Now more than half way through the year, we are in the heart of earnings season on Wall Street; one of four times throughout the year that we hear directly from the CEO’s of the companies we own on how their businesses are performing. Through the first few weeks we are struck with the following quote from former New York Yankees Manager Joe Torre:
“Unless you have bad times, you can’t appreciate the good times”
Taking part right in the heart of the COVID Lockdowns and pandemics second quarter earnings last year were negative across the board with revenues, profits, and margins all seeing large drops across the board. Quite the contrary in 2021, earnings as a whole have been little shy of spectacular so far.
Expanding on this with some data, as of 8/2/21, analysts are expecting earnings to be up 90% year-over year for the second quarter. Moreover, 89% of companies reporting have beaten profit forecasts – the highest reported in a data set tracking back to 1994. (Seeking Alpha).
Touching on dividends, the subject of this quarterly letter, we ended the quarter once again with no portfolio companies cutting or eliminating their dividend, as many portfolio companies have announced increases to their dividend payouts so far in 2021.
The stock market as a whole is expecting significant dividend growth over the next three years with current expectations from the global stock market (MSCI All Country World Index) to grow dividends by 25% per share from 2021 – 2023. (Capital Group 2021 Mid-Year Outlook).
In this quarter’s note we wanted to spend time discussing another important element of investment returns over time, stock buybacks. While they get significantly more blow-back from the media, there’s a case to be made that dividends and buybacks are roughly identical for investors.
Dividends are the use of cash to distribute directly to investors, while stock buybacks are the use of cash to repurchase shares in the company. Dividends give investors cash, to either spend, reinvest, or purchase shares in other companies, while buybacks provide investors with a larger ownership interest in the company given the decreased number of shares outstanding. For an expanded look at the power of buybacks over time, I’d recommend reading the last few annual letters from Warren Buffett who has eloquently detailed the power of share buybacks in increasing his ownership of Apple overtime.
From his most recent newsletter Warren Buffett 2020 Annual Letter:
But that’s far from all of the good news. Because we also repurchased Berkshire shares during the 21⁄2 years, you now indirectly own a full 10% more of Apple’s assets and future earnings than you did in July 2018. This agreeable dynamic continues. Berkshire has repurchased more shares since yearend and is likely to further reduce its share count in the future. Apple has publicly stated an intention to repurchase its shares as well. As these reductions occur, Berkshire shareholders will not only own a greater interest in our insurance group and in BNSF and BHE, but will also find their indirect ownership of Apple increasing as well. The math of repurchases grinds away slowly, but can be powerful over time. The process offers a simple way for investors to own an ever-expanding portion of exceptional businesses. And as a sultry Mae West assured us:
“Too much of a good thing can be . . . wonderful.”
While we have an explicit preference for dividends in our portfolios, as they are historically much less volatile than the level of buybacks, stock buybacks remain an important component of returns.
In line with increasing dividends, the second quarter saw many cyclical business restart share repurchase programs (stock buybacks). In fact, new buyback announcements for 2021 have exceeded the entire calendar year of 2020 by 42%! ($431 Billion vs. $307 Billion – JP Morgan)
All told, for the S&P 500 dividends and share buybacks are estimated to be as high as $1.5 Trillion over the next 12 months. Put another way, this is a 3.9% annualized return or “shareholder yield” for investors. This number is made more striking when compared against the bond market where the benchmark 10 year treasury rate recently plunged below 1.2%.
To us, this creates the foundation for potential future returns for dividend growth investors. While valuations are modestly above historical norms, capital returns in the form of current dividends, share buybacks, and future dividend growth have the potential to offset any contraction in valuations.
As we’ve written about before, a key part of our investment process is analyzing our companies’ quarterly earnings calls, which is led by Dr. Lyle Bowlin. Below are a few examples that have caught our eye in the past few months:
While we are unable to report portfolio performance in these letters as the result of timing differences for all investors, please reach out if you’d like to discuss your portfolio or anything else. It is a privilege to serve as your experienced advisor.