Dividends are like comfort food for the investing world. Their steady income payments can help investors support a sustainable retirement and provide succor when the underlying company’s stock takes a header during a market downturn like the one we just went through. But the current pandemic crisis was like no other downturn.

And in a recent research report, UBS analyst Victoria Kalb discussed what shareholder distributions could look like after Covid-19. Specifically, she asked, would share buybacks and dividends become socially unacceptable among some investors?

The dramatic global economic shutdown that began in March has stanched the cash flow at countless businesses and led to drastic actions to preserve funds. The roster of corporations cutting or suspending their dividends includes Ford Motor Co., Delta Air Lines, Freeport-McMoRan, Boeing, Darden Restaurants, Macy’s, Marriott International, Schlumberger, Dick’s Sporting Goods, Las Vegas Sands, the Walt Disney Co. and many others.

And sectors ranging from banks and airlines to hotels and energy companies have experienced a spate of suspended share buyback programs.

In her report, Kalb noted that well-run companies will seek to maintain a balance between sustaining their long-term financial health and servicing providers of capital. But Covid-19 pressures could upset this balance in at least three ways:

“While it is, of course, too early to know if attitudes have changed permanently, closer scrutiny of social issues may make it more difficult to continue with (or restart) distributions in line with prior practice,” Kalb wrote.

Does that mean dividends run the risk of being politically incorrect, or at least stigmatized to some degree, within ESG investing circles or elsewhere?

“It depends,” said Erika Karp, founder and CEO of Cornerstone Capital Group, an impact investing advisory firm. “If we’re talking about government spending and government stimulus and bailouts of any sort … if we’re talking about money that belongs to the public and then that goes to the companies and they distribute it, there’s a major problem there. That’s something that exacerbates income and wealth inequality, which is already a pretty serious problem.”

 

Karp added that buybacks and dividends aren’t a big issue if they’re funded by private capital, though she considers buybacks to be a form of financial engineering.

Dividends are another matter. “If we have an investor who needs dividends to generate cash, we can do a dividend strategy,” Karp said. “You can do sustainable and impact investing with a dividend strategy. There’s no inconsistency at all with that.”

Buyback Bogeyman
For now, both buybacks and dividends are verboten for companies participating in the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, which includes a $500 billion package of loans, loan guarantees and other investments designed to aid certain businesses affected by the pandemic.

Public companies that borrow money under the CARES Act can’t buy back company stock (unless they had a pre-existing contract to repurchase shares) or issue dividends for one year after the loan repayment or expiration of the loan guarantee.

Buybacks have become a bogeyman of sorts. Critics contend they are an accounting gimmick that artificially boosts a company's per share earnings and, consequently, its stock price. They also say buybacks divert money that should be reinvested into the company or that they deplete cash reserves that could provide a cushion during an economic downturn.

These are valid points. But another valid point is that corporate buybacks have evidently been the prime support pillar for U.S. equities during the past decade or so.

Brian Reynolds, chief market strategist at research firm Reynolds Strategy, said in a Wall Street Journal article last month that corporate buybacks have been the only net source of money entering the stock market since the financial crisis in 2008. He noted that contributions from all other sources—ranging from exchange-traded funds and mutual funds to foreign buyers and households—netted out to roughly zero.

Bob Shea, CEO of TrimTabs Asset Management, said he has charts that draw a similar conclusion. He noted that bonds have been the asset class attracting the most money since the great financial crisis, and that there were net outflows in U.S. equities last year even as the S&P 500 gained roughly 30%.

“There were some inflows to equities in April, but there were more inflows to bonds and commodities than equities last month,” Shea said. “To be able to sustain current valuations, we’ll need some new sponsorship of equities [if corporate buybacks are curtailed].”

TrimTabs has two ETFs that focus on free cash flow, and the current cash flow crunch has been a big story line during the pandemic-fueled economic catastrophe. Shea said it remains to be seen how this will impact shareholder distributions.

“I don’t think they’re equal; I think the stigma of buybacks is worse than dividends,” he said. “Dividends will be judged a little more kindly, but it will be on a situational basis. With dividends, it depends on the financial condition of the company and whether they’re taking government money.”