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Financial Times: Raised dividends better for stocks than buy-backs

By Chris Hughes
Published: May 9 2007 03:00 | Last updated: May 9 2007 03:00

Raising dividends is more effective at boosting a company’s share price than launching a share buy-back, according to research by Morgan Stanley.

The findings follow a bumper year for share repurchases, which totalled £46bn in 2006 against only £28bn the year before and which were pursued by blue-chip stocks including Vodafone, BP and Royal Dutch Shell. Some 58 per cent of UK companies have active buy-back programmes, almost twice the level in 2004.

However, Morgan Stanley found that buy-backs supported share prices only in weak equity markets, where-as stocks with strong dividend growth proved to be consistent outperformers.

Since 1997, the average performance of stocks that have been increasing their dividends has been 12.7 per cent per annum, against market growth of 10.3 per cent.

By contrast, the average performance of a stock pursuing a share buy-back programme was only 8.2 per cent per annum. Buy-backs helped stocks outperform only in the bear market of 2000 to 2002 and in 1997.

Stocks with top-quartile dividend growth rose by20 per cent per annum, yet stocks with top-quartile buy-backs relative to their market value rose by only 12 per cent.

“Dividends are a much more powerful signal of confidence in a company’s long-term performance, given that management is resistant to cutting dividends. Buy-backs do nothing for income investors and they have no impact on the future direction of the business,” says Graham Secker, the analyst behind the research.

“The reason they work in a down market is because the company is providing demand for the stock,” he adds.

Adding £62bn of dividends, last year’s intensive buy-back activity helped push the real cash yield on UK equities to 6.4 per cent, which Morgan Stanley says was probably a record.

The pay-out ratio – which measures distributed cash as a proportion of company earnings – was 64 per cent including buy-backs, but only 42 per cent when based on dividends alone.

Morgan Stanley estimates that buy-back activity will begin to decline for this year, taking the real cash yield on shares to about4.8 per cent.

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