MARCH 2014

2014 Distribution PolicyChallenging conventional wisdom about dividends and buybacks

Published by Corporate Finance Advisory

For questions or further information, please contact:

Corporate Finance Advisory

Marc Zenner marc.zenner@jpmorgan.com (212) 834-4330

Evan Junek evan.a.junek@jpmorgan.com (212) 834-5110

Ram Chivukula ram.chivukula@jpmorgan.com (212) 622-5682

2014 DISTRIBUTION POLICY | 1

1. Shareholder distributions continue to riseShareholder distributions continued to increase in 2013, driven by both rising dividends and buybacks (Figure 1). Total common dividend payments by S&P 500 firms have scaled new peaks, rising by $15 billion to $318 billion over the past year. Aggregate share repurchases have surged from a recent low of $293 billion in 2009 to $474 billion. While this rise in buybacks is significant, the buyback total remains $115 billion shy of the all-time high of $589 billion, achieved in 2007.

Figure 1

S&P 500 distributions vs. S&P 500 index, 1993–2013

86 94 106 117 128 138 141 133 137 135 155 172 197 227 252 253 246 225 263 303 318 32 45

77 104 129 168 189 171 156 148 153

217

329

485

589

400 308

475 411 474

0 0 0

0 0

0 3 8 8 7 2

35

1

4

6

1 3

1 6

118 138 184

222 257

306 332 312 301 290 310

424

716

848

657

540

739 720

794

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 $0

$100

$200

$300

$400

$500

$600

$700

$800

$900

$1,000 Dividends S&P 500 (left axis) Buybacks Special dividends ($bn, right axis)

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000 Y/Y change Dividends1 Buybacks Largest increase 18% 73% Largest decrease (12%) (32%)

535

293

4

2

528

These trends have not been limited to the U.S. In all but one of the major markets analyzed, growth rates for dividends have been materially higher over the last 10 years than over the preceding decade. In particular, dividend-growth rates in Germany, Japan and Canada were multiples of their respective growth rates in the preceding decade (Figures 2A and 2B). When analyzing this data, it should be noted that this growth is especially noteworthy because it includes the drop during the financial crisis. As part of this trend, yields have also risen meaningfully over the past decade, though they have dipped over the last couple of years on the back of strong equity market performance.

Source: Bloomberg, FactSet, S&P Index Services1 Excluding special dividends

2 | Corporate Finance Advisory

Figure 2A

Dividend yields, 1993–2013

0%

1%

2%

3%

4%

5%

6%

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

S&P 500 S&P/TSX Composite (Canada) FTSE 100 (U.K.) DAX (Germany) TOPIX (Japan)

Figure 2B

Dividends paid, 1993–2013

CAGR

1993–2003 2003–2013S&P 500 6% 7%S&P/TSX Composite (Canada) 4% 12%FTSE 100 (U.K.) 4% 5%DAX (Germany) 4% 14%TOPIX (Japan) (1%) 8%

Distributions have displayed unexpected patterns as they bounced back from crisis lows. In this report, we answer five questions regarding distributions in today’s environment. In each case, our answers challenge conventional wisdom.

1. Do growth firms pay dividends?

2. Are technology firms participating in the dividend trend?

3. How high are payout ratios?

4. Will rising rates hurt dividend paying stocks?

5. Do firms overpay during share repurchases?

Source: FactSetNote: Analysis done in local currency and based on aggregate dividends

EXECUTIVE TAKEAWAY

Shareholder distributions have rebounded from

their crisis lows and have been embraced by a

wide range of firms. Of the entire S&P 500, 84%

pay dividends and more than half repurchased

shares this past year. Less than 10% did not

distribute any cash whatsoever to shareholders.

Does the focus on distributions encourage capital

discipline or does it starve our economy of

needed growth capital?

2014 DISTRIBUTION POLICY | 3

2. Challenging conventional wisdom2.1 Do growth firms pay dividends?Conventional wisdom has been that growth firms do not make distributions—and definitely do not pay dividends. Boards often delay dividend initiations for fear that announcing such a strategy would signal the lack of suitable investments. In today’s environment of strong cash flows and favorable financing markets, that notion is not as relevant. Rather, distributions, both in the form of dividends and share repurchases, are being viewed by investors as a signal of management discipline. As a result, firms of all growth profiles are now embracing shareholder distributions as a value-enhancing mechanism. Low-growth firms continue to lead the pack, returning over half their operating cash flow to shareholders in 2013 versus one third two decades ago (Figure 3, left side). More interestingly, high-growth firms, which did not always have excess cash flow to distribute, return almost half (46%) today, versus hardly anything a decade ago (Figure 3, right side). Interestingly, the distributions are approximately split between one- third in dividends and two-thirds in buybacks for both low- and high-growth firms.

