• USD 1.318 trillion on share buybacks;
• USD 1.276 trillion on capital expenditures;
• USD 0.376 trillion on research and development; and
• USD 0.605 trillion on common dividends.

To put these numbers in perspective, around that time period, the entire market capitalization of the S&P 500 was approximately $14 trillion. I was under the impression that corporate America spends more in research and development. However, this observation tells me otherwise.

The share buyback was the highest expenditure while dividend comes last. Dividends are approximately half in value than share buybacks. But isn’t share buybacks actually returning value to the shareholders? If that’s the case, why companies are not on buying binge in this market environment? The current environment provides the best buying opportunity for their stock. Shareholders need downward support “now”. Instead companies are saying they are persevering cash. Why didn’t the preserve cash when they had piles of them? The Standard and Poor’s research report made an interesting observation which is as follows:

Quoting from the report: “Traditionally, companies have used buybacks to offset the issuance of employee options, M&A activity, to temporarily support their stock and to reduce their share count. Over the past decade the option portion has accounted for the major use of repurchased shares and actual share reductions the least. Companies usually highlight and lump these expenditures, along with dividends, and present them as a return to investors of shareholder value.”

Majority of the buybacks is to offset the share count change due to exercise of options by the managements and employees. Typically, the majority of the options are held by management and executive teams, while employees’ have minuscule percentage. Buying back the stock provides support and helps keep prices at higher levels, so that management gets higher value for their options. This is an indirect way to pay themselves.

In addition, the reduction in share count helps increase the EPS quarter after quarter (assuming controlled buying through out the year). Here, let us look at PEP, INTC, and GE.

Pepsi: From 2003 to 2007, PEP spent USD 10.298 billion in share buybacks and USD 8.099 billion on dividends. During these 4 years dividends were consistently lower than buybacks. Now the conventional wisdom says the share count should have been reduced by now. The share count reduced from 1.705 billion (2003) to 1.605 billion (2007). This is only 100 million shares. So does USD 10.298 billion buy only 100 millions shares? The math says, USD 10.298 billion/0.1 billion shares, is approximately USD 100 per share. But during this period PEP never went near USD100 per share.

INTC: From 2003 to 2007, INTC spent USD 22.385 billion in share buybacks and USD 8.422 billion on dividends. During these 4 years dividends were consistently lower than buybacks. The share count reduced from 6.487 billion (2003) to 5.818 billion (2007). This is 669 million shares. So does USD 22.385 billion buy 669 millions shares? The math says, USD 22.385 billion/0.669billion shares, is approximately USD 33 per share. But during this period INTC was well under 33 (it was at 33 for brief period around Dec. 2004). Same observation is repeated.

GE: From 2005 to 2007, GE spent USD 25.717 billion in share buybacks and USD 31.264 billion on dividends. Important note is, during these 3 years dividends were consistently higher than buybacks. The share count reduced from 10.484 billion (2005) to 9.987 billion (2007). This is approximately 496 million shares. So does USD 25.717 billion buy 496 millions shares? The math says, USD 25.717 billion/0.496billion shares, is approximately USD 51 per share. But during this period GE was well under 51 (it was never at 51). Same observation is repeated.

It shows that PEP, INTC, GE just bought back shares to offset the options exercised by management and employees. This is an indirect way to transferring profits back in the pockets for management (and to lesser extent employees).

Summary is….
Above examples show that there seems to be a missing fine print which is not being communicated to the shareholders. It appears that managements are more intent towards balancing the options pricing needs (rather than shareholder interests). In these examples, I do not see value being returned to shareholders.

This post was originally published on The DIV-Net on September 10, 2009.

Procter & Gamble Company (PG): The 4Q09 earning per share was $0.80 (vs. $0.84 in 3Q09).

• The key highlight was reduced earnings on q-o-q and y-o-y basis (vs. $0.92 in 4Q08) and reduced revenue.
• For year 2009, EPS increased by 17% to $3.64 (from $4.26). This increase is due to sale of Folger’s business unit.
• Yearly dividend of $1.76/share is well covered with earnings. Payout ratio is at 41%.

Clorox Corporation (CLX): The 4Q09 earning per share was $1.20 (vs. $1.08 in 3Q09).

• The highlight was 8% increase in EPS (vs. $1.13 in 4Q08) on y-o-y basis.
• For year 2009, EPS increased 16% to $3.81 (from $3.24)
• Increased EPS came from combination of increased revenue and cost control.
• Annual dividend of $2.00/share is well covered with earnings. Payout ratio is 52%.

The Chubb Corporation (CB): The year 2Q09 earnings per share was $1.54 (vs. $0.95 in 1Q09).

• This is increase in earnings on y-o-y (vs. $1.27 in 2Q08)
• The highlights were increase in operating income (6%) and reduced revenue from premium collections.
• Quarterly dividend of $0.35/share is well covered with earnings. The annual payout ratio is 23%.

PepsiCo (PEP): The year 2Q09 earnings per share was $1.02 (vs. $1.05 in 1Q09).

