earnings.

    Or so that’s what my corporate finance professor taught ;p

  2. bg

    This post is one of the best advertisements I have ever seen for Minsky. Dividends plus stock buybacks exceeded profits? That is clear evidence of positive feedback leading to a bubble in asset prices.

  3. john bougearel

    bg- good catch, 2.6 T in divs and share buybacks vs 2.4T in earnings reported or shall we say massaged because after all, the cheap debt financed the buybacks to shrink float and goose the earnings ~ so tehse managements participated in the same fiction as the reckless banks did lending them the money.

    I kept looking at the annual growth rate in CB lending (roughly 15%) in absolute amazement in the past 3 years, saying it can’t stay up, it can’t stay up, it can’t stay up.

    But give the CB’s enough viagra and they can amaze.

    And yes, a company that can’t invest in their business is a prime suspect, but for years the fiction went on about how wonderful stock buybacks were.

    Joseph Piotroski from the Univ of Chicago wrote his disertation on value investing and separitng winners from losers, used a binary system to aggregate 9 filters. Stock buybacks was one of the 9 filters, being counted as a net positive if a company bought back its own stock in the previous year. Such a filter does not works so well in an economic negative real rate environment. Just another model that can’t stand the test of a negative interest rate environment.

  4. phil_hubb

    Good article. Of course, like nearly every good article in the NY Times, it’s published at least a year late.

    The rear view mirror at the NY Times is spotless. Unfortunately the windshield apparently isn’t.

  5. captain holiday

    Even a broken record can be right twice a day, or something like that:

    Dividends are universally dead meat!

    NOVEMBER 26, 2008 3:21 AM
    doc holiday said…
    Dividends are universally dead meat! IMHO, the reason stocks are still highly overvalued is because of dividends that are out of line with fundamental future valuation. These days, I just look at the dividend as the percentage that the stock is over-valued.

    >> I stand by my call, the ship is sinking!

  6. Anonymous

    out of interest would anyone know the div, share buybacks and earnings for the different industry groups in the SP500?
    I assume banking sector must have been very large contributor to this outcome!

  7. ndk

    From the fourth quarter of 2004 through the third quarter of 2008… As a group, shareholders were paid about $200 billion more than their companies earned over that four-year period.

    Woah.

    That's just incredible. It was one of the best corporate profit environments in history, with profit-to-GDP levels near record highs. And look at the total return rendered shareholders — abysmally negative.

    The looting makes me as furious as always, but this is much more significant than just looting. If the corporation is interested in maximizing return to shareholders over the longer term, it will invest in anything that yields a higher total return than simply distributing profits to shareholders in some form.

    I've mentioned a few times that I feel something is fundamentally deeply wrong, and cited some share repurchases instead of investment in production, R&D, and their own businesses. Now I have a much better data point. They invested not only all of their profits, but then some.

    Either our corporations are systematically moronic and the incentive system is totally FUBAR, which I admit has a strong case, or there are structurally very few projects and investments in the U.S. economy that have a sufficiently positive return(a very low number, at this point) that they'll be undertaken. That structural pressure means deflationary forces will be stronger and investment will be low for a long time to come.

  8. ndk

    This post is one of the best advertisements I have ever seen for Minsky. Dividends plus stock buybacks exceeded profits? That is clear evidence of positive feedback leading to a bubble in asset prices.

    Excellent point, bg. Paying a return to equity holders is not like making a coupon, but if these had been mandatory payments, then in Minsky’s parlance, the entire public U.S. corporate sector is an aggregate Ponzi borrower. Dude.

    out of interest would anyone know the div, share buybacks and earnings for the different industry groups in the SP500?
    I assume banking sector must have been very large contributor to this outcome!

    I don’t know the dividend and and buybacks info, 3:22, but I do know that the percent of all corporate profits produced by the financial sector rose from some 13% of all around 1980 to 27% prior to the collapse.

    I don’t know whether that includes the financial profits of GE, GM, retailers, or all the other corporations that were once banks in drag, and are now actually banks. Heh.

    It’s the sort of thing that makes me very uneasy about GDP measurements(21% financial services in ’06) and output gap measurements, which happens to be exactly what stimulus planning is based on.

  9. Anonymous

    was the last sentence an attempt at dramatic irony?

    “As a seasoned investor said at the time, “Why should I invest in companies if they aren’t willing to invest in the business of their business?”

