Stock buybacks and dividend payouts are not mutually exclusive. Many publicly-traded companies use both of these tactics to distribute excess profits to shareholders. However, few companies employ these tactics in a predictable and consistent manner.
A 10-year snapshot of Microsoft’s outstanding share count juxtaposed with the dividend paid per share.
I've created the "X Factor Index" to highlight companies that have increased dividends and reduced outstanding shares for 10 consecutive years or more.
(On a dual-axis time series chart, the trend-line of the share count and the trend-line of the dividend rate intersect to create an “X" shape.)
There are at least 18 companies that meet my strictest criteria for inclusion, summarized as:
Dividend per share increased for 10 consecutive years or more;
Share count reduced for 10 consecutive years or more; and
Positive sales growth.
X Factor Index: Stock Portfolio (June 2021)
Agilent Technologies (A)
Accenture PLC (ACN)
The Allstate Corporation (ALL)
Aon PLC (AON)
Avery Dennison Corporation (AVY)
Blackrock, Inc. (BLK)
The Home Depot, Inc. (HD)
Lockheed Martin Corporation (LMT)
Lowe's Companies, Inc. (LOW)
Mastercard Incorporated (MA)
Microsoft Corporation (MSFT)
Northrop Grumman Corporation (NOC)
Primerica, Inc. (PRI)
Service Corporation International (SCI)
Target Corporation (TGT)
Tractor Supply Company (TSCO)
Texas Instruments Incorporated (TXN)
Visa Inc. (V)
A hypothetical $100,000 portfolio invested equally amongst these companies in June 2011 would be presently valued at more than $750,000, assuming that dividends were reinvested (and notwithstanding the impact of taxes and trading fees).†
Hypothesis
I believe that a basket of companies using free cash flow growth to pay an increasing dividend and to simultaneously reduce the number of outstanding shares may outperform the broader stock market because of two complementary factors:
1. The compounding effect of growing, reinvested dividends; and
2. A potential "scarcity premium" resulting from a lower supply of shares*.
*In a shareholder's utopia, all share repurchases would result in fewer outstanding shares, yet this is rarely the case. Many companies use stock buybacks to mitigate executive compensation that is paid out in stock options or restricted stock units. Other companies issue new shares to fund dividend payments.
Extensibility
To make the X Factor Index suitable for the majority of investors, it may be necessary to broaden the stock selection criteria while attempting to avoid the dilution of investment returns. (Equity index funds can hold hundreds or thousands of stocks to diversify capital and to protect the investor from an over-concentration in a small number of securities.)
Here is one alteration to the methodology, highlighted in italics:
Share count reduced by at least 10% over a 10 year period;
Dividend per share increased for 10 consecutive years or more; and
Positive sales growth.
This loosened criterion would allow a stock to qualify for the index even if the parent company had a one year "blip" where outstanding shares increased (like Apple) or a multi-year stretch where outstanding shares remained constant (like Church & Dwight).
Another method is to maintain the strict criteria using a time horizon that is less than 10 years. This may result in higher returns if it allows the investor to "get in early" on a fundamental trend. Here are some companies that meet the strict criteria using a five year time horizon:
Extended X-Factor Index: Stock Portfolio (June 2021)
Apple Inc. (AAPL)
Booz Allen Hamilton Holding Corporation (BAH)
CDW Corporation (CDW)
Dollar General Corporation (DG)
Domino's Pizza, Inc. (DPZ)
Fortune Brands Home & Security, Inc. (FBHS)
Huntington Ingalls Industries, Inc. (HII)
Humana Inc. (HUM)
Lennox International Inc. (LII)
Lam Research Corporation (LRCX)
Old Dominion Freight Line, Inc. (ODFL)
S&P Global Inc. (SPGI)
Tetra Tech, Inc. (TTEK)
Zoetis Inc. (ZTS)
Disclosures
Past performance does not guarantee future results. This material is provided for informational purposes only and is not an offer, invitation or solicitation to buy or sell any securities.
I own shares of CDW, Domino’s Pizza, Lam Research and Tractor Supply Co.
† Each of the companies above qualifies for inclusion in the X Factor Index as of this writing, however, this may not have been the case in June 2011. Therefore, the hypothetical 10-year performance of the portfolio above is potentially misleading. Over the last five years, the X Factor Index has outperformed the CRSP US Total Market Index by more than 30%.