Figure 3

Growth and shareholder distributions are not mutually exclusive

35% 23% 21%

0% 2% 37%

35% 26%

57%

1993 2003 2013

Dividends/CFO Buybacks/CFO

6% 0% 15% 0% 2% 31% 6%

46%

1993 2003 2013

High growthLow growth

In the current low-growth environment, shareholder distributions have been receiving unprecedented attention. In fact, an equal amount of capital is now allocated to shareholder distributions as is to organic investments. As Figure 4 illustrates, dividends and buybacks in 2013 were almost as high as the combined amount of capex and R&D. The ratio of shareholder distributions to organic investments has held steady in the post-financial crisis period at close to 100%. This ratio was less than 40% two decades ago.

Figure 4

Ratio of dividends and buybacks to capex and R&D for S&P 500 firms

0%

20%

40%

60%

80%

100%

120%

140%

1993 1994

1995 1996

1997 1998

1999 2000

2001 2002

2003 2004

2005 2006

2007 2008

2009 2010

2011 2012 2013 (D

ivide

nds +

buyb

acks

)/(Ca

pex +

R&D

)

Dividends Buybacks

Source: Bloomberg, FactSetNote: Median of S&P 500 firms with I/B/E/S consensus long-term EPS growth estimates less than 5%

Source: Bloomberg, S&P Index Services

Source: Bloomberg, FactSet Note: Median of S&P 500 firms with I/B/E/S consensus long-term EPS growth estimates greater than or equal to 15%

4 | Corporate Finance Advisory

2.2 Are technology firms participating in the dividend trend?Historically, strong dividend-paying firms were concentrated in certain sectors. This trend has changed significantly in recent years. The evolving payout policies of growth-oriented firms and the trend of tech firms embracing dividends have changed the distribution landscape. Tech firms are now grabbing a significant share of the attention and capital of yield-seeking investors. As Figure 5 illustrates, telecoms, REITs and utilities still have the highest median dividend yields. However, for tech firms, which were historically among the lowest dividend payers, the median dividend yield (1.5%) is now comparable to that of firms in more traditional dividend-paying sectors such as consumer discretionary (1.5%), financials (1.6%) and industrials (1.7%).

Figure 5

Most sectors now have a preponderance of dividend payers in the S&P 500

4.5%

1.5% 1.1% 0.9%

1.0%

0.0% 0.0% 0.3% 0.0%

6.0%

2.2% 1.8% 1.7% 1.6% 1.5% 1.5% 1.3%

0.6%

8.1%

2.9%

3.7%

4.5%

3.0% 2.7%

2.3% 2.2% 2.3% 2.2% 2.5%

1.8%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

Teleco

mREITs

Utilities

Consumer

StaplesMater

ials

Industrials

Financials

Informatio

n

Technology

Consumer

Discret

ionary Energy

Healthcare

Divid

end y

ield (

%)

25th percentile Median 75th percentile

3.5%

4.2% 4.5%

Source: FactSetNote: Dividend yield based on share price as of 12/31/13 and latest annualized dividend

EXECUTIVE TAKEAWAY

Do growth firms pay dividends? Yes.

In today’s environment of strong cash flows and

favorable financing markets, firms of all profiles

pay meaningful dividends.

2014 DISTRIBUTION POLICY | 5

As tech firms have grown in size and economic relevance, so has their contribution to overall shareholder distributions. The tech industry’s share of the total distributions by S&P 500 firms has more than tripled in the last 20 years from 6% to 20% and is now higher than that of any other sector (Figure 6). In fact, four of the top 25 dividend payers in the S&P 500 are from the tech sector, and some of the largest tech firms are yet to pay dividends. This trend of rising tech dividends has been at the expense of more traditionally dividend-oriented sectors, such as utilities and consumer staples, whose share of the dividend pie has declined.

Figure 6

S&P 500 total payout by sector as a % of total repurchases and dividends, 1993–2013

6%13%

20%1%

2%4%

4%

15%4%

3%

20%13%

11%

6%

4%3%

15%

9%11%

7%

5%

12%

5%

23%

13%

10% 8%9%

15% 17%12%

0%2%

1993 2003 2013

Healthcare

Energy

Financials

Consumer Discretionary

Industrials

Materials

Consumer Staples

Utilities

Telecommunication Services

REITs

Information Technology

Source: FactSet, Bloomberg; data based on all S&P 500 firmsNote: Total payout refers to the sum of dividends and share buybacks

EXECUTIVE TAKEAWAY

Are tech firms participating in the dividend trend?

Absolutely.