    Is a share buy back not re-investing in the business?

    The investment community seemed to forget what Miller and Modigliani had to say about the capital structure of the firm during the bull market period!

  10. fresno dan

    “Why should I invest in companies if they aren’t willing to invest in the business of their business?”
    Because the CEO’s of the companies are idiots and frauds, and had NO IDEA of what they were doing, and NO IDEA of how to invest. Banking is SIMPLE – a banker is GIVEN money at 3%, lends at 6%. Yet this gravey train wasn’t enough.
    Remember, Did Hank Paulson know how Goldman was making money???
    any answer is disturbing

  11. wintermute

    The tide has gone out and now we see that dividends were excessively paid. What an opportune moment to share what Michael Shedlock just put on his blog:

    Earnings PE (S&P 500) Target
    $25.00 12 300
    $35.00 12 420
    $45.00 12 540
    $55.00 12 660
    $25.00 15 375
    $35.00 15 525
    $45.00 15 675
    $55.00 15 825
    $25.00 18 450
    $35.00 18 630
    $45.00 18 810
    $55.00 18 990

    Does that mean that the lowest of these possiblities is staring us in the face?

  12. ruetheday

    It is illegal to pay dividends from any source but retained earnings. When do we start prosecuting people? What’s that you say? These companies cooked the books to make their retained earnings appear higher? Ok, then two crimes have been committed. When do we start prosecuting?

  13. Richard Smith

    Anonymous of 5:28

    You’d have to see how much of the buyback cash went towards buying back shares held by insiders and granted under incentive schemes.

    My word verification for this comment was “phock”.

  14. Richard Kline

    bg: “Dividends plus buybacks exceeded profits?” Dude, why the question mark. It’s common knowledge that Americans are Exceptional; so exceptional that we don’t _need_ to actually generate profits: the rest of the world just mails us tribute. I mean, am I right? Everytime I’ve watched a TV set for thirty years that’s where they begin and end their spiel, anyway.

    ndk: “Either our corporations are systematically moronic and the incentive system is totally FUBAR, which I admit has a strong case, or there are structurally very few projects and investments in the U.S. economy that have a sufficiently positive return(a very low number, at this point) that they’ll be undertaken. ” Well, no, that’s not how I see it. One can generate profit in this country in the normal course of doing business. (Not that I’m a fan of for-profit commerce, but let’s not go there tonight.) But one has to consider the context that led these many firms to _borrow money_ over the last few years to make their bogus fat divident numbers. From the mid-80s, we had a fat stock bubble making big profits for a handful of firms, which the markets excessively rewarded. In the 90s, we had the .com bubble, which while it did not lead to mega-dividends it did generate BIG capital gains for some firms. Which the markets excessively rewarded. Than through the hollow 00s we’ve had the FIRE Balloon, which has led to B-I-G dividend payouts by the focal parasites. Which the markets excessively rewarded. In each case, public authorities should in pursuance of their public charges have quased the faux bloats—but nobody wanted this done, and many paid well to ensure that this was not done.

    In consequence, firms doing real business had to compete with firms riding bubble-boosted market parabolics. Those real business firms were punished by the markets, and their managements disemployed if they couldn’t come up with ‘competitive’ numbers. Everyone turned to beating down and kicking out their labor forces, but there was only so much revenue that could be snatched back from such operations. Some companies fudged their books, but that has criminal penalties. Soooo borrowing too cheap money to ‘invent revenue’ looks good and passes the fixers whiskers. I mean, just do the math. . . . It’s the society which is sick, not the commercial opportunities per se.

    And re: john bougearel on neg real rates, yes, those neg real rates severely distorted incentives and returns over the last seven years—which is exactly why conventional economic reasoning over that time had few intersections with realities, as I know that you know. All the basics of economics we discuss and here policy makers presently discuss apply to contexts of positive return on capital. But here’s the problem going forward: we _still_ have neg real rates, and everything that public financial officials in the US are doing now to intervene in the financial crisis pushes those neg real rates more negative. Into contexts where the underlying reasoning of those actions fails. So that the intended outcomes of those actions can be expected to be far from the _actual_ outcomes of those actions. . . . And that is exactly what worries me about the impending massive money/credit creation, that we will have Through the Looking Glass outcomes in severely neg real rate conditions. Like the currency doing a funhouse twisteroo, or hidden barter arrangements in hitherto most unlikely market subsectors. Or you-pick-it.

