After a string of juicy profit gains beginning five years ago, third-quarter 2007 numbers overall look to be thin soup.
But a number of companies will give their reports some spice by promising to put more cash into shareholder pockets.
Aluminum producer Alcoa began the third-quarter earnings reporting season late Wednesday with an earnings-per-share number that disappointed analysts but with a pledge to repurchase 25 percent of the company shares.
Soothing investor nerves with cash is not a bad idea, as long as the payouts don’t deplete prospects for future profits.
Data from the Standard & Poor’s Capital IQ research service show that payouts to shareholders, largely through share repurchases, have become a more important tool of investor relations in the last four years. Among companies with more than $300 million in stock market capitalization, four of 10 major sectors are paying out more than the companies make in profits.
You might assume that information technology companies would retain their profits for research and development and other growth projects. Many tech companies pay no dividends.
But, as a sector, major information tech stocks are second only to so-called consumer discretionary stocks, which include retailers and entertainment companies, in returning cash to shareholders.
In the 12 months ended Sept. 30, large technology companies paid out nearly 150 percent of profits in buybacks or dividends.
“Companies are returning more than they earned,” said Jeremy Payne, a senior vice president at Capital IQ. In some cases, such as cash fortresses Microsoft and International Business Machines, cash is available on the balance sheet to hand out.
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But often “it’s an indication that companies borrowed money to make these payments,” Payne said. “It’s a tool not only to return cash to shareholders but also to manage their capital structure.”
In part, debt-financed payouts represent a reaction to the surge in leveraged buyouts of companies by private partnerships. Until recently, leading LBO shops have had no trouble borrowing to acquire companies at premium prices. It’s not surprising that company managers, as a defensive move, would borrow to reward shareholders as well, Payne said.
“One of the things the LBO guys are looking for is underlevered companies, because that allows them to purchase the equity with additional debt,” he said.
Sectors with the lowest payout rates — energy and materials — face enormous cash requirements to develop their products, such as oil and chemicals. These companies retain profits to finance expensive operations.
But companies with high capital costs are also less likely to be targets of leveraged buyout sharpshooters.
In this decade the highest payout rates overall were in 2001 and 2002, during the Nasdaq bust.
“The fact that valuations were lower, because the bubble had burst, made the purchase of common stock more attractive,” Payne said.
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Graphic: Payout rates by major industry sector %% SECTOR PAYOUT RATES* Consumer discretionary 149.6% Information technology 147.8% Telecommunications 138% Health care 119.9% Consumer staples 91.2% Utilities 76.9% Industrials 74.3% Financials 72.3% Energy 60.2% Materials 56.3% %% *Share repurchases plus dividends/profits, last 12 months
Source: Standard & Poor’s Capital IQ
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