Tech firms now pay 15% of all S&P 500 dividends

and 20% of all S&P 500 distributions, triple their

level of 10 years ago.

6 | Corporate Finance Advisory

2.3 How high are payout ratios?Traditional analysis suggests that dividend and total payout ratios have been relatively flat to down over the last two decades1 (Figure 7, left side). For U.S. multinationals, however, distributions are typically paid only with domestic cash. This restriction increases effective payout ratios and may strain U.S. firms as global growth recovers and their overseas cash balances rise. Firms are already seeing the signs of this: The ratio of dividends paid to domestic net income has risen by more than one-third from 32% to 44% over the past 20 years (Figure 7, right side). Absent a change in tax rules, many U.S. multinationals will increasingly be forced to contemplate alternative sources of capital to support their payout policies, up to and including the issuance of debt in the U.S. to support investor expectations that almost all free cash flow—both foreign and domestic—be distributed.

Figure 7

Rising non-U.S. income places upward pressure on U.S. payout ratios

31% 32%

27%

36% 33%

44%

Dividends (% of global net income) Dividends (% of U.S. net income)

Relatively flat1.7% CAGR

1993 2003 2013 1993 2003 2013

Source: FactSetNote: Medians based on S&P 500 constituents as of 12/31 for each year; excludes firms that do not break down sales by geography; assumes same profit margin for U.S. operations as non-U.S. operations

1 For instance, please see our March 2013 report: “2013 Distribution policy: How macro views shape the dividend vs. buyback dilemma”

EXECUTIVE TAKEAWAY

How high are payout ratios?

Higher than you think.

Payouts are almost half of distributable, domestic

income creating an issue for global firms with

trapped cash.

2014 DISTRIBUTION POLICY | 7

2.4 Will rising rates hurt dividend paying stocks?Investor demand for yield in the current low-rate environment has led to a dividend premium and has helped to fuel the growth in dividend distributions. As interest rates rose from May 2013 through the end of the year, investor appetite for bond-like equities declined. This reduction in demand was most felt by firms in yield-oriented sectors, like REITs and utilities (Figure 8). Firms that have a history of generating strong cash flow growth as the economy grows have, however, not been affected by rising rates. Thus, dividend-oriented sectors with limited leverage to a growing economy and rising rates will suffer when rates rise. Conversely, firms that will be able to offset higher rates with accelerated dividend growth should be able to avoid valuation pressure.

Figure 8

Valuation impact of surging treasury rates in the spring and summer 2013

U.S. 10-year Yield 1.4%

S&P 500 Index

S&P 500

Dividend Aristocrat Index2

19%

16%

S&P 500 Buyback Achievers Index1 27%

MLP Index3

7%

(11%)

Yield-oriented sectors underperformed

Firms with best-in-class distribution policies performed strongly

Utility Index4

REIT Index5

(9%)

May 2013 through December 2013

Source: BloombergNote: Total return from 5/1/2013 to 12/31/2013 assuming dividends reinvested1 S&P 500 Buyback Achievers Index is comprised of the top 100 S&P 500 firms that have the highest buyback ratio in the last 12 months (SPBUYUP)

2 S&P 500 Dividend Aristocrats Index is comprised of S&P 500 firms that have increased dividends for the past 25-plus consecutive years (SPDAUDP)

3 Alerian MLP Index (AMZ)4 PHLX Utility Sector Index (UTY)5 MSCI US REIT Index (RMZ)

EXECUTIVE TAKEAWAY

Will rising rates hurt dividend paying stocks?

Not necessarily.

Dividend paying firms that are levered to the

economy may be able to grow dividends in an

accelerated fashion, offsetting rising rates.

8 | Corporate Finance Advisory

2.5 Do firms overpay during share repurchases?Firms are thought to ramp-up share repurchases when cash flows are strong and dial them back during periods of weak cash flows and/or unfavorable capital markets environments, leading to low returns from share repurchases. Firms have, however, generally earned returns in excess of their cost of equity. In particular, stock buybacks by S&P 500 firms have almost doubled since their recent trough immediately following the financial crisis (Figure 1), leading to a significant cumulative return of 12% since 2005 for S&P 500 firms.

Our analysis indicates, however, that if firms had dollar cost averaged their repurchases through the period, they could have generated even higher returns (Figure 9). This result indicates that a consistently strong share repurchase program may help firms enhance shareholder value. This notion is particularly applicable in today’s environment of significant cash flow generation, high cash balances, low leverage and limited growth opportunities. Furthermore, despite major indices currently trading near all-time highs, investors continue to reward firms that raise debt to return capital to shareholders.

