This edition of the Keeley Teton Dividend Tracker includes our usual semiannual update and a look at what companies that do not pay dividends could pay dividends. The dividend universe produced mixed results in the first half of 2024. Performance among size and style indexes varied with dividend payers outperforming in large cap and mid cap, but lagging in small cap. The number of dividend payers grew slightly and their weight in most benchmarks increased. The breakdown of raisers, cutters, and omitters did not change much. The biggest difference in this period was that several large growth companies initiated dividends. Alphabet, Meta, Salesforce, and Booking Holdings all announced new dividends.
This made us wonder what other companies could initiate payouts. With some of the largest growth companies launching distributions, maybe investors will worry less that an initiation is a sign of slowing growth and focus more on the view that it is a sign of confidence about the future. We looked through the universe of non-dividend payers to identify some companies that could pay dividends.
SEMIANNUAL UPDATE
The Dividend Universe
Observations
We typically see more turnover in the first half than the second due to the Russell reconstitution, which takes place at the end of June.
- The number of dividend payers increased in all three size indexes in both number and percentages.
- The weighting of dividend payers was pretty stable in the small and mid-cap indexes but increased significantly in the Russell Top 200 due to the initiation of dividends by Meta Platforms and Google.
Dividend Changes
Observations
Because companies usually raise their dividend the same time every year, we look at the year-over-year change in the indicated dividend.
- The pace of initiations picked up and was the strongest we have seen since the reinitiations in the first half of 2021 by companies that omitted their dividends during the Covid pandemic. The fifty small cap initiations is up from thirty-two in the twelve months ended December 2023. The 10 in the Russell Top 200 is the most we have seen in over five years.
- The column titled “Avg. Increase” presents the average increase of the companies raising their dividends over the last year. Outliers impact these calculations as the median increase is about 8% in each index. If we look at the median increase for all dividend payers, it was flat for the Russell 2000, 5% for the Russell MidCap index, and 7% for the Russell Top 200.
- The percentage of companies raising their dividends has come down from a year ago. It was similar to the last quarter for small caps and midcaps, but fell sharply for large. Midcaps are the only size group where the percentage of dividend payers raising their payouts is in line with prepandemic levels. Fewer small cap and large cap companies are boosting their dividends since before the Covid pandemic.
- The numbers are small, but cuts and omissions declined a little for small caps and mid caps but rose for large caps. Most of the reductions for the companies in the Russell Top 200 arose from variable dividend policies at natural resource companies. Lower oil prices led to lower payouts at ConocoPhillips and Pioneer Natural Resources, for example. This had a smaller impact in the Russell 2000 and the Russell Midcap indexes
- Initiations and the impact of the Russell reconstitution pushed the percentage of dividend payers slightly higher in the Russell Top 200 and Russell Midcap. However, it remains below prepandemic levels in all three indexes. We suspect that is a function of the type of company that has been able to become public over the last few years.
Yields and Returns
Observations
The table above presents the simple average of the yield on the dividend-paying stocks within each index. The yield on the index is lower because not all stocks pay dividends. The right side of the table shows the performance of dividend payers and non-dividend payers.
- Yields rose for small caps, remained stable for mid caps, and fell for large caps. The difference largely reflects the performance difference between the market cap buckets.
- Dividend payers generally outperformed in the first half, but there was a lot of inconsistency. In the Russell 2000, they outperformed in value, but not in growth or overall. Midcap dividend payers generated better results than non-dividend payers across the board. Large cap was like small cap with superior performance by dividend payers in value, but not in growth.
Feature: Who’s Next?
The big news in dividends during the first half of the year was the initial dividends by mega-cap tech stocks Alphabet and Meta Platforms. In addition, Booking Holdings and Salesforce initiated payouts. Together, these four companies add more than $4 trillion in market cap to the dividend universe and will pay $19 billion in dividends per year. They boost the dividend growth rate on the Russell Top 200 index by 4%.
While companies initiate dividends at different times and for different reasons, all four of these companies mentioned that they wanted to diversify their capital return program. Historically, “growth” companies expressed reluctance to initiate dividends because they worried that doing so would send a message that they lacked adequate internal reinvestment opportunities. Few investors would categorize these four firms as lacking opportunities. Another interesting aspect of these four firms is that all have, and will continue to have, active share repurchase programs. In fact, the repurchase authorizations dwarf the cash that will be paid out as dividends.
The question in our mind now turns to “Who else will initiate a dividend?”
We have said that paying a dividend tells you three things about a company and how its management/board views it: 1) Management and the board believes the company will generate cash on a sustainable basis. 2) Because of the commitment to pay shareholders a dividend, the company will likely be conservatively financed, and 3) The board understands who owns the company.
As an initial cut to answer the questions, we screened for US companies with a market capitalization of greater than $200 million. They also had to be profitable in 2021, 2022, and 2023, and expected to be profitable in 2024 and 2025. This parameter provides evidence of the sustainability of cash flow. The screen turned up 558 stocks that do not pay dividends. We do not think all of these will eventually pay dividends, but we will take you through our thinking to those that would seem most likely to.
Keep in mind that these are not recommendations. We have not performed intensive research on the companies that we identify, and many factors impact stock returns aside from dividend initiations. Of note, only two of the four companies we mentioned outperformed the S&P 500 from the time they announced their dividend policy until the end of the second quarter.
