OVERVIEW
This article looks specifically at three ways that a company can use to enhance shareholder value (other than mentioning “AI” frequently) :
Dividends
Stock repurchases
Fire employees
All three of these strategies have been used extensively by companies during this round of earnings. For example:
META Platforms: A combination of solid earnings and a favourable outlook pushed META’s (Facebook/Instagram/WhatsApp) shares up 20.3% the day after the earnings were released on February 1st, but the shares were undoubtedly also boosted by META announcing that it would start paying a dividend and would increase its share repurchase program to $50 billion. (Keep in mind that the company also downsized its workforce sharply in 2023 by 10,000 employees.)
UBER: Just yesterday (February 14th), UBER announced before the open that the company’s Board had approved a share repurchase program of up to $7 billion. UBER shares closed nearly 15% higher on the day.
There are many other examples of companies employing one or more of these methods – which I will discuss in more detail below – to enhance shareholder value.
ENHANCING SHAREHOLDER VALUE
Companies have many ways of enhancing shareholder value. Some of these techniques involve strategic corporate actions by management teams, and others involve more traditional corporate finance techniques / financial engineering. There are plenty of examples of value-enhancing techniques being deployed by companies during the current round of earnings. In fact, the first that comes to my mind – and perhaps the easiest for management teams – is to say “artificial intelligence” or “AI” as many times as possible during post-earnings analysts’ calls. Companies that are able to tether themselves even remotely to AI will normally see their share price gap up, although in many cases this might not prove to be permanent. However, there are other more traditional and proven value-enhancing techniques which have been used for decades to enhance shareholder value, three of have appeared frequently during this round of earnings:
Increasing dividends (or starting a dividend program);
Announcing share repurchase programs, or increasing the amount of such programs; and
Reducing staff by firing employees and / or closing unprofitable business lines.
None of these value-enhancing techniques are especially revolutionary, and all are well steeped in history as far as enhancing shareholder value. Paying (or increasing) dividends and having a stock buyback program both essentially involve the return of capital to shareholders. Reducing staff is a corporate action which normally improves operating margins, and hence, the bottom line.
Dividends
Dividends are the most well-known and traditional way for companies to return cash to shareholders. For investors that require periodic cash payments for lifestyle reasons (e.g. people that are retired), companies with a long history of paying dividends are especially attractive. The natural evolution of a company as it matures is to begin paying a dividend. Establishing a regular dividend program, and ideally increasing the dividend periodically as cash flows improve, makes these stocks attractive to certain types of investors. It also provides a defensive element, providing a de facto floor to the stock price by virtue of its dividend yield. The corollary – and one of the worst things a company can do – is to reduce or eliminate its dividend.
Companies that pay dividends are often associated with mature, slow-growing companies, but this is not entirely true. In fact, over 80% of S&P 500 companies pay dividends[1]. The dividend yield of S&P 500 companies is currently around 1.37% according to gurofocus.com. Companies in sectors that are deemed to be faster growing organically with more opportunity for investment, like communications and information technology, often have lower dividend yields. Companies in sectors that are deemed more mature with more predictable cash flows and less organic growth ahead – like utilities, energy and real estate – usually have the highest dividend yields.
Some investment funds and / or strategies only include companies in their portfolios that pay dividends. Starting a dividend is one reason (amongst others) that the share price of META increased when it announced its earnings recently. Starting a dividend, even if modest, is a signalling mechanism, suggesting that the company is becoming more mature and comfortable with its future outlook. It also broadens the investor base for the company’s stock.
The table below shows the dividend yields of the 15 largest companies by market capitalisation)in the S&P 500 (calculated using data from YahooFinance.com on February 12, 2024).
The table below from US News and World Report shows the top nine highest paying dividend stocks in the S&P 500 as of January 11th 2024.
As mentioned above, a high dividend yield is generally reserved for slower growing companies with solid and defensive cash flow profiles, enabling them to confidently pay dividends quarter after quarter. However, high dividend yields – especially when such yields increase suddenly – can also be a sign of operating stress, which in turn could foreshadow a decrease in or outright elimination of the dividend. This can mean that the dividend might soon be reduced. You might find it interesting to learn that Altria (MO), which has the highest dividend yield in the S&P 500 per the table above, has increased its dividend for 55 consecutive years.
If you are interested in digging deeper and doing more research on the sector yields and company dividend history, check out the website dividend.com.
