Despite Cash Hoards, Companies Aren’t Paying Out

With cash reserves of U.S. public companies sitting at all-time record highs, investors might think dividend payments would be booming as well. Combined with the relatively new 15% dividend income tax rate, investors should be reaping the rewards of record cash payouts. However, the average S&P 500 company is paying less than 2% annually out to its shareholders.

Why does the average large cap stock pay out less than 2% in dividends? Well as we’ve seen this year, M&A activity has been red hot. Corporate profit margins are at cycle highs, so further cost savings have to be squeezed out via merger synergies. So far in 2005, deals have been running rampant on Wall Street. One need just look at the recent earnings report from Goldman Sachs (GS) to see evidence of that.

In addition to mergers and acquisitions, the rise of stock option compensation over the last two decades certainly accounts for the reduction in dividend yields. In order to minimize the equity dilution from option issuances, companies need to instate massive share repurchase programs. The money to do so comes straight from free cash flow that would otherwise be widely available for cash payouts to shareholders.

Throughout history, stock market returns have come from the combination of equity price appreciation and dividend payments. Yields that have averaged about 4 percent historically, along with 6 percent annual growth in earnings, explains the 10 percent average annual return from equities since the 1800’s.

With 2% dividends and peak margins upon us, it’s no wonder that some suspect future stock market returns, say during the next decade or so, will fail to hit the magic 10 percent mark. Even if somehow peak margins can be sustained, which is unlikely, investors are only looking at 8 percent annual returns from stock indices in the near to intermediate term. While that kind of performance pales in comparison to the great bull market of 1982-1999, it will still mark the highest return of any asset class, so abandoning the stock market because of it makes little sense.

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7 Thoughts on “Despite Cash Hoards, Companies Aren’t Paying Out

  1. Ginsberg on September 27, 2005 at 6:59 AM said:

    I think you’re right that the average S&P500 dividend yield is less than 2% (there’s a big article about dividends in the September issue of SmartMoney), but I think you might be wrong to say that companies are paying out less than 2% of profits.
    A 2% yield is 2% of the share price, which is probably around 15 times profit -> thus the 2% dividend would actually be 30% of the profits.
    Not trying to nitpick :), great blog.
    The Earning Curve

  2. Chad Brand on September 27, 2005 at 7:10 AM said:

    Thanks for pointing out my typo. I corrected it. You are correct, the average payout ratio right now is in the mid-to-high 30% range, down from a historical average well in 50’s.

  3. RC Swanson on September 27, 2005 at 8:22 AM said:

    Wouldn’t the fact that interest rates continue to rise be a large contributing factor in companies continuing to hold their cash? They earn more interest and income on these ‘stockpiles’.

  4. Chad Brand on September 27, 2005 at 8:28 AM said:

    For those companies who are holding the cash for the purpose of earning interest, you could be right. However, most companies are using the cash, just for things other than dividends.

    Another point to consider is that even though rates are up a lot in the last year. historically they are very low, so in the past when rates were much higher, cash hoards were much lower.

  5. NO DooDahs on September 27, 2005 at 2:40 PM said:


    The “dividend” tab shows the history going back to 1988. The low point of 2000 may have been due to the love affair with growth and tech stocks (which typically didn’t have profits to pay dividends with in 1998-2000 LOL).

    Download the file and calculate the div/profit for yourself. The ratio’s been as high as 70% as recently as 1992.

    Lots of research shows that companies paying dividends are better long-term investments, not only for the dividend, but they actually get more productive growth then companies that keep the money. Peter Lynch described this phenomenon as di-worse-ification.

  6. David Hopkins on September 28, 2005 at 12:11 PM said:

    It will be interesting to see if some of the tech companies with huge cash hoards start to give some (or in the case of MSFT, more) back to shareholders. My guess is that CSCO, MSFT, et al do want the market to stop thinking of them as exciting growth companies, so they are reluctant to start paying out a meaningful dividend. That would have “mature company” written all over it.

  7. Chad Brand on September 28, 2005 at 12:24 PM said:

    I do think MSFT will increase their dividend, but something really meaningful (i.e. 3% annually) probably won’t happen overnight even though they could afford to do so. It would also help their flat-lined stock price. Ever since they stopped giving stock options and moved toward stock grants they have needed less cash for stock buybacks.

    Cisco though is the opposite case. They are still giving out tons of options, so they will likely continue to use their cash for buybacks, rather than dividends, in order to avoid diluting existing shareholders.

    The bottom line is, unless growth picks up or they boost payouts significantly, the stocks are pretty much dead money as their multiples have come down to where large cap tech normally trades.

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