Money Matters - Simplified

Dividends Aren't Enough: Heavy Machinery

I love cash. As an investor, nothing makes me happier than a company that returns money to shareholders, rather than spending it recklessly on a CEO's pet projects or an ill-fated acquisition. Historically, investors have often looked at a stock's dividend yield to identify these shareholder-friendly enterprises. But I prefer a slightly different metric -- one proven to further maximize investor returns.

A 2007 study in The Journal of Finance suggests that investors should also factor net share repurchases into the equation, through a metric called the net payout ratio. According to the authors of the study, this ratio not only identifies companies that are paying back investors, but also predicts future equity returns better than the dividend yield.

Let's crunch the numbers
To find the net payout yield, start by adding up all the cash the company spends on both dividends and share buybacks. Next, subtract its share issuances. Finally, divide the resulting number by the company's current market cap.  

The ratio that you end up with represents the percent of each invested dollar that a company is returning to shareholders. This simple calculation handily allows us to adjust for shares issued through employee stock options and other forms of shareholder dilution. Some companies will spend a lot of money buying back shares just to counteract the dilutive effect of their stock compensation programs, without creating any value for shareholders.

Here are the net payout yields for a few companies in the heavy machinery industry:

Company

Net Payout Yield (TTM)

Dividend Payments (TTM)

Net Share Repurchases (TTM)

Market Cap

Caterpillar (NYSE: CAT)

2.2%

 $1,051

 ($142)

 $41,548

Deere (NYSE: DE)

1.8%

 $475

 $28

 $27,394

Cummins (NYSE: CMI)

1.7%

 $140

 $110

 $15,146

Kubota (NYSE: KUB)

1.7%

 $172

 $2

 $10,026

Source: Capital IQ, a division of Standard & Poor's. Payout yield is author's calculation. All dollar figures in millions.

It's also interesting to look at the emphasis that each company puts on dividends versus stock buybacks:

How powerful is this payout?
Based on the analysis above, Caterpillar looks like a potential buy for investors searching the heavy machinery industry for a stock with a solid net payout yield. As you can see from the data above, these companies have made a strong commitment to returning cash to shareholders.

Keep in mind that this data only looks at trailing-12-month numbers, so it does not correct for recent changes in a company's dividend or buyback policy. While dividends tend to remain fairly stable, share buybacks can vary substantially from year to year. Investors should also look at a company's dividend payout ratio to make sure the dividend is sustainable, and examine historical buyback patterns to ensure that the buybacks aren't a one-time event. If you can build a diversified portfolio with a few of these high-yielders, healthy returns -- and plenty of cash -- are likely to follow.

© 2010 UCLICK L.L.C.