Five Questions for Richard Helm
The manager of Cohen & Steers Dividend Value fund discusses dividend stocks and why he thinks share buybacks aren't the deal they're cracked up to be.
New York-based Cohen Steers has long been known as a money-management firm specializing in real estate stocks. In the past several years it has been branching into other types of income-producing securities, including preferred stocks and dividend-paying stocks of utilities and other kinds of companies.
Richard Helm runs Cohen Steers Dividend Value (symbol DVFAX), launched in August 2005. Previously, he managed Washington Mutual's $2.3-billion WM Equity Income fund, where he compiled a 10% annualized return in four years, easily topping the SP 500's 2% annualized return over the same period. As he did with the WM fund, Helm is focusing at his new fund on companies that are increasing their dividends by at least twice the rate of inflation. We recently chatted with Helm, who's based in Seattle, during a visit to Cohen Steer's midtown Manhattan offices. The conversation revolved around the relative merits of dividends versus share buybacks.
KIPLINGER'S: Many analysts and portfolio managers say they like to see companies return cash to shareholders in the form of dividends or share buybacks. But you're not a big fan of share buybacks. Why not?
HELM: I am adamant that in most cases share buybacks do not make economic sense. When a company buys back shares, they take cash off the balance sheet, so they weaken their balance sheet. Worse yet, they borrow money to buy back shares, so they leverage up the balance sheet. In fact, they're deploying money into their own stock not because they have faith their stock is undervalued, but more likely because they've got too much cash on the balance sheet and it's depressing their return on equity [a measure of profitability]. So they don't grow the business, they artificially inflate earnings at best, and they're lowering their net income potentially by taking the cash that could have earned some rate of interest off the balance sheet.
But investors almost uniformly view share buyback announcements as a positive move. It increases your share turnover, but it reduces your float [shares outstanding]. So is that a positive? I don't really think so. When you think about it, management is compensated largely on measures such as share price and return on equity. It makes sense to get that cash off the balance sheet because then when I take my net income and divide it by equity, if my equity is lower, my return on equity goes up. You suddenly went from a low-growth company to a high-growth company on ROE and you didn't do one thing to increase your business. I think the market misses this. It's not that it's bad in every situation. It's that the market as a blanket rule thinks it's positive and it isn't always positive.
How do management stock options fit into the picture? There are studies that show most companies that buy back shares actually issue more shares than they buy back. So when you think about that, all they're doing is spending cash on the balance sheet in order to effectively stem the dilution they would have from handing out all these management options. Now I think you have to attract and retain good management. But you are just getting on this treadmill where you're buying back shares on the one hand and issuing them with the other hand, and you're spending cash that is just not benefiting anybody except management, which owns all those options. So it's really a transfer of cash from the balance sheet to management.
Congress lowered the tax rate on most stock dividends to 15% in 2003, and that expires in 2008. What will happen if Congress fails to extend the lower rate? I fully anticipate at this point that it will be extended. Even if it is not, remember that in 2003 when it actually passed, there was about a two- or three-day pop in dividend paying stocks. Then that was it. They just kind of trended back to the norm. If it's not extended, I think it will probably be the same thing: a short-term sell-off in some of these dividend payers and then back to normal.
Do you think the SP 500's dividend yield will ever return to its historical norm [about 4.5% vs. 1.8% now]? Cash on the balance sheet was $2.3 trillion in December, an all-time high level. Think about that in terms of depressing your return on equity. Management wants that cash off of their balance sheets, and that's why they're announcing these huge repurchases. Payout ratios [dividends as a percentage of earnings] are at all-time lows -- 30%. The historical average is 51%. I think that will bottom and start to come back up as more and more people, more and more shareholders, more and more institutional managers start demanding dividends. In a low-return environment, dividends become a larger and larger part of the total return. Historically, depending on the period you look at, they're 40% to 45% of your return. But if you're talking about a 3% yield on a market that may only produce 6% a year, you're talking about half your return.