Earnings Diluted 4% by Record U.S. Share Sales, Dividend Cuts

By Elizabeth Stanton, Michael Tsang and Eric Martin

June 8 (Bloomberg) -- American common equity is increasing for the first time in five years, threatening to dilute corporate profits as companies sell a record amount of stock and cut dividends the most since 1938.

Wells Fargo & Co., ProLogis and more than 150 other companies raised $82.2 billion this quarter, beating the record pace at the height of the technology bubble in 2000, according to data compiled by Bloomberg. The combination of adding shares and restricting dividends will reduce annual equity returns as much as 4.1 percent, the data show.

“The math is inescapable,” said Alan Gayle, the Richmond, Virginia-based director of asset allocation at Ridgeworth Investments, which manages $60 billion. “You’ve got weak earnings, the share price goes down and then, ‘What? They want to raise equity?’ Clearly that isn’t a good thing.”

Companies are taking advantage of the biggest rally in equities since the 1930s to sell shares even after earnings fell seven consecutive quarters during the worst recession in half a century. Banks ordered to raise capital by the government account for 23 percent of underwritten sales, data compiled by Bloomberg show.

The flood is trimming earnings available to shareholders, a warning sign to Lyxor Asset Management SA, Research Affiliates LLC and James Investment Research that returns may not be high enough to justify buying stock.

Offerings since March 31 will increase outstanding shares in the S&P 500 by 3.4 percent on an annualized basis, adjusting for the market values of companies selling stock, data from Bloomberg and S&P show. The rise is based on S&P’s calculation of shares added or removed from the index through sales, buybacks and takeovers, known as the divisor.

Bigger Pool

Record mergers, acquisitions and repurchases reduced the divisor the past four years. Now, the increase is penalizing existing shareowners by spreading earnings and dividends across a larger pool of stock. The annualized increase in the S&P 500’s share count would cut estimated per-share profit this year by 3.3 percent to $57.23, data compiled by Bloomberg show.

The 46 percent decline in S&P 500 corporate earnings since its peak in the second quarter of 2007 is forcing companies to conserve cash by shrinking dividends, data compiled by Bloomberg show. Combined payouts will fall 23 percent to $21.97 per share for companies in the benchmark index this year, the most since the 36 percent drop in 1938, S&P estimates.

Cutting the dividend yield by 0.8 percentage point from last year to 2.34 percent and the dilution from share sales would cut the S&P 500’s total return by 4.1 percent, data compiled by Bloomberg show.

Impaired Returns

While a reduction of that size represents less than a third of the average yearly increase in the index from 1982 through 2007, it’s a bigger drag in markets battered by the worst losses in 70 years, when the S&P 500 tumbled 38 percent last year. U.S. equities have returned 6 percent on average since 1900, inflation-adjusted data compiled by the London Business School and Zurich-based Credit Suisse Group AG show.

“If anyone said to me a 5 percent reduction on your annualized return doesn’t matter, I’d say try explaining that to your client, especially considering the way the numbers have been over the past two or three years,” said Brian Shepardson, who helps manage $2 billion at Xenia, Ohio-based James Investment Research.

Existing shareholders are better off accepting a smaller slice of future earnings because some companies would have failed without new money, said Mark Hantho, the New York-based head of equity capital markets at Deutsche Bank AG.

Bank Losses

U.S. financial companies accounted for almost two-thirds of about $1.5 trillion in global asset writedowns and credit losses that drove shares of banks, brokers and insurers in the S&P 500 down as much as 84 percent since their 2007 peak.

Seventy-nine financial companies sold $