European companies are finally buying back their stock, opening up opportunities

By Joachim Klement

The pandemic has put an end to the dividend fetish in European boardrooms

When I meet fund managers in the U.S., we often talk about European equity markets. Everyone agrees that European stocks are attractively valued, but in one form or another, many fund managers ask: "If these stocks are so cheap, why aren't companies buying back their shares?"

Historically, dividends have played a much more important role in Europe than in the U.S., while European companies remained reluctant to return capital to shareholders in the form of buybacks.

No, I don't get it either.

After all, in most countries in Europe, just like in the U.S., capital gains taxes are lower than income taxes so returning capital through dividends leads to a higher tax bill for private investors. Why would companies do that to their investors?

Be that as it may, it seems as if the pandemic has put an end to this dividend fetish in European boardrooms. When the pandemic hit in 2020, most companies suspended their dividends to preserve cash for what at the time looked like impending doom. But the world didn't end, and companies started to reinstate their dividends again, albeit generally at lower levels than before.

Paying lower dividends has two advantages for businesses. First, they have an easier time covering their dividends with their earnings so there is more of a margin of safety against future dividend cuts. Second, using buybacks instead of dividends gives businesses more flexibility to return capital to shareholders. It's what U.S. businesses have been doing for decades.

The result is that today, the dividend yield of the Stoxx Europe XX:SXXP is 3.4% vs. the more typical 3.7% in the past, but the buyback yield is 1.8%. This is the same buyback yield in Europe as in the S&P 500 SPX. And meanwhile, you still get an additional 2% in dividend in Europe vs. the S&P 500.

European companies have increasingly bought back their own shares and some companies have done so aggressively. The top 20% companies by buyback yield are buying their shares at a rate of 4.6% each year. And these are not just dodgy banks and slow-growing commodity stocks. These buyback leaders include industrial automation and robotics company ABB (ABBNY) (SE:ABB) (buyback yield 4.2%), Danish fashion jeweller Pandora (DK:PNDORA) (6.8%), and British budget hotel chain Whitbread (WTBDY) (UK:WTB)(8.3%).

European buyback leaders have outperformed the Stoxx Europe by a cumulative 43% over the last ten years or a good 3.7% per year. Yet three-quarters of this outperformance came in the last four years since the pandemic. Before 2020, the outperformance was rather subdued and very spotty. It is only with the change in attitude of European executives that buybacks have started to drive performance.

Meanwhile, U.S. companies have continued to buy their shares back at the same pace as in the past. But there are buyback kings here as well that have bought back far more than the average company. General Motors (GM) (buyback yield 17.3%) tops the list, while hotel chains Marriott (MAR) (6.7%) and Hilton (HLT) (5.5%) seem to be in a race who can buy back more shares than the other. And among the Magnificent 7, Alphabet (GOOGL)stands out with a large buyback yield of 5.3%.

This opens a huge opportunity for investors. They simply need to identify the companies that aggressively and consistently buy back their shares like the ones I mentioned above.

Then they buy these stocks and... do nothing. They just sit there and watch the company buy back more and more shares from other investors. The number of shares in circulation drops and the earnings per share rise. It is supercharged earnings growth based on simple math. And I know, most people don't like math, but here is a way to make math work in your favor and all you have to do is buy some stocks and just sit there.

Joachim Klement is head of strategy at Liberum, a London-based investment bank. He is author of "7 Mistakes every Investor Makes" and "Geo-Economics: The Interplay between Geopolitics, Economics, and Investments." He also publishes the blog "Klement on Investing" on Substack.

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04-08-24 1034ET

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