Figure 9

Share repurchases have generated significant returns

S&P 500 returns on repurchases executed during a given quarter

6.4% 6.7%

6.4% 6.5%

6.1% 6.3%

6.4% 5.5% 5.2%

4.6% 4.8%

4.9% 6.9%

6.9% 8.9%

16.2%

20.0% 18.6%

16.7% 15.1%

15.1% 15.8%

18.3% 16.2%

14.4% 15.2%

20.4% 23.0%

19.8% 22.7%

23.8% 27.9%

23.2%

15.3%

10.4%

0%

5%

10%

15%

20%

25%

30%

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

Cumulative ROI 12.2%Dollar cost averaging 13.2%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: J.P. Morgan, Standard & Poor’s and FactSet as of 2/15/2014; data based on all S&P 500 firmsNote: Returns include dividend savings. Returns for last four quarters not annualized; distribution data for 2013 Q4 not yet available

2 For further reading, please see our recent brief: “Leveraged recaps: Unlocking hidden balance sheet value”

EXECUTIVE TAKEAWAY

Do firms overpay during share repurchases?

Not really.

Firms have generated high returns and investors

continue to respond well to firms that use debt or

excess cash to fund buybacks.

2014 DISTRIBUTION POLICY | 9

3. Summary of takeawaysFirms have ramped-up shareholder distributions in the post-crisis period, encouraged by a variety of factors from investor demand for yield to favorable capital markets and minimal investment opportunities. While these factors remain important today, firms should understand the evolving distribution landscape. Firms and senior decision makers should challenge conventional wisdom as they seek to continue their value-enhancing distribution policies.

Figure 10

The new “conventional wisdom” about dividends and buybacks

Do growth firms pay dividends?

YesIn today’s environment of strong cash flows and favorable financing markets, firms of all profiles pay meaningful dividends.

Are tech firms participating in the dividend trend?

AbsolutelyTech firms now pay 15% of all S&P 500 dividends and 20% of all S&P 500 distributions, triple their level of 10 years ago.

How high are payout ratios?

Higher than you think

Payouts are approaching half of distributable, domestic income creating an issue for global firms with trapped cash.

Will rising rates hurt dividend paying stocks?

Not necessarily

Dividend paying firms that are levered to the economy may be able to grow dividends in an accelerated fashion, offsetting rising rates.

Do firms overpay during share repurchases?

Not reallyFirms have generated high returns on share buybacks and investors continue to respond well to firms that use debt or excess cash to fund buybacks.

10 | Corporate Finance Advisory

Notes

2014 DISTRIBUTION POLICY | 11

12 | Corporate Finance Advisory

This material is not a product of the Research Departments of J.P. Morgan Securities LLC (“JPMS”) and is not a research report. Unless otherwise specifically stated, any views or opinions expressed herein are solely those of the authors listed, and may differ from the views and opinions expressed by JPMS’s Research Departments or other departments or divisions of JPMS and its affiliates.

RESTRICTED DISTRIBUTION: Distribution of these materials is permitted to investment banking clients of J.P. Morgan, only, subject to approval by J.P. Morgan. These materials are for your personal use only. Any distribution, copy, reprints and/or forward to others is strictly prohibited. Information has been obtained from sources believed to be reliable but JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively JPMorgan Chase & Co.) do not warrant its completeness or accuracy. Information herein constitutes our judgment as of the date of this material and is subject to change without notice.

This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. In no event shall J.P. Morgan be liable for any use by any party of, for any decision made or action taken by any party in reliance upon, or for any inaccuracies or errors in, or omissions from, the information contained herein and such information may not be relied upon by you in evaluating the merits of participating in any transaction.

IRS Circular 230 Disclosure: JPMorgan Chase & Co. and its affiliates do not provide tax advice. Accordingly, any discussion of U.S. tax matters contained herein (including any attachments) is not intended or written to be used, and cannot be used, in connection with the promotion, marketing or recommendation by anyone unaffiliated with JPMorgan Chase & Co. of any of the matters addressed herein or for the purpose of avoiding U.S. tax-related penalties.

J.P. Morgan is the marketing name for the investment banking activities of JPMorgan Chase Bank, N.A., JPMS (member, NYSE), J.P. Morgan PLC (authorized by the FSA and member, LSE) and their investment banking affiliates.

Copyright 2014 JPMorgan Chase & Co. All rights reserved.

We would like to thank Mark De Rocco, Noam Gilead, Nina Gnedin and Sarah Hellman for their invaluable comments and suggestions. We also thank Jennifer Chan, Siobhan Dixon, Sarah Farmer and the Creative Services group for their help with the editorial process. We are particularly grateful to Nicholas Kordonowy for his tireless contributions to the analytics in this report as well as for his invaluable insights.