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Companies are sitting on record amounts of cash and are understandably a little gun-shy about how to use it in these turbulent times. Businesses can use their excess cash in many different ways: they can fund organic growth, make acquisitions, pay dividends or buy back stock.
Of course, a company can just let that money sit in the bank (which seems to be the trend right now for many tech companies), but with interest rates near record lows, they're generating very low returns for their shareholders.
Ideally, a company should use its capital to maximize long-term value for their shareholders. But unfortunately some managers understand this better than others. Many corporate executives are more concerned about empire-building than producing high returns on capital and often make reckless decisions with shareholders' money.
Buybacks & Dividends
It's not uncommon for companies to distribute more and more cash to shareholders as they mature. Bigger companies have less growth opportunities and compete in crowded markets, so they plow back less of their earnings into the company and more into shareholders' wallets. And dividends, along with stock buybacks, are the quickest and surest way to return value to shareholders.
When a company actually buys back its shares, it has a direct benefit in that it reduces the number of shares outstanding. This means that earnings are divided among fewer shares. In other words, your piece of the pie just got bigger.
But stock buybacks don't always add value. If a company commences a share repurchase in a stock that is overvalued, clearly that's not a good use of shareholder money. The cash would have been better spent paying a higher dividend, investing for growth, or just leaving it in the bank.
So make sure the underlying business is sound before investing in a company that's buying back its own stock, because all the buybacks in the world won't save a company headed off a cliff.
4 Shareholder-Friendly Companies
With that in mind, here are 4 solid, shareholder-friendly companies generating strong free cash flow, raising their dividends and lowering their shares outstanding by buying back stock:
Free Cash Flow Year-to-Date: $3.574 billion
Share Buybacks Year-to-Date: $2.993 billion (84% of FCF)
Dividends Year-to-Date: $1.894 billion (53% of FCF)
The Golden Arches has been firing on all cylinders over the last few years, growing not just in the emerging markets, but in the sluggish markets of the U.S. and Europe. Shareholders have been handsomely rewarded over that time as shareholder-friendly McDonald's buys back its stock and raises its dividend while still investing for growth.
The company has lowered its shares outstanding by 16% over the last 5 years while raising its dividend by 180% over the same period. It currently yields 3.0%.
Free Cash Flow Year-to-Date: $9.690 billion
Share Buybacks Year-to-Date: $11.465 billion (118% of FCF)
Dividends Year-to-Date: $2.593 billion (27% of FCF)
IBM has been in the news recently after the Oracle of Omaha announced on CNBC that he had recently bought over 5% of the company. So why Big Blue? Among many reasons, Mr. Buffett stated that they "treat their stock with reverence which I find is unusual among big companies.... They really [are] thinking about the shareholder."
In fact, IBM has reduced its shares outstanding by 21% since the end of 2006 while simultaneously raising its dividend by 150% over the same period. It currently yields 1.7%.
Free Cash Flow Year-to-Date: $9.000 billion
Share Buybacks Year-to-Date: $4.367 billion (49% of FCF)
Dividends Year-to-Date: $3.441 billion (38% of FCF)
Like it or not, Philip Morris International generates a ton of free cash flow from its cigarettes, especially from its flagship brand Marlboro. The company was spun off from Altria in 2008 and does not sell its products in the U.S., leaving it less exposed to the regulatory risk here.
The company has bought back 14% of shares outstanding since the end of 2008 and pays a dividend that yields a stellar 4.3%.
Free Cash Flow Year-to-Date: $3.038 billion
Share Buybacks Year-to-Date: $2.172 billion (71% of FCF)
Dividends Year-to-Date: $0.644 billion (21% of FCF)
Accenture is a leading consulting and technology services company. This asset-light business model requires relatively little capital expenditures, leaving plenty of dough left over for shareholders.
Accenture has been using that dough to buy back stock and has reduced its shares outstanding by 14% over the last 4 years. It has also been aggressively raising its dividend, which currently yields 2.5%.
The Bottom Line
Companies have several options when it comes to deploying their excess cash. These 4 cash machines are choosing to return value to shareholders through stock buybacks and dividends.
Todd Bunton is the Growth & Income Stock Strategist for Zacks.com and Co-Editor with Steve Reitmeister of the Reitmeister Value Investor that snaps up discounted value stocks and sells them after the market realizes their true worth for long-term gains.
Disclosure: The author owns shares of IBM.
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