Advisory intelligence: Investor preferences toward capital allocation
While the 2010s witnessed a boom in shareholder buybacks, investor preferences have shifted in recent years to favoring dividends, according to new research from the Strategic Capital Intelligence team at Nasdaq IR Intelligence.
The analysis offers insight into investor views on capital allocation at a time when many companies are faced with difficult decisions around dividends and buybacks as they manage the impact of Covid-19.
‘Historically, buybacks have been a very popular way of returning wealth to shareholders, because: one, they don’t come with the long-term commitment of dividends; two, they send a clear message about management’s opinion on valuation; and three, they create an immediate impact on EPS,’ says Addison Holmes, who heads up Nasdaq’s Strategic Capital Intelligence team for the US western region.
‘And as we delved into the data, we noted that buybacks have actually been the largest source of US stock market demand since 2010. So again, a really huge driving force in the market.’
Despite the historical popularity of buybacks, Nasdaq research shows a shift in investor preferences around the start of 2018. In the first eight years of the decade, the Nasdaq Buyback Achievers Index outperformed the Nasdaq Dividend Achievers Index. But for the last two years, the index of long-term dividend payers has been on top.
‘You can glean more information through initiation of a dividend – in what management thinks about its ability to sustain it going forward,’ says Holmes. ‘I think that was one of the really big driving factors in the shift in investor preference.’
Of course, capital allocation strategies are now being rethought amid the Covid-19 outbreak. With consumer demand collapsing and unemployment heading to levels not seen since the Great Depression, companies must prioritize protecting cash flow and shoring up balance sheets.
‘Since the beginning of March, about 84 of the S&P 1500 companies have suspended their dividends, and another 90 have suspended their buybacks,’ says Holmes. The sector taking most action is consumer discretionary, she notes, which currently leads in terms of cutting both dividends and buybacks. The suspensions are also largely driven by companies with a market cap of less than $8 bn.
‘In analyzing the profile of those companies making suspensions, I also notice that the inability to sustain dividends and buybacks is largely correlated with leverage profile,’ says Holmes. ‘More than 50 percent of the companies I analyzed had what I would consider to be a high leverage profile relative to other companies with a similar market cap.’
As might be expected, the suspension of dividends or buybacks is correlated with negative market reactions, namely share price falls and downward revisions of analyst estimates. ‘It makes sense that analysts will be less optimistic about earnings and cash-flow prospects after learning a company’s management doesn’t believe its current dividend or buyback policy is sustainable through a time of economic hardship,’ explains Holmes.
When conducting her research, she noticed that sentiment is more affected by suspensions of dividends than of buybacks. ‘My interpretation is that, while a buyback is a singular event, a dividend represents a continued commitment to distribute wealth to shareholders,’ she says. ‘So suspension of a dividend provides more information about the long-term prospects of a company.’
The study also shows that larger companies are more likely to field questions on capital allocation during earnings calls than smaller peers. ‘At a high level, complexity grows with market cap, and larger-cap entities have more complex dividend and buyback strategies,’ says Holmes. ‘They’re a little more sophisticated and they tend to receive more investors’ and analysts’ questions around their strategy, so the IR teams have to be more sophisticated and better understand those strategies.’
The IR contribution
As a company’s eyes and ears in the market, IR teams have the chance to demonstrate their strategic value by taking part in discussions around capital allocation strategies. These decisions ‘can be very challenging as management and CFOs must balance the growth and sustainability of the business with investor demand for, say, a dividend,’ says Holmes.
‘IR teams can make a really valuable contribution to this process, because they are the capital markets liaison, and they are going to end up communicating these decisions to investors. So when we run capital deployment studies, we’re typically working in conjunction with both the IR team and usually the CFO’s team.’
For IROs, the initiation of a dividend or buyback also presents the opportunity to target new types of shareholders. To demonstrate this, Nasdaq’s research includes a case study of Hanesbrands, which started paying dividends in 2013. Upon initiation, yield investors began to flow into the stock. ‘There’s a whole new type of investor that’s going to have an appetite for your stock and your profile as you change how you’re deploying capital,’ explains Holmes.
As a final point, she notes that each company must consider its own unique circumstances and shareholder base when making changes to capital allocation strategies and trying to anticipate investor response. ‘There’s no universal strategy that works for all companies, and IROs can help their management teams construct effective capital allocation strategies by incorporating that capital markets lens,’ she says.