The allure of high dividend yields can be enticing for investors looking to generate income. However, as experienced contrarians know, these yields are often accompanied by red flags that require deeper analysis. A high yield can reflect declining share prices rather than the positive signal of increasing payouts. For instance, take Verizon Communications (VZ), which currently boasts a 6.5% yield. Although it has raised its dividend modestly over the past five years, the total return for VZ shareholders, when accounting for inflation, has been negative. Compared to the S&P 500’s impressive 108% return during the same period, VZ’s lackluster performance suggests that a high dividend yield does not always correlate with a healthy stock investment. This underscores the necessity for investors to look beyond the surface and consider other factors that may contribute to high yields.
To more effectively measure a company’s capacity to generate returns for shareholders, it’s essential to distinguish between three categories: current dividends, future payout growth, and share buybacks. The traditional focus on dividend yield often overlooks the significant impact of buybacks. When a company repurchases its shares, it reduces the number of outstanding shares, thus increasing earnings per share and enhancing overall shareholder value. This reality calls for a more comprehensive metric called shareholder yield, which encompasses dividends as well as buybacks, providing a fuller picture of how much a company is rewarding its investors.
For illustration, let’s examine Lockheed Martin (LMT), a leader in defense and aerospace technology. Although it has a relatively modest current dividend yield of 2.3%, Lockheed’s strong dividend growth of about 38% over the past five years has positively influenced its stock price. Additionally, the company has repurchased an impressive 16% of its shares in the last five years, thereby contributing to improved performance in per-share metrics. By combining these elements, Lockheed’s shareholder yield becomes more significant: when calculated, it yields approximately 6.6%. This is nearly triple the nominal dividend yield, which once again highlights how nuanced the reward structures can be for shareholders.
Calculating shareholder yield involves adding the total amount a company spends on dividends and share repurchases, while also accounting for any cash received from share issuances. In Lockheed’s case, this results in a total expenditure of approximately $8.75 billion in the last year, set against a market cap of $132.9 billion. This calculation amplifies the attractiveness of the investment, demonstrating that focusing solely on a high current dividend yield can often result in missed opportunities.
Another compelling example in the market is Valero Energy (VLO), a large refinery. While its current dividend yield stands at 3.2%, its shareholder yield is a staggering 14.6%. Over the past 12 months, Valero disbursed $1.4 billion in dividends and invested $4.8 billion in buybacks for a total shareholder return of $6.2 billion, out of a market cap of $42.6 billion. This ratio showcases how strategically positioned refiners can provide outstanding shareholder rewards, particularly in periods of stable demand, which supports investment cash flows. Despite recent missed earnings targets, Valero’s solid fundamentals position it as an appealing investment.
In summary, the analysis of dividend yields should extend beyond the superficial metrics that often dominate conversations among investors. While high yields can initially seem beneficial, they frequently hint at underlying issues, such as a declining stock price. Instead, metrics like shareholder yield—which take into account dividends and buybacks—provide a clearer perspective on true investment potential. Stocks like Lockheed Martin and Valero Energy exemplify the value in looking past current dividend yields and emphasizing the broader picture of shareholder returns. This insight enables contrarian investors to identify opportunities that could yield substantial long-term rewards, making a compelling case for a diversified and nuanced investment strategy focused on overall shareholder value formation.
