Investing in stocks is risky business. That's why it's always nice to find a company that makes a habit out of rewarding you for taking on that risk of ownership. The most common ways companies do this is through dividends and share repurchases.
To figure out which companies on the Dow Jones Industrial Average (INDEX: ^DJI) were the most generous with their cash over the past five years, I divided the total cash returned to shareholders by each company's total earnings over the same period.
Too much of a good thing?
The results were surprising. You'll be forgiven for thinking of the Dow as a group of blue-chip fiscal tightwads with a short leash on their cash, but the Dow companies that paid out the most over the past five years have been anything but.
% Earnings Returned (5 Years)
Alcoa (NYS: AA)
Home Depot (NYS: HD)
Verizon (NYS: VZ)
That's right, Alcoa has actually paid out 3 times as much as it earned over the past five years; Home Depot and Verizon look downright conservative by comparison. While we love to have our companies return cash to us as partial owners, these three prove there can actually be too much of a good thing. These trends are clearly unsustainable. It's not just them, either. More than 40% of Dow stocks paid out more than they earned over the past five years.
This problem isn't restricted to the Dow, either; it's become a broad market habit in recent years. In 2007, nonfinancial businesses paid out $750 billion in dividends and share repurchases but earned only $480 billion. Charting the payouts compared with profits for these companies since then reveals the same trend, albeit to a lesser degree.
Of course, there are a few caveats here. The past five years include the worst economic meltdown since the Great Depression. Given the prestige and perceived stability with continually raising or at least maintaining a dividend, many companies probably felt pressured to pay out more than they could reasonably afford. Of course, that doesn't justify the action, but it may explain it a bit.
The reality is that companies should have been more comfortable admitting weakness and cutting their commitments if needed. That's exactly what General Electric (NYS: GE) did in 2009. The company also put a leash on share repurchases, making about 75% of the purchases over the past five years in 2008 alone and then dialing back sharply. The result? Over the past five years, GE has paid out a still handsome, but far more sustainable, 88% of its earnings in the form of dividends and share repurchases.
You could argue that GE should have bought back a few more shares when they were trading at dirt cheap 2009 levels, but when you're looking at investing in a company over the long term for its habit of returning capital to shareholders, it's more important the company be able to sustain those payments than anything else. In addition, 2009 was a time of such high uncertainty and weakness inside GE that keeping money in-house to shore up GE Capital will probably pay more outsized gains over the long run than some timelier share repurchases.
How to play it now
GE isn't a prefect allocator of capital, of course. It has suffered its share of black eyes, and one of our top analysts will tell you in his newest report why you should sell GE. The report is a must-have for anyone holding GE or thinking about it.
Considering the track record and long-term potential of each stock like this is vital to true wealth-building. The few companies that make the cut quickly become The Stocks Only the Smartest Investors Buy, while the rest fizzle out and erase wealth. While Home Depot, Verizon, and Alcoa have some merits, none has earned my hard-earned dollar. Instead, I've put a lot of my money in the same camp as Warren Buffett, and you can, too. Read about where Buffett puts his cash and where he wishes he could invest. Our analyst report is free.
At the time thisarticle was published Austin Smith owns no shares of the companies mentioned here.Motley Fool newsletter serviceshave recommended buying shares of Home Depot. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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