    Neg real rates radically change the parameters of economic interaction. And we are going to do this in a wide open economy so that the impacts of those negative real rates are not defined by our domestic econo-financial dimensions but rather by the dimensions of our commerce and capital flows. And despite global deleveraging, the US is yet _far more globally interpenetrated_ than many if not most economic zones. So our domestic reasoning for the effect that our stimulus will have is defined by domestic parameters configured in conditions of positive real rates, while the actual outcome we will experience will be defined by multi-zonal flows configured by massively neg real rates. The only thing I can guarantee is that those actual outcomes are _unlikely_ to be what policy intends. Discussions in comments on NC in recent days of boosting employment in China in consequence of our ‘Stupid Stimulus’ Bill may be quite accurate, for example—if the Chinese keep lending us the money, that is.

    Nothing in public policy has yet come to grips with the cancer-inducing hallucinogen which are neg real rates. The addicts just scream for more.

  15. harris

    Dividends plus buybacks would also exceed earnings if companies were changing their capital structure. A company could just borrow the money to reach their new desired debt to equity ratio. For example, if debt to equity is $25/$75 and the company wants to go to 50/50, it will borrow $25 and use it to buyback $25 of its equity.

  16. john bougearel

    NDK

    “there are structurally very few projects and investments in the U.S. economy that have a sufficiently positive return(a very low number, at this point) that they’ll be undertaken. That structural pressure means deflationary forces will be stronger and investment will be low for a long time to come.”

    That is precisely how to read between the lines. There were no more positive return investments to be made in the past decade! It is amazing to ponder that statement for a moment. Every investment project to be made suitable for connecting with the global engine of growth (the US consumer) over the past 30 years had already been made. All of that investment to tap US consumer demand had gone towards increasing overseas production in developing countries. The overinvestment in overseas production guaranteed excess production/overcapacity, thereby ensuring deflationary/lower prices for years to come for the US consumer.

    Seeing no other engine of growth out there to pursue, what were the multinationals to do but to let the deflationary forces kick in and game the financial statements till the inevitable recession/depression set in.

    The deflationary horizon must stretch as far as the eye can see if the captains of industry could find no positive return investments to make this past decade. Until a new engine of growth is in place, here we will sit in our deflationary squallor.

  17. john bougearel

    RK,

    I get your point about “firms doing real business had to compete with firms riding bubble-boosted market parabolics” squeezed them senseless if they did not behaviorally respond.

    But it just underscores the incredible difficulty of competing on the same playing field when the damn wage gap between developing and developed countries are so wide and widening. Reversing the trajectory of that wage gap will go along way towards reducing global trade imbalances and disequilibrium and increasing consumer demand in the rest of the world (where consumer demand needs to grow most while our own consumer demand shrinks).

    and yes, conventional economic reasoning does not intersect with that reality. Conventional economic reasoning is too busy pursuing mistaken goals, hence they are busy ensuring undesirable outcomes. I would argue however, that the actual outcomes of these policies are not in conflict with the intended outcomes. Since we can see the possible actual outcomes and risks of these policies are not unforeseeable, they can not be said to be unintended. And that is galling.

  18. Richard Smith

    Harris,

    Agree, and with interest rates so low over the last few years, equity funding has been relatively unattractive. The capital reconfiguration you describe can look rational.

    However, paying a dividend is (modulo shareholder pressure) optional. In the bad times, you can cut dividend payouts. Debt repayment isn’t so optional.

    Secondly, you don’t need to roll equity funding.

    I suppose if I was an insider who’d cashed out over the years via option schemes I might be able to contemplate a revenue drop and seized up capital markets in a relaxed manner.

    Less congenial for other types of shareholder, methinks.

  19. Anonymous

    Where are the floodlights to shine on this stinking %&@# so that the public gets a clue?

    How is this behavior stopped? Where are the consequences? Where is the rule of law?

    Why is there not rioting in the streets over this? When will there be?

  20. Anonymous

    Maybe, the public should be informed and thereby switch what’s left of their money, 401ks etc. to Fund managers who can prove they went for value investing rather than playing the casino games of recent years.

    Too many of the “professionals” and their attorneys were in one these scams against the public and genuine investment.

    As for banks, will take the long term steady interest rate on savings accounts of past years.

    independent

  21. doc holiday

    Buybacks are always correlated to increases in option grants. If you think for one second that a buyback is going to add value to a stock, take a very close look at The S&P 500 and Dow and then show me a stock that wasn't diluted from option grants. The insiders will always come first and shareholders will always pay the piper!

