The ‘ultimate’ objective of any corporation is to create value for its stakeholders. In fact, one factor common among companies that turn out to be ‘great’ long-term investments is their focus on enhancing ‘shareholder value’. (Read: High Quality ETFs for long-term outperformance)
Most investors focus on dividends while looking for value enhancing investments but by focusing on dividends alone, investors miss the bigger picture. Corporate actions such as buying back shares and repaying debt also create value for shareholders.
Companies that consistently generate strong cash flows can be relied upon as excellent long-term investments since they can utilize that cash to pursue investment opportunities that enhance shareholder value or return cash to shareholders.
Many U.S. companies have accumulated huge cash piles in recent years. They are likely to return more money to shareholders via dividends and buybacks. These actions enhance shareholder returns in the years to come.
Below, we present three ETFs that hold companies focused on enhancing shareholder value and thus can be excellent choices for long-term investors. (See: No Trick, Just Dividend ETF Treats for Q4)
Focus on Dividend Growth ETFs for Long-Term Outperformance
Dividend stocks and ETFs had seen a lot of interest in the past 2-3 years as investors searched for yield in the ultra-low interest environment. However they have been out of favor of late, since the taper talk started. Further, many sectors that are traditionally high dividend payers—like utilities and telecom—were punished by investors worried about the rate increase.
However investors should remember that historically more than 40% of the market returns have come from dividends. Among dividend payers, I prefer companies that have been consistently increasing their dividends in the past and have the potential to do so going forward too.
Stable, cash-rich companies that have a consistent record of increasing their dividends have outperformed the boarder market over the longer-term. (Read: Dynamic ETFs to Energize your portfolio)
ProShares S&P 500 Aristocrats ETF (NOBL)
NOBL follows the S&P 500 Dividend Aristocrats index that targets companies that have increased dividend payments each year for at least 25 years, and meet certain market capitalization and liquidity requirements. The index weights its holdings equally and each sector’s weight is capped at 30% of the index weight.
Top sectors currently are Consumer Staples (24%), Industrials (15%) and Materials (13%) and Healthcare (13%). It has minimal exposure (less than 2%) to Utilities and telecom.
The product has an expense ratio of 35 basis points and the index currently has an attractive dividend yield of 2.57%.
While the ETF was launched very recently, the index has been consistently outperforming the broader market index with lower volatility since its inception in 2005.
Over the past five years, S&P 500 Dividend Aristocrats index had total returns of 19.4% compared with total returns of 16.3% for the S&P 500 index.
Buybacks Continue to Outpace Dividends
While most investors prefer dividends to buybacks, the fact is that companies have been returning more cash to shareholders via buybacks than via dividends. Companies in the S&P 500 spent about $3.1 trillion on buybacks from 2004 to 2012, while they paid $2.1 trillion in dividends in the same time.
The trend has continued with share repurchases increasing to $118.1 billion during 2Q 2013, up 18.1% from the prior-year quarter. (Read: 3 Niche ETFs Crushing the market)
While dividends are simpler to understand and put money in the pocket, buybacks have their own advantages—they reduce the outstanding share count and thus increase earnings per share. Further, they are more tax efficient.
PowerShares Buyback Achievers Portfolio (PKW)
PKW tracks the NASDAQ US Buyback Achievers Index, which is comprised of companies that have repurchased 5% or more of their common stock in the trailing 12 months.
The ETF has been outperforming the broader markets over the last five years—it has returned ~176% versus 112% for the S&P 500 ETF. The product continues to shine this year too, with 38% return compared with 26% for SPY.
The fund charges an expense ratio of 71 basis points currently. ConocoPhillips, Amgen and Oracle are the top holdings as of now.
Focus on the Big Picture with Free Cash Flow
Free cash flow is key measure of the inherent strength of a company. Three key indicators of free cash flow are dividend payments, net share repurchases and net debt paydown, which together determine the shareholder yield.
By looking at the shareholder yield, investors can get the big picture of total capital return by a company to its shareholders.
Cambria Shareholder Yield ETF (SYLD)
SYLD is an actively managed fund based on the research that free cash flow is a key predictor of a company’s strength.
This product invests in companies that show strong characteristics in returning free cash flow to their shareholders by way of cash dividends, share repurchases, or by reducing their leverage.
SYLD has a diversified portfolio of 100 stocks with market caps greater than $200 million, with a tilt towards large cap stocks that currently comprise 56% of the portfolio. Consumer Discretionary (19%) Financials (18%) and Information Technology (14%) occupy the top three spots in terms of sector exposure.
Expense ratio of 0.59% looks pretty reasonable for an actively manage fund. Since it inception in May this year, the fund has returned 11.9% compared with 7.8% for SPY during the same period.
The Bottom Line
Companies that consistently generate strong cash flows and utilize that cash in ways that enhance shareholder value have always tended to be strong performers over longer-term. Three ETFs presented above present a convenient way to invest in such companies.
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- shareholder value