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Opting for European Dividends

By Benjamin Shepherd on October 22, 2015

When it comes to the subject of stock repurchases, most people either love ‘em or hate ‘em.

On the “love ‘em” side of the debate, you have the increase on earnings and other per-share items. With fewer shares to spread the money around, you see an immediate bump even in the absence of growth. You’re probably quick to point out that the growth buybacks create are essentially meaningless if you’re in the “hate ‘em” crowd though, and that money could be spent on real growth ventures.

Until recently at least, the debate over share buybacks has largely been confined to U.S. shores. Largely thanks to the fact that the American economy has been growing fairly slowly even as American companies have been sitting on a huge cash hoard, they spent $305.2 billion on share buybacks alone. European companies spent just $38.3 billion last year though, since they’ve generally opted to devote cash to dividends instead.

With Europe only recently emerging from its recession and still slogging through slow and uneven growth, European companies are coming under increasing pressure to adopt the American buyback model. With conditions on the continent eerily similar to those of the U.S. post-2007, right down to the European Central Bank’s program of quantitative easing (QE), it’s almost hard not to see the logic. With long-term growth prospects still in question and cheap debt available thanks to QE, it almost makes sense to boost asset values with buybacks.

So far though, European companies don’t seem too tempted by the idea. According to data from S&P Capital IQ, share repurchases as a percent of market capitalization have actually flat lined at about 1% over the past year or so, versus nearly 3% here in the U.S. Net debt at European companies also hasn’t spiked despite the plunge in interest rates, with more opting to refinance existing debt at lower rates rather than taking on new loans.

There’s also the issue of taxes in Europe, which are also likely to be holding back share buybacks. Not only are corporate taxes varied from country-to-country, so too are the taxes levied on dividends and capital gains for individual shareholders. On balance though, dividends are often treated more favorably for both companies and investors, making dividends more advantageous.

There’s also the issue that European executives usually have less of their compensation tied to share price performance, leaving them with less incentive to resort to buybacks to boost their own incomes. Only about 20% of an American CEO’s salary is made up of base pay, with the rest coming in the form of incentive payments, restricted stock awards and options. As a result, they have a clear incentive to boost their company’s share price. On the other hand, most European executives would be shocked to have even a third of their compensation tied to share performance.

The fact that European companies are more committed to dividends than buybacks is a major reason why about a third of our Global Income Edge portfolio holdings are European. We do generally favor American companies right now since our own growth prospects are stronger, we place a major emphasis on dividend growth. And Europe is where a lot of that growth is at, especially since multinationals in that region have shown a clear preference for boosting payouts to deploy their piles of cash rather than turning to buybacks. As income investors, that’s good news for us.


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