• The key highlights were reduced y-o-y EPS (vs. $1.05 in 2Q08).
• Y-o-Y revenue reduced by 3%. The reduction in EPS was due reduced sales of Pepsi’s beverage products.
• Quarterly dividend of $0.45/share is very well covered. Quarterly payout ratio is 44%.

While PG and CB showed reduce earnings and revenue, the payout factor has sufficient room to cover the dividends. These four companies keep marching and battling the recession.

A quick and simple answer is, no it does not affect dividend growth if dividend investors understand what it really means.

Corporations pay dividends from the combination of profitability, cash flow, income, prudent money management, etc. With the current state of economy in United States (and other parts of the world) majority of the corporations are facing negative growth. In such a scenario where will dividend growth come from? In these challenging environment dividend investors need to look at the macro economic scenario and understand how it will play out in long haul over a period of next 10 years, 20 years, or 30 years.

We read a lot about demise of US dollar. At a very fundamental level, which country’s currency becomes a global currency will depend upon political maturity and economic stronghold at global level.

• United States: Every nation in this world wants to do business with US because of its strength in free market system, strength of its institutions, innovative and entrepreneurial business environment, and open minded consumer base. History shows us that every bust is followed by a boom albeit of a different economic form or shape or pattern. Looking back 100 year or more we can see boom and bust in different sectors such as first in textile industry, then infrastructure industry, then automobile industry, then space and airline industry, then hardware and software industry, and finally real estate and financial industry. The present financial crisis may shrink US GPD by couple of trillion dollars from 13 trillion, but still it will be the largest economy.

There is definitely some rational logic behind demise of dollar and I would agree to most of them. However, there is fundamental flaw in this chain of reasoning. While there is lot of talk of demise of dollar, it does not talk about its replacement? Which currency in the world will replace US dollar? There is also a lot of discussion that emerging markets (particularly BRIC nations) will be the driver of global economy. In order for BRIC nations to provide leadership at global stage, these nations have to demonstrate political maturity and economic foresight to the global citizens.

• China: It has a long way to go in demonstrating trust among in own people first and then among League of Nations. History suggests that world domination comes only after prosperity of its own citizens. A nation cannot dominate beyond its borders with struggling and constraint population. It’s currency, Yuan, has trust issues among the global nations. Who wants to trade in Yuan?
  
• Brazil: It is still just a potential and needs to show political maturity and independent thought at world stage.
• India: It is too diverse, too much democratized, and busy with inconsequential bickering with neighbors. It’s economy is growing but still not in top five to have any meaningful bargaining power. It’s currency, Indian Rupee, is still searching an identity and role at world stage.
• Russia: It may perhaps have some legacy military strength; however, it is still confused between communism and free market economy. Its currency, Rubble, is no way near to be global currency.
• Japan’s stagnant economy and aging demographics is not able to support the cause of Yen being global currency.
• The nearest contender is European Euro. Last few years it has thrown challenge to the US Dollar’s status. I believe the issue with Euro is that it represents the bigger economies (e.g. UK, France, Germany, etc) and smaller economies (other European nations). It represents multiple countries. Other than the largely available European market, it does not have any other argument or bargaining strength. Individual countries still continue to use their own currencies and have not shows any inclination to phase it out. I believe it is still in its infancy, in a sense that it still needs to shows its resilience amidst fragmented political landscape.
  

While in long term evolutionary basis, 30 or 40 years down the line, one may see the change, but I don’t expect this to see within next 20 years time frame. I would go only so far as saying that for next 12 to 20 years, BRIC nations will be the catalyst in real global growth and corporate earnings. Here in US we are facing some head winds and perhaps may continue to do so in near future. I cannot predict when this will end.

I can say that in next 10+ years, there will be quite a large number of US and other multinational corporations that will still standing on their own strengths. There are quite a few corporations that are well positioned to continue their growth in developed markets and emerging economies. Mentioned below is the list of companies that are deriving their revenue (and hence earnings) from all types of economies. Figures in bracket indicate approximate percentage revenue from emerging markets. Most of these corporations have paid growing dividends in last five years as measured in their native currency.

• Proctor and Gamble (35%)
• Unilever (30%)
• Johnson and Johnson (60%)
• Qualcomm Inc. (60%)
• Intel Corporation (50%)
• International Business Machines (45%)
• Microsoft Corporation (33%)
• ABB (27%)
• The Coca Cola Company (60%)
• Pepsico Inc. (50%)
• Cadbury PLC (24%)
• Nestle (26%)
• Siemens AG (23%)
• Vodaphone PLC (20%)
• Exxon Mobil Corporation (60%)

Summary is…

I cannot predict what will happen to the value US Dollar and/or future growth from emerging markets. Dividend growth investors have many choices to position themselves which will blunt the effect of these issues. Invest in dividend growth companies that have notable presence in all markets. After that, the discussion of dollar demise becomes purely academic in nature.

Another option is to simply track Dow Index which can done by Dow Diamonds (DIA).

Full Disclosure: Long on PG, UL, PEP, JNJ, and INTC