Some of the Best Dividend Stocks Do Not Pay Dividends

Companies are sitting on a record pile of cash, upwards of $2 trillion for non-financial U.S. corporations. Whether it is because of political uncertainty or just not enough high-growth projects in which to invest, one thing is certain, shareholders are seeing a boom in cash returns.

The Factset Dividend Quarterly, for the second quarter 2013, shows that 71% (353 companies) in the S&P500 are paying a dividend and buying back shares. More companies (85%) are paying dividends than anytime in the last 15 years and total dividends paid increased 15.7% over the last year.

Cash is king but there is one problem with those dividend hikes you are so happy to get, they commit cash in the future as well. Should a high growth project come along in the future, the company will have to make the decision to cut payouts or sacrifice growth.

I still think good dividend-paying companies should be the core of your portfolio, providing a stable series of returns and cash flow, but some of the best dividend stocks do not even pay dividends.

There is another way companies are spending their massive cash hoards, through share buybacks. Companies spent $415 billion to buy back their shares last year and this year looks like that amount will be bested. Buybacks amounted to 63% of free cash flow and 3% average shares outstanding in the four quarters to June of this year.

Share buybacks really work for investors in the same way as dividends. When the company buys back shares, income is spread over fewer shares and the earnings-per-share increases. If investors are willing to pay the same price-to-earnings multiple for the stock, then the price increases and shareholders have more total wealth. If the company chooses to pay a dividend then you have the cash payment but the share price may not increase at all. The only real difference is that, with dividends, you have no control as to when you receive the cash return.

I know dividend investors hate to sell their shares. Why sell off something that is putting cash in my pocket every three months? But what if a company does not pay a dividend? You can still get those regular cash returns by selling a small portion of shares and your taxes won’t change if you hold the stock for more than a year.

Two of the best non-dividend, dividend stocks

Tenet Healthcare Corporation (THC) is one of my favorite plays on the changing healthcare environment. Hospitals took a cut in Medicare reimbursements in 2010 on the promise of a public healthcare program down the road. They lose billions every year treating the uninsured, so a mandatory insurance program could send profits higher. While implementation of the Affordable Care Act hasn’t gone well, it is only a matter of time until everyone is insured and hospital stocks take off.

The company repurchased 17 million shares over the last year, more than 16% of the total share count. That sounds to me like a company trying to buy its shares back on the cheap, before they head higher.

Tenet has cut its share count by 25% since 2010 with an annual buyback of almost 9% of shares and the stock has more than doubled over the period. Earnings are up from $1.72 per share in 2009 to $1.99 over the last four quarters. Revenue growth has been sluggish on lower reimbursement payments but could jump higher on lower losses to uninsured patients.

DirecTV (DTV) is probably the ‘golden goose’ of stock buybacks, buying 87 million shares last year for almost 15% of the shares outstanding. The company has consistently reduced the share count since 2005 with just 574 million shares outstanding. DirecTV has been aggressively looking for a mobile carrier to buy and leverage its existing media empire.

The company has a strong presence in international markets and should do well next year on subscription packages for the World Cup games. Earnings have more than tripled from $1.45 per share in 2009 to $5.07 over the last four quarters. Revenue growth has been fairly consistent at an annualized pace of 9% over the last four years.

Be careful when screening for companies that are buying back shares. The income statement will show each year ’s total share count. If the total shares outstanding is not decreasing even with buybacks, it could mean the company is paying out too much in options and debt convertible to shares. This means those buybacks are not putting money in your pocket, but in management’s.

I still favor dividend-paying stocks over others but the massive increase in share buybacks is a good reason to create your own dividend in some of these companies as well. Make sure you hold the shares for at least a year so you avoid short-term capital gains and focus on strong companies with strong cash flows.


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