Value Investor Daily #71

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Shareholder Yield: A Data-Driven Approach to Unlocking Value

While dividend investing has long held appeal for its promise of steady income, a growing body of evidence suggests that focusing solely on dividends may overlook a critical component of shareholder value creation: stock buybacks.

Meb Faber, co-founder and Chief Investment Officer of Cambria Investments, champions the concept of shareholder yield, a metric that encompasses both dividends and buybacks to provide a more comprehensive view of how companies reward their investors.

"If a company pays a 10% dividend or buys back 10% of its shares, the result for shareholders is nearly identical," Faber explains. "It's about finding disciplined companies that prioritize rewarding their investors.”

This philosophy underpins the Cambria Shareholder Yield ETF (SYLD), which has generated a compelling 12.02% average annual return since its inception in 2013 through October 31, 2024. This performance significantly surpasses the 9.8% return of its benchmark, the iShares Core S&P Mid-Cap ETF (IJH), over the same period. It’s also outperformed the S&P 500 in the last ten years. This outperformance is particularly striking considering the extended period of growth stock dominance in the market.

Dissecting Shareholder Yield: Dividends and Buybacks

Shareholder yield recognizes that companies can enhance shareholder return through two primary mechanisms:

1. Dividends: These periodic payments provide investors with a consistent stream of income, often favored by those seeking current income or building retirement portfolios. According to a study by Hartford Funds, dividend-paying stocks in the S&P 500 have historically outperformed non-dividend payers, with an average annual return of 9.3% versus 4.2% from 1973 to 2022.

2. Stock Buybacks: When a company repurchases its own shares, it reduces the number of outstanding shares. This can lead to an increase in earnings per share, even if overall earnings remain constant, thereby boosting the value of the remaining shares. Data from S&P Global shows that S&P 500 companies spent $877.5 billion on buybacks in the last twelve months, up from $812.5 billion in the year prior but down from the record in 2022 of just over $1 trillion.

By considering both dividends and buybacks, shareholder yield provides a more holistic view of a company's commitment to returning value to its shareholders. This approach can uncover opportunities that traditional dividend-focused strategies may overlook.

The SYLD Approach: A Quantitative Framework

The Cambria Shareholder Yield ETF (SYLD) employs a robust, quantitative framework to identify companies with high shareholder yield potential:

1. Shareholder Yield: The strategy starts by ranking companies based on their shareholder yield, calculated as the sum of dividends paid and net stock buybacks divided by market capitalization. This ensures that the portfolio is tilted towards companies actively returning capital to shareholders.

2. Valuation: SYLD incorporates a value screen to avoid overvalued companies, even if they have high shareholder yields. This is crucial because companies can artificially inflate their shareholder yield through excessive buybacks funded by debt or at inflated prices. SYLD utilizes metrics like price-to-earnings (P/E) and enterprise value-to-EBITDA (EV/EBITDA) to identify companies trading at reasonable valuations.

3. Financial Quality: To ensure the sustainability of shareholder yield programs, SYLD focuses on companies with strong financial health. This includes factors like high return on equity (ROE), low debt-to-equity ratios, and consistent free cash flow generation.

4. Momentum: SYLD incorporates a momentum filter to avoid "value traps" – companies with declining share prices that may appear cheap but are actually facing fundamental challenges. This filter helps to identify companies with positive price trends, suggesting improving investor sentiment and potential for future growth.

This multi-factor approach helps ensure that SYLD invests in companies with high shareholder yields, the financial strength to sustain their capital return programs, and positive stock price momentum.

The Case for Shareholder Yield

Investing in companies with high shareholder yields offers several compelling advantages:

* Disciplined Capital Allocation: Companies prioritizing returning cash to shareholders tend to be more disciplined in their capital allocation decisions. They are less likely to engage in empire-building through value-destroying acquisitions or to overspend on executive compensation. Research by McKinsey & Company has shown that companies with a strong focus on capital allocation outperform their peers by a significant margin.

* Alignment of Interests: A high shareholder yield can signal that a company's management team is aligned with the interests of its shareholders. This alignment can lead to better corporate governance and a focus on long-term value creation.

* Attractive Valuations: While not always the case, companies with high shareholder yields can often be found at attractive valuations relative to their earnings and growth prospects. This is because the market may not fully appreciate the impact of buybacks on shareholder value.

Apple: A Shareholder Yield Exemplar

Apple Inc. (AAPL) is a prime example of a company that has successfully utilized shareholder yield to enhance shareholder value. Over the past decade, Apple has returned a staggering $833 billion to shareholders through a combination of dividends and an aggressive stock buyback program. This strategy has been instrumental in driving Apple's impressive total shareholder return, showcasing the power of shareholder yield in action.

Beyond U.S. Borders: Emerging Market Potential

While SYLD concentrates on U.S. companies, Meb Faber emphasizes the potential of international markets, particularly emerging markets. He points to the significant undervaluation of these markets relative to the U.S., despite their substantial contribution to global GDP and population growth.

"Emerging markets are often overlooked," Faber observes. "They account for a small fraction of global market capitalization but represent most of the world's population and GDP. There's a lot of untapped value there.”

Data from MSCI supports this view, showing that emerging markets have historically traded at lower valuations compared to developed markets, offering the potential for higher returns over the long term.

SYLD: Performance and Portfolio Composition

SYLD holds 100 U.S. companies diversified across various sectors, with notable holdings like CNX Resources (energy), PayPal (fintech), and Kohl’s (consumer discretionary).

The average P/E ratio of its holdings is only 16x, compared to 34x for the S&P 500.

These figures highlight SYLD's ability to generate strong returns while maintaining a reasonable valuation and offering a higher dividend yield than its benchmark.

Considerations and Risks

While shareholder yield offers a compelling investment approach, it's crucial to acknowledge potential risks:

* Sector Concentration: SYLD can have sector concentrations, which may increase volatility. As of October 31, 2024, the ETF had approximately 20% of its assets in the consumer discretionary sector, 18% in financials, and 17% in energy.

* Buyback Timing: Companies may repurchase shares at inopportune times, such as when their stock price is overvalued. This can destroy shareholder value instead of enhancing it.

* Market Volatility: Like all investments, SYLD is subject to market fluctuations and can experience losses, especially during periods of economic uncertainty or market downturns.

Stocks With High Total Shareholder Returns

We ran our own screen to come up with a dozen large-cap stocks with at least 3% each of dividend and buyback yields.

Conclusion

Shareholder yield provides a valuable framework for investors seeking to identify companies prioritizing returning capital to shareholders. This approach offers a more complete picture of shareholder value creation by considering both dividends and stock buybacks.

The Cambria Shareholder Yield ETF demonstrates the potential of this strategy, delivering strong returns and outperforming its benchmark. However, as always, investors should carefully consider the potential risks, conduct thorough research, and assess their own investment objectives and risk tolerance before investing.

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Value Investor Daily

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