What Dow Dividend Investors Must Know About Buybacks

Dividend investors generally regard the Dow Jones Industrials as a fertile ground for smart dividend-stock ideas. On the whole, though, the Dow's overall dividend yield is relatively low, at just 2.1%.

Yet for those who argue that the Dow 30 are on the whole stingy about their dividend payouts, it's important to remember that businesses have two main ways to return capital to shareholders. When you include both buybacks and dividends, you get a much different picture of what the Dow's most shareholder-friendly stocks are, with Intel and Cisco Systems dropping out of the limelight and Home Depot and Goldman Sachs looking a lot more attractive.

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Going beyond yield
Portfolio manager Mebane Faber recently looked at the 30 stocks in the Dow from both of these perspectives. When you look only at the dividend yields of Dow stocks, the usual suspects rise to the top of the list: telecom stocks and pharmaceutical companies, along with technology companies like Intel and Cisco that have been more recent converts to the dividend-growth bandwagon. By contrast, financial companies generally fare poorly, with many banks still suffering from capital restrictions that limit their ability to pay higher dividend payouts.

But considering the impact of stock issuance and buybacks to consider what's known as net payout yield makes major changes to the order of the Dow 30. Telecom giant AT&T still ranks near the top of the list, as it combines substantial buybacks with the highest dividend yield in the Dow. But Intel and Cisco both fall from among the top-yielding Dow stocks into the bottom half of the Dow by net payout yield, as Intel makes only the smallest of net buybacks while Cisco actually issues more stock than it buys back.

By contrast, many stocks that seem stingy on a dividend-yield basis actually have extensive buyback policies. Home Depot, for instance, yields less than 2%, but when you add in the impact of buybacks, its net payout yield climbs to about 8%, third highest in the Dow. Even more impressively, Home Depot expects to ramp up its buyback program even further, with its $17 billion repurchase authorization through the fiscal 2015 year representing 15% of its current market cap.

Similarly, some financial stocks have had better luck getting authorization for stock buybacks than for permanent dividend increases. Goldman Sachs pays a dividend yield of just 1.3%, putting it in the bottom five of Dow stocks. But Goldman spent $6.17 billion on buybacks in 2013, repurchasing 39.3 million shares of its common stock. Adding in those buybacks pushes Goldman into the top five, with a net payout yield of more than 7%.

Dividend yields are still an important aspect of stocks, as they generally are more reliable and consistent than repurchase programs. Nevertheless, ignoring stock buybacks can lead you to make erroneous assumptions about which Dow stocks are actually the best at return capital to their shareholders.

What buybacks don't tell you
One of the dirty secrets that few finance professionals will openly admit is that dividend stocks as a group handily outperform their non-dividend-paying brethren. The reasons are too numerous to list here, but you can rest assured that it's true. However, knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.

The article What Dow Dividend Investors Must Know About Buybacks originally appeared on Fool.com.

Fool contributor Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Cisco Systems, Goldman Sachs, Home Depot, and Intel and owns shares of Intel. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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