    I would guess that will be the next thing to watch, i.e, increased option grants across the board, to help the poor insiders, during this extended downturn.

  22. S

    Buybacks were Wall Street’s answer to retaining capital for management’s discretion. Buybacks have always been a “creative” solution for management to pretend they are putting shareholders first. Dividends are sticky and hence impose a discipline on the management team. The low interest rate environment created a massive incentive for bankers to pitch leverage recap, which became a cottage industry. The earnings tailwind from “accretive” buybacks is yet another manifestation of artificially low interest rates. So what do we get now? Of course if you can’t grow revenue and you can’t grow margins and you can’t lower interest costs well then you lower the tax rate. This is as old a trick on Wall Street as there is. So it is not surprising that the proposed tax plan in the stimulus embeds tax breaks. The move down the income statement is a striking parallel to the web our “intelligence” economy finds itself caught in.

  23. Anonymous

    What might the effect of non-cash expenses be on this analysis? Norris has used net income which is net of all kinds on non0cash items. Notably, stock option expensing became mandatory in the period in question. I agree that this looks bad, but it may not be as bad as it appears at first blush.
    The analysis should be done with an eye to the cash flow statement.

    Love the blog, Yves. Keep up the good work!

  24. Anonymous

    “Think of the firm as a gigantic tub of whole milk. The farmer can sell the whole milk as is. Or he can separate out the cream and sell it at a considerably higher price than the whole milk would bring. (That’s the analog of a firm selling low-yield and hence high-priced debt securities.) But, of course, what the farmer would have left would be skim milk with low butterfat content and that would sell for much less than whole milk. That corresponds to the levered equity. The M and M proposition says that if there were no costs of separation (and, of course, no government dairy-support programs), the cream plus the skim milk would bring the same price as the whole milk.”

    If you want to lever up the firm to pay out dividends and conduct sharebuy backs…the resulting equity in the firm is going to be that much more risky!

  25. Richard Kline

    john bougearel: ” . . .[I}t just underscores the incredible difficulty of competing on the same playing field when the damn wage gap between developing and developed countries are so wide and widening." No, I do not buy this argument. It has been oft repeated, and enough of it is true for it to get traction, but at its core, john, it is _totally bogus_.

    It is true that as economies mature, labor intensive manufacturing becomes uneconomical _as mass primary employers_. One sees this in the UK, in Deutschland, in Japan, in Hong Kong. There is enough of this dynamic, the ceding of labor-intensive, low value-added manufacturing to more peripheral economies, to demonstrate a real vector. So yes, the US was certain to lose some labor-intensive manufacturing over the 1950-2000 period. This did not have to be to E Asia; it could have been to Latin America, for example, and in fact significant production migration _has_ occured there, to Mexico, Brazil, and even Colombia, Peru, and Salvador.

    It was not necessary for the US to cede all of its chip plants to East Asia. It was not necessary for the US to cede all of its finished textile plants to other locations. It was not necessary for the US to lose as much of the machine tool industry as it has. It was not necessary for the US to let both its rail freight lines and the manufacturing capacity to retain them severely erode. We didn't have to cede all of our mobile phone manufacturing to other countries.

    . . . But it would have taken an explicit industrial policy to support training, wages, and market share for onshore concerns. Something else also missing from the 'We can't compete' line is that quality and sourcing of products really _do_ count, but is was exactly in quality in many of the above areas that American industrial management FLOPPED MISERABLY in the 1960-90 period. We had the ability; we did not have the execution. We were late on inventory controls, for example. There was a lot of talk about how we would maintain the [white collar] engineering and software design shops, and so control the process. The counterargument, which is completely winning the game, now, is that you can’t control the soft engineering if you don’t control the hard engineering: we are losing gradually in the areas where we thought we had a multi-generation advantage, to become no more than comeptitive at best. And etc., and etc., but look, a national policy to retain some of this capacity together with pressure for the firms to actually excel at production could have been made BUT WASN’T.

    Instead, we got increased advertising, increased financial manipulation, and increased union-busting, i.e. efforts to wring profits from _non-production_ parameters. THIS has been the American way for two generations. It deserved to fail, has failed, and has left us in a much worse position than if we had built down core production rather than ceded competition.

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