The Long-Term, Cash Squeeze, High Dividend Growth Strategy

in investing •  7 years ago 

The long-term, cash squeeze, high dividend growth strategy is commonly used by companies all over the world. Many investors are misled by the offset that occurs in company data when this strategy is deployed.

The following is a short post describing this strategy, why companies use it, and how it might affect future dividend growth.

The Long-Term, Cash Squeeze, High Dividend Growth Strategy
A company’s free cash flow (cash from operations minus capital expenditures) can be used for any corporate purpose whatsoever. A superior dividend grower (SDG) should have a management commitment to using “excess” cash flow to increase its dividend payouts.

Another popular use of cash is to purchase the company’s own stock, referred to as a “buyback program” or simply as “buybacks”.

One result of large buyback programs is to reduce the number of shares outstanding. This in turn does two things to a SDG.

First, such a program will boost the increases that are reported for earnings per share, at percentage levels greater than the percentage increases in net income.

For example, because of fewer shares outstanding, earnings per share amounts might increase 7%, while net income amounts would increase only 3% or 4%.

Secondly, because there are fewer shares outstanding, it takes less money to pay increasing dividends.

From this perspective, a buyback program makes corporate earnings look good, has a tendency to boost the price of the stock, and helps to maintain large dividend increases.

Thus, a significant buyback strategy combined with a commitment to a 10% dividend growth may be a laudable corporate financial strategy.

The strategy described above works very well when there is enough free cash flow to support it. This strategy also works fairly well even when the expense of buyback and dividends exceeds the cash to support it, simply by increasing net debt, reducing working capital or other temporary means.

In fact, this can go on for many years within some companies. That is, buybacks and dividend increases are not consistently supported by increases in revenues and net income, but rather by debt, retained earnings and other means.

The longer this process continues, and the greater the difference between money made and money spent, the greater becomes the threat to continued high dividend increases.

When there is not enough free cash flow to support such a strategy, it can be called a “cash squeeze” investment philosophy.

We do not know of a simple, easy way to monitor companies for the long-term occurrence of such a “squeeze” process. This is a very complex financial strategy, and can be occurring on almost a “stealth” basis.

In order to see this financial strategy at work, selected data for a five year period will be examined for company X (the name of this company has been removed, however all data presented below is accurate and from a real company).

First of all, let’s look at the positive side of this strategy.

The dividend growth of company X has been very healthy with a CAGR of over 11% for the last five years.

Over the same time period, earnings per share have increased at the rate of 4.89% ($3.23 to $4.10), and the price of the stock has gone from about $65.20 to $88.11, for a CAGR of 6.27%.

On the other hand, revenues have increased at a rate of 2.44% per year, and net income has only increased a paltry 1.55% per year.

Company X’s free cash flow has actually gone down so that payout ratios are now beginning to rise from historical levels.

How has this been done? X has an active buyback program, and has reduced its outstanding shares by 14% or about 2.7% per year over this same period. In addition, X’s total debt loads are beginning to rise in order to support this strategy.

There will be a point in the future where X will run out of the financial flexibility needed to continue this strategy at the same level.

This future point could be years away, but the threat to the increase in their dividend is building up to an extent that it no longer would qualify as an SDG.

As evident from the example presented, an individual investor could easily be misled by this complex financial strategy. When you research a company for your portfolio, regardless of your investing strategy, ensure that you fully understand the data presented, as well as the story behind that data.


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Very good explanation. I have always try to gather this thought of stock buybacks are a good thing because a lot of US companies have been doing it for years. Best example is Yahoo, before it got sold. They were losing market share and was continuously trying to boost stock price by using their flow of cash for buybacks. That made the stock look good on surface but everything was falling apart on the inside. Hackers stolen data, the off and on merger with Verizon, and CEO Mayer subpoenaed. They had known the data was stolen months before they disclosed it to the public, terrible service to have been hiding it.

I can not understand why Mayer could earn so much over the years at Yahoo when the company was still losing money and market share. It must be those cheap lending rates the fed created that allowed corporations to continuously borrow and do buybacks. I have only started investing in 2008, but have seen more stock buybacks than stock splits in my life. I personally started to question if buybacks are really a good thing and often now I look at it as a bad thing.
Investors get instant gratification for gains from buybacks, but if the company fundamentals are not sound the long term view will not be good.

Corporations are downsizing staff and putting money back into the company to make their numbers go up. But continuously doing this would only lead to catastrophic failure. Yahoo got away because they were able to sell themselves but to imagine many more doing the same. Sooner or later there won't be enough money to do mega mergers. Then will this whole scheme fall apart and the government and corporations would blame it on speculators, lol. Thanks.

Very interesting, I did not know companies could do that! Thanks for sharing, I'm sure this will help people make better investment decisions. Do you know where I could read more about this?

Thanks for reading! I'll be posting a lot more like this, stay tuned! I'm not sure if there's others posting information quite like this. To be completely honest, there's a lot of dirt in the water when it comes to investing, especially dividend growth investing. There's a lot of false returns being shared and number manipulation to entice people to invest. We hope to change that by being fully transparent about how we share our portfolio and our returns and exactly how we go out and analyze companies to add to the portfolio.

I've been reading up on it like crazy since yesterday, couldn't agree more that there is so much dirt in the water when it comes to investing. Will definitely stay updated.

I am writing my own blog posts based on cryptocurrencies and how to make a passive income with them, if you are interested!

Glad to hear it! I will check out your post right now and let you know what I think on there! Thanks!

Cheers! First post about Neo has also gone live if you're interested, would love to hear your thoughts.

I have been hearing about these two concept " buypack and cash squeeze from my elder brother who enage in long term investment but i did not no anything about those concept until i go through your work and found out their meaning.I am happy to widen my horizon by just comming in contact with your post.thanks you very much ,i must appreciate you for affecting my life.

Thank you for reading and leaving your thoughtful insight! It means a lot that we can help you out to become a more educated investor. Never invest in things you don't understand. The game is full of people who use their understanding and your lack of understanding to take advantage of you. Hopefully we can continue to make you a more educated investor! Thanks again!

Man that's clever. I never knew corps do that. Thanks for McEducating me!

haha thanks for McReading! It means a lot!

I am nervous of company buy back programs that are financed by debt for the following reasons
1 Increasing debt can't go on forever (as you mentioned)
2 The perverse incentives it creates.
Many companies pay bonuses according to their share prices performance . If the share price goes up the employees get more money. Share buy backs add to the demand and decreases supply of shares therefore increasing the price. This creates an extra expense for bonus payments which comes at the cost of long term viability of the organisation as the money wasn't used to improve the company's situation
The perverse incentives encourage a fragile company with high debt and low capital reserves.

Of coarse each company should be judged on its own merits but a company doing buybacks with debt isn't a positive long term sign generally.
Thanks for the article

It's all about yield on cost. And it works. But 90% of the population can't hold a stock long enough to make it work lol.

I totally agree! Most people are completely impatient and miss out on the real big returns that come with time.

Excellent read and strategy. Cannot agree more. Thanks for sharing

Thanks for reading! I appreciate it!

Welcome as always

  ·  7 years ago Reveal Comment

Thanks for reading! I appreciate it! Looking forward to talking with you more as well!

Wow i really like this strategy definitely gonna give it a try for my next trade idea! Thanks for sharing

It's a great strategy and can make you very rich over time!

Great post to enable us to make strategical decisions. Fully upvoted through steemfollower!

Thanks for the support!

Great article, thanks.

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Thanks a lot for this accurate analysis ! I always enjoy digging deep in order to find the coin's site, the team and more information about their project, where they're heading to... it tells a lot to know if they are really serious about it, because sometimes I've not found a proper site, meaning it is either a scam coin or a project which is still beginning, but sometimes I've also found a really complete site with all the team's tasks, an interesting overview of the project, so there are also serious teams out there, all in all there is a lot of enthusiasm and positivity in this crypto world so in my view it is here to stay and we can even end up turning the system around, at a time I hope oil companies will disappear, fiat money will disappear and only programmers and scientists will rule this world :D

Very Good Post Like That

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Keep calm... Let march end 😎

@dividendgrowth, where did you go? I just discovered your page and can't get enough - I hope you keep posting! Thanks for making everything accessible and easy to understand :) as and investor I'm pretty green to say the least, and I am most comfortable with a reliable and lower-risk investment strategy (for the most part) so many of your ideas have really resonated with me. Thank you and please keep it up!

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very nice and clear information about squeeze, i always read your post. its very helpful and interesting for all user.

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