Why Not Pay Dividends?
Profitable companies will talk about a lot of reasons why they do not pay dividends, but it really boils down to two things: they cannot pay dividends in light of their financial condition, or they do not want to pay dividends. Companies may not be able to pay dividends for a variety of reasons. They may have too much debt to comfortably declare a dividend; they might be going through a corporate transition that will consume cash; they might have agreed to be acquired. Several reasons also exist why companies might not want to pay dividends. In addition to the belief that “growth companies don’t pay dividends,” some companies may elect to return capital through share repurchases instead of dividends. This method is likely more tax efficient and may provide a boost to EPS and management compensation.
Winnowing Down The Likely Candidates
We looked at several factors to narrow the list of companies from the 558 passing the initial screen for profitability. We first tossed out companies (8 companies) that had omitted their dividend recently, figuring that they are unlikely to reinitiate quickly. Next, we looked for companies that could comfortably initiate a dividend. We eliminated companies with high leverage or recent cash flow deficits. As a final step, we looked at the valuation of companies. Companies that trade at low valuations might be better off using money that could be returned to shareholders as dividends in a share repurchase program. We outline our methodology in the chart to the left.
This left us with 368 companies that passed all our screens for the ability to pay dividends and trade at more than 10x 2025 estimated EPS. To gauge a company’s potential willingness to pay dividends, we looked at whether it has paid dividends in the past and whether it returns capital to shareholders by other means such as buybacks or special dividends.
Among the 368 companies, 322 (88%) repurchased stock during 2023, while only eleven paid dividends in the last five years. Seven of the eight that previously paid dividends repurchased shares.
We Think Valuation Should Impact The Decision
With market appreciation outpacing earnings growth this year, valuations have expanded. The S&P 500 traded at 21.9 times next twelve months’ earnings at the end of June, up from 20.4x at the end of the year and 17.4x at the end of 2022. This, combined with the rise in interest rates, makes the math behind share repurchases challenging. The table below illustrates this with a hypothetical company. It shows that share repurchases when the valuation is above 25 times forward earnings do not add to EPS compared to interest earned on the accumulation of cash.
We admit that this is a simplistic look at the math. Companies have their unique circumstances and can argue that buying back stock today that will be much more valuable in the future is a good use of corporate resources. Nevertheless, the bar should be high for companies buying back stock at elevated valuations.
For that reason, we divided the 368 companies that could pay dividends into two groups: those trading between 10x and 25x 2025 expected earnings and those trading above 25x forward earnings. The table below provides some summary statistics about these two groups. We see some interesting comparisons and contrasts between these two groups.
The main similarity between the two groups is that both cohorts were active in buying back their own stock. In addition, very few of the companies that do not pay dividends did so in the past. Most of those that ceased paying dividends did so in 2020.
The biggest difference we see is in the size cohorts. The highly valued group has much larger weights in the market cap strata greater than $25 billion. This is interesting in that larger companies tend to have a higher propensity to pay dividends. Among the 1,671 companies with a market cap greater than $200 million and profitability from 2021-2025, ~60% of the stocks in the smaller cohorts pay dividends whereas ~80% of the companies in the larger market cap groups do so.
The other noteworthy difference is that while the two groups have similar percentages of companies paying dividends, the lower valued group buys back more stock. The median repurchase percentage for this group in 2023 was 1.2%, about three times that of the more richly valued group. This is encouraging and probably means that the highly valued companies are simply buying back stock to offset dilution from employee stock grants. While we do not necessarily view that as the best use of corporate resources, at least it is limited.
The tables below show the largest companies, by market capitalization, in these two valuation groups. Again, these are not recommendations of the stocks, or even predictions that these companies will initiate dividends. We are only pointing out that they could pay dividends without straining their financial flexibility.
Who Could Pay Meaningful Dividends?
The last part of our analysis looks at what companies could pay a dividend that might be meaningful to shareholders. “Meaningful” is probably in the eye of the beholder, but we set a minimum of 1% and looked at the highest potential yields among the two valuation cohorts. In estimating how much a company could pay, we used 25% of consensus estimates for 2024 free cash flow. Where there was no free cash flow estimate, we used consensus estimates for other elements of free cash flow. Where estimates were lacking for those items, we annualized calendar first quarter results.
The table below lists the ten highest potential yields in each valuation cohort. Will all these companies pay dividends? That seems unlikely. But it also seems likely that some of them will. After all, Corcept Therapeutics, UiPath, Qualsys, and Cross Country Healthcare all spent multiples of the cash that would be required to pay dividends at these levels on repurchases last year.
Conclusions
We think the recent dividend initiations by some of the biggest growth companies in the stock market have some implications for dividend investors. Historically, growth-oriented companies seemed reluctant to pay dividends because they feared that doing so would create the perception that they lacked internal avenues of investment. That is a difficult position to take when some of the largest growth companies pay dividends. The decision should come down to a company’s ability to initiate and sustain the dividend and the relative attractiveness of paying a dividend compared with other ways of returning capital to shareholders. While it might take some time for growth investors to get on board with this view, we think it will happen. Our work shows that plenty of companies remain candidates to join the dividend stock universe.