Quality over quantity: The case for total shareholder yield

This article was written by Sean Murphy, Equity Indices Product Manager and Steve Hou, PhD, Quantitative Researcher at Bloomberg. 

With recent market volatility, many equity investors are seeking ways to de-risk their portfolios. While some have headed for the sidelines, others have instead maintained their equity allocation while employing more defensive positioning. ETF strategies that target low–volatility, quality, and dividend stocks have been gathering assets this year, but these factors can be difficult to find in a single strategy.

Take dividend payers for example: a stock’s dividend yield may appear attractive not because of a high dividend amount, but because of a lower price. This price depreciation may be the result of a degradation in the earnings quality of the company, increased share issuance, or unsustainable levels of debt.  

One possible alternative is to focus on share buybacks as well as dividends. The perception of many investors is that companies conducting both must have strong financial health. Without examining debt levels, however, a strategy may select stocks that benefit today’s equity investors at the expense of tomorrow’s.

In the past, companies have issued debt and used the proceeds to fund dividends or to buy back shares. While this practice has waned in recent years due to higher borrowing costs, such firms will need to repay or roll that debt at some point, perhaps when interest rates are not as accommodative to the bottom line. 

A more refined approach

With so many potential pitfalls, the Bloomberg Shareholder Yield Index (BSHARP) takes a more refined approach to identifying companies with high shareholder yield. The index examines the total return of capital, which includes dividends paid, net buybacks, as well as debt repayment.

Within this framework, shareholder yield is total returned capital as a percentage of the company’s market capitalization. Examining debt levels achieves two objectives. While debt is an important metric in measuring quality, it also may identify companies whose interest expense may decrease, which could benefit equity investors moving forward. The index also analyzes a company’s total return of capital in comparison with its free cash flow. This helps to ensure that the value a company returns to its shareholders in the form of dividends, buybacks, and debt repayment is within its capacity.  

To be eligible for inclusion in the index, a company must be part of the Bloomberg US large & mid cap universe excluding real estate investment trusts and pass certain tradability thresholds. More importantly, a company must have positive total returned capital, positive free cash flow, and capacity (total returned capital as a portion of free cash flow) below 150% for the trailing five years. Of the companies that remain, the largest 50 companies by total returned capital are selected for inclusion. The index is weighted according to each company’s shareholder yield, with companies that have high shareholder yield having a higher allocation in the index. 

A current index constituent that demonstrates the Bloomberg Index approach to total shareholder yield is Altria (NYSE: MO). The company pays a dividend above the broad market, with a trailing yield of over 6% (vs 1.3% for the Bloomberg 1000). At the same time, the company bought back over $3 billion in shares last year. Altria was able to do so without taking on more debt. In fact, the amount of long-term debt the company has outstanding has dropped by over 6% year-over-year. The combination of dividends, share repurchases, and debt repayment results in a total shareholder yield of 11%. There is even room for this to continue and grow, as Altria has been able to return cash to shareholders through robust free-cash-flow, which has remained north of $8 billion for the past 5 calendar years.  

Identifying under-the-radar companies

Using this multipronged approach to shareholder yield helps to identify companies that might otherwise fly under the radar. Paying an above-average dividend, for example, is not a requirement for the Bloomberg Shareholder Yield Index. KLA Corp (NASDAQ: KLAC) may seem like an outlier as the company pays only a small dividend, but it has provided attractive total shareholder yield due to a robust share repurchase program.

In fact, the company recently announced an expansion of that program, authorizing an additional $5 billion in stock buybacks. The company has been able to achieve this while also reducing debt outstanding, with the resulting shareholder yield totaling nearly 4%. Despite low and non-dividend paying stocks being eligible for the index, the overall yield of the constituents in aggregate is still noticeably higher than that of the broad market. In fact, that gap has recently widened, as 95% of the dividend paying stocks within the index have grown their dividend amount over the past year.

Taking a closer look at the balance sheet

This methodology helps avoid names that a simplistic approach may otherwise include. Take Ford (NYSE: F) for example. With an attractive yield of roughly 6%, the company is a constituent of many dividend indices. But Ford has also been a net issuer of both stock and debt. Another is Diamondback Energy (NASDAQ: FANG), which at first glance seems like a stock with strong shareholder yield. The company has an above-average dividend yield and a stock buyback program. But examining the balance sheet reveals a meaningful increase in debt, which more than offsets the dividends and share repurchase. In both instances, the shareholder yield is negative, something dividend yield would never be.  

From a factor perspective, the Bloomberg Shareholder Yield Index goes beyond delivering exposure to value and dividend yield factors when compared to the broad market. Using the TLTS function on the Terminal highlights exposure to quality and lower volatility companies relative to the market cap weighted Bloomberg 1000 Index. Looking further, when we compare BSHARP to a value benchmark, the index delivers the same expected tilts, but without sacrificing quality.

Dividend and shareholder yield strategies are often associated with value investing, yet the BSHARP Index outperformed the broad market over the 10-year period, one defined by the significant contribution of growth names to broad market returns. Even still, the primary contributor to returns was earnings expansion rather than multiple expansion, as the trailing P/E of the index has remained relatively constant over that same period.  

Conclusion

Equity markets have been volatile this year. Investors are adjusting their allocations accordingly, with income, quality, and low-volatility strategies of particular interest. The Bloomberg Shareholder Yield Index employs a multi-faceted approach to identify companies returning capital to shareholders in a responsible and repeatable way.

The methodology seeks to avoid missteps that overly simplistic approaches may fall into by going beyond superficial data points to take a more holistic approach to shareholder yield. The result is an index consisting of “shareholder-friendly” companies that have a track record of consistency and quality, traits that may help investors navigate the current environment. Investors can gain exposure to the companies in the BSHARP Index through an ETF offered by First Trust, ticker SHRY.

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