The $27.5 Million Difference ‘Hidden Yields’ Could Have on Your Portfolio
When NXP Semiconductors (NASDAQ: NXPI) announced the takeover of Freescale Semiconductor (NYSE: FSL) at the beginning of the month, investors seemed more than a little pleased. Shares of FSL jumped 11.8%, while NXPI blasted 17.3% higher on news.
This was just the latest run in NXPI’s powerful advance that has seen shares more than double since my system signaled it was a “buy” in December 2013.
The combined company will be the No. 1 automotive semiconductor supplier, and the merger also allows NXPI to diversify across other markets. Moreover, the $40 billion, nearly all-cash deal speaks to management’s confidence in the health of its company and the industry.
In this extremely low interest rate environment, cash-rich companies have been forced to find alternative methods to grow their money, which has helped spur M&A activity.
From corporations to individuals, everyone is searching for better yields. Most investors focus on dividend yields, but there is another yield that is even more important that most investors overlook.
I call it the “hidden yield,” and if you are ignoring it, you’re missing roughly half of the cash companies distribute to investors.
NXPI doesn’t pay a dividend, yet it has a “hidden yield” of 7.4%, nearly double the average company in the S&P 500.
Investment manager Jim O’Shaughnessy, author of “What Works on Wall Street,” did a comprehensive review of this metric. He ran a study between 1927 and 2013 and found that investing in stocks with the highest levels of this “hidden yield” grew a $10,000 investment to $33 million — an average return of 9.8% per year after inflation.
Over the same period, a $10,000 investment in a broad market index returned just $5.5 million, or an average annual return of 7.5%. That’s a difference of $27.5 million.
The only real difference between the two results was a focus on shareholder yield.
Shareholder yield is the combination of a stock’s dividend yield and its buyback yield. As I said, many investors focus on dividends, but they often overlook the important buyback yield.
When a public firm purchases shares of its stock in the open market, it is called a stock buyback. Management takes the shares and deposits them in their corporate supply called Treasury stock. This reduces the company’s investible pool of outstanding shares, called the float.
If the same number of investors wants to own the stock but there are fewer shares available, the price will rise. Since there are fewer shares outstanding, the ones available in the market become more valuable. It’s the basic economic principle of supply and demand.
With fewer shares outstanding, your ownership of corporate earnings also increases. For example, if you own 10% of a company that earned $1,000, your share of earnings would be $100. But if that company bought back half of its stock, your portion of the earnings would double to $200. Effectively, your shares become more concentrated.
Buybacks can also act as price support for a stock. When management uses market weakness to aggressively buy the dip in their company’s shares, it shows they think the stock is cheap at those levels. This can help foster investor confidence and lead others to buy as well.
By combining buybacks with dividends paid, we get a more complete picture of the total cash flow a company is paying out to shareholders. And as O’Shaughnessy’s research showed, buying stocks with the highest shareholder yield significantly outperforms the market.
Another important study on shareholder yield was completed by the Portfolio Strategy team at Goldman Sachs (NYSE: GS), which reviewed buybacks, dividends and shareholder yield from S&P 500 stocks over the past 20 years.
The group found that the companies with the largest buybacks beat the market by an average of 5.3% per year, and that picking S&P 500 stocks based on highest shareholder yield trounced the market by an average of 6.2% per year.
How to Calculate Shareholder Yield
Let’s say Company ABC had 1,000 shares outstanding in its float 12 months ago and today it has 900 shares. The trailing 12-month net difference of shares (100) is 10% of the starting number of shares in the float (1,000), so this translates to a 10% buyback yield for shareholders (100 shares / 1,000 shares = 0.1).
(Note: When you calculate buyback yield, be sure to look at the net difference in shares. Companies will sometimes add shares to the float even while buying back shares.)
Over the same 12-month period, Company ABC paid out $1 in dividends. If the stock trades at $20 per share, that gives us a trailing 12-month dividend yield of 5% ($1 / $20 = 0.05).
To find the shareholder yield, we add the buyback yield (10%) and dividend yield (5%) together to get 15%.
Now, I will admit, NXP Semiconductors’ high shareholder yield isn’t what initially alerted me to the stock. Rather, it was its high score on another metric that most investors also do not take into consideration.
This indicator signaled NXPI was a “buy” in December 2013, and since that time shares have returned an outstanding 125%.
It’s called the Alpha Score, and only a select few traders know about this indicator. But I will tell you that one of its key components is cash flow. Cash is the lifeblood of any business. Companies need positive cash flow to invest in new opportunities, pay dividends and buy back stock.
So it stands to reason that a company that is growing cash is in a better economic position to continue growing its business than one that isn’t.
A company’s cash flow rank makes up half of its Alpha Score, while a key technical component makes up the other half. Stocks with the highest Alpha Scores have the biggest propensity for making huge moves.
But you don’t need to take my word for it; I’ll let the numbers do the talking.
In addition to NXPI, which is up 29% so far in 2015, seven other Alpha Score stocks are up between 20% and 53% since the beginning of the year. Some of these winners are long-term positions once again making big runs; others are fresh entries that have soared in the few weeks since we purchased them.
With an average year-to-date return of 31% they are beating the S&P 500’s 1% return by a whopping 30 percentage points!
If you want to learn more about this indicator that is absolutely killing it so far this year, including the name and ticker symbol of a top-rated Alpha Score stock flashing “buy” now, follow this link.