Microsoft 's announcement of a 22% increase in its dividend Tuesday contained an even bigger potential present for investors: a $40 billion stock buyback program.
By announcing its massive buyback program, Microsoft joined a legion of companies opting to use their cash to invest in their own stock.
Companies are announcing buybacks in a big way, increasing them 18.1% to $118.1 billion in the second quarter from a year earlier, says Standard & Poor's senior index analyst, Howard Silverblatt. That's the most since the third quarter of 2007.
Tech rival Apple's $16 billion in second-quarter buybacks was an enormous part of the buyback story in the second quarter. Without its stock repurchases, buybacks would have increased just 2%.
Why the rush to buy back stock? Companies have lots of cash, and buying back stock is a safer play than buying other companies or even increasing dividends. Once a company boosts its dividend, it's reluctant to reduce it, because Wall Street sees a dividend cut as a sign of weakness.
And buying back stock is better than letting corporate cash languish on the books, where it earns little. Right now, companies have a record $1.14 trillion in cash and equivalents.
Making the announcement isn't the same as buying back the stock. Some companies announce buybacks but never buy back the stock, or as much stock as they announced.
Many companies -- particularly tech companies -- use buybacks to fund stock options. And that doesn't reduce the number of shares outstanding, so there is no benefit to shareholders as a whole. Tech companies, which are heavy users of options programs, account for 31.5% of all expenditures for buybacks.
Not all companies are particularly good at buying back their stock. In the second quarter of 2009, near the bottom of the bear market, companies in the S&P 500 bought back just $24.2 billion in stock -- a record low.
Nevertheless, companies that actually reduce the number of shares outstanding have fared better than those that increase dividends regularly. For example, the PowerShares Dividend Achievers fund, which invests in stocks of companies that have raised their payouts regularly, has gained 13.5% this year, according to Morningstar. The PowerShares Buyback Achievers fund, which buys shares of companies that have reduced their number of shares outstanding, has gained 25.7%.
Wall Street's reaction to Microsoft's announcement was tepid. Shares closed up 13 cents, or 0.4%, Tuesday when Microsoft said it would punch up its dividend 5 cents, to 28 cents a share, starting Dec. 21.
Investors were hoping for a bigger program. Microsoft had about $76 billion in cash at the end of its fiscal year, which ended June 30. And it's expected to be able to pay its buyback program through free cash flow, projected at $24.1 billion in fiscal year 2014 and $26.9 billion in 2015, says S&P analyst Gary Albanese.
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