Cut the Pay-Out, Boost the Buy-Back?

Deck: 
The pros and cons of dividend pay-out reductions and stock repurchase programs in uncertain economic times.
Fortnightly Magazine - October 15 2002
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The pros and cons of dividend pay-out reductions and stock repurchase programs in uncertain economic times.

The Dow Jones Utility Average currently stands at its lowest level in five years. Electric and gas utilities, along with U.S. companies generally, have been consistently lowering their payout ratios over the past several years, and that downward trend is projected to continue. What do these facts portend for utility investors in the near future?

If the trend toward lower payout ratios continues, utilities will be regarded less and less as income stocks, and more as hybrid income/growth investments. We could see a significant increase in utility stock repurchases. Utility management may see this as a more flexible and tax efficient way to return funds to stockholders than through growing dividend payments. Given the projected decline in payout ratios, these stock repurchases may become a partial substitute for dividend payments. While capital gains may represent most of the return received by utility investors, they are merely an exchange of wealth among individual shareholders. In other words, capital gains are what investors provide to each other. The only ways that utility companies can provide cash to investors directly is through dividend payments and stock repurchases. In the current environment, the historic division of free cash flow between dividend payments and stock repurchases may be altered, with dividend growth slowing and stock buybacks increasing.1

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