Share buybacks
Share buybacks can be viewed similarly to dividends in that they are the return of capital to shareholders. Share buybacks can occur through a formal tender offer by a company, which tends to be unusual and rare, or through quarterly buyback programs in which a company repurchases shares in the open market, with timing and price/share at its sole discretion.
Share buybacks not only effectively provide cash to shareholders through a market bid, but also reduce the number of shares held by third-party investors. If a company is also paying dividends, stock buybacks reduce dividends paid to third-party investors, and – if the shares are ultimately cancelled (rather than sitting in Treasury) – can reduce the number of shares outstanding. This is relevant in that the number of outstanding shares is the denominator in the formula to calculate earnings-per-share (EPS). As number of shares decreases, EPS increases ceteris paribus. Share buybacks also serve as a form of anti-dilution for companies that award shares or options as part of incentive pay, since the company can use the repurchased shares as the awards, thereby avoiding dilution.
As a way to return capital to shareholders, some companies prefer share buybacks rather than paying dividends, because stock repurchase programs are more dynamic than dividends. The repurchase price can also be set by the company at its discretion with the price theoretically representing the price at which a company believes its shares are undervalued by the market. The amount of shares repurchased in the open market during a given period is also entirely at the company’s discretion. Having a disclosed basket or target in terms of an amount for share repurchases does not require that the company actually repurchase shares but it is a strong signal to investors that the company will periodically step in to support its share price.
Normally companies will announce the maximum amount of share buybacks they will do during a period, such as during a quarter or over an entire year. The amount of share buybacks that occurred during the preceding quarter is often disclosed by the company, or it can be calculated (approximately) using the share information on the balance sheet from quarter to quarter (noting that share buybacks normally go into Treasury shares).
From an investor’s perspective, share buybacks provide a market bid for the shares into which a shareholder can sell and realise liquidity in lieu of receiving a regular (taxable) dividend each quarter. However, there is also a school of thought that when a company is repurchasing its shares, it is because it cannot find sufficient investment opportunities itself to meet a hurdle return, often a sign of a company’s maturity from high growth oriented to a more stable (or some might say boring) growth trajectory. Others also make the case that stock repurchases are a bad use of cash since liquidity should be preserved “when the sun is shining” to meet other obligations should business conditions deteriorate. This can become especially contenscious if companies use leverage to repurchase shares.
Some companies both pay dividends and regularly repurchase their shares, but others rely solely on share buybacks to return capital to shareholders. Perhaps the best known company that has used only share buybacks for many years is Berkshire Hathaway, which has never paid a dividend. However, many other well-known companies regularly use stock buybacks to return capital to shareholders. I found an article on Yahoofinance.com which lists the companies with the 11 largest share repurchases in the four quarters ended Sept 30, 2023. You will recognise most of these names.
Many companies announced stock repurchase programs, or increased the amount of such programs, during the current round of earnings, providing support for their stock prices.
Laying off employees
Closing business lines or laying off employees reduces headcount, which reduces employee costs, often the largest single operating cost line item. In most cases, such decisions have limited or no impact on the top line. Layoffs are used by management teams to improve the efficiency of certain business lines and of the company overall, thereby ensuring that limited capital is allocated to the highest-return business segments. Layoffs usually lead to an improvement in overall operating margins, which improves bottom-line profitability. In some cases, layoffs can be a defensive measure as business deteriorates, but most recently, layoffs have been made by some highflying companies that are strategic, meaning that management is taking proactive measures to defend itself against future margin deterioration caused by slowing sales in certain business lines.
According to layoffs.com, nearly 263,000 workers were laid off from US companies in 2023. Of course, this has to be viewed in the context of the US employment market adding 2.7 million jobs during the year, with the unemployment rate ending the year at a stunningly low 3.7%. Layoffs seem to be concentrated in technology and financial services, although no sector has been immune. As mentioned above, proactive workforce reductions often reflect management’s outlook for relative growth across business segments, as they allocate capital to faster growing segments and those with better operating margins. The net change in number of workers also reflects a relative shift in growth of employment in goods companies, which is lagging growth in the services sector.
Some of the companies that have announced layoffs (or further layoffs) so far in 2024 are listed in the table below.
Most of the companies in this table have seen their share prices increase this year, demonstrating that targeted layoffs can be a component of enhancing shareholder value.
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[1] Note that over 90% of DJIA companies and around 50% of NASDAQ 100 companies pay dividends.