How Will Tax Reform Affect Buyback And Dividend ETFs?

The performance of buyback ETFs has been moderate in the last one year as PowerShares Buyback Achievers ETF PKW has gained about 13.5% in the last one year (as of Feb 23, 2018) versus the 15.9% rise in the SPDR S&P 500 ETF (NYSE:SPY) (AX:SPY) . S&P 500 buybacks fell down 5.3% for the 12-month period ending September 2017.

Will Tax Reform Boost Buyback?

President Trump’s administration passed a tax plan in December that mainly revolved around cutting corporate taxes and adjusting personal tax rates. The final tax version cuts the corporate rate from 35% to 21% (read: Tax Bill: What ETF Investors Need to Know).

The Trump administration also proposed a move from the current worldwide tax system to a territorial system, allowing companies to send their offshore profits back to the United States without extra taxes. Investors are expecting tax savings to result in fatter and faster dividend hikes and more stock buybacks (read: What Makes iShares' Dividend and Buyback ETF Launch Timely?).

Are Hopes Too High?

As per an article published on Financial Times, 400 earnings calls revealed that 28% of companies intend to return cash to shareholders, while 44% plan to enhance capex and wages. A great deal of tax savings can also be used as debt repayments. Instead of higher payouts, if debt retirement becomes corporations’ priority, especially in a rising rate environment, companies can produce a healthy leverage ratio.

Still, “Morgan Stanley (NYSE:MS) analysts expect a greater overall amount of cash from tax savings to be dedicated to dividends and buybacks than capex,” as quoted on Financial Times. Morgan Stanley’s analysts are forecasting that 43% of the total tax savings will go to dividends and buybacks, 30% will be shelled out on capex and employee compensation and just 8% will go to “balance sheet repair.”

In any case, increase in returns to shareholders has already been an established trend. Tech behemoths “have been raising buybacks and dividends by issuing bonds against savings held offshore.”

But then, if the global economy gains momentum, and central banks tighten policies faster, interest rates are expected to rise faster. So, accessing the debt market to finance buybacks would not be an easy task going forward.

Plus, investors should also note that the S&P 500 is hovering around multi-year highs and a loose fiscal policy (if at all it materializes) may spur stock rally even further. Amid such inflated prices, buying back their own shares may not be a great idea for the corporations.

ETFs in Focus

Whatever the case, investors can keep a tab on the following buyback ETFs.

PowerShares Buyback Achievers Portfolio PKW looks to track companies that have implemented a net reduction of 5% or more in shares outstanding in the last 12 months (see Total Market (U.S.) ETFs here).

Another buyback ETF SPDR S&P 500 Buyback (NYSE:SPYB) ETF (AX:SPY) measures the performance of the top 100 stocks with the highest buyback ratios in the S&P 500 in the last 12 months.

Yet another fund iShares U.S. Dividend and Buyback ETF DIVB invests in U.S. companies that return capital to their shareholders through dividends or stock buyback.

AdvisorShares Wilshire Buyback ETF TTFS looks to generate long-term capital appreciation.

Bottom Line

Call transcripts of tech biggies did not evoke any enthusiastic on dividends and buybacks. But not every company has been stingy, as per Financial Times. The article revealed that Pepsi (NASDAQ:PEP) plans to hike its dividend by 15%, make a one-time pension payment and speed up capital spending while Procter & Gamble (NYSE:PG) raised its plans for share repurchases to $6-$8 billion from $4-$7 billion.

Overall, the outlook for buyback and dividend activity is neither too optimistic nor too pessimistic. It remains to be seen what decides the path of buyback ETFs — whether Trump’s tax plan benefits the activity or if the Trump rally and an all-time high corporate leverage come in the way of shareholder’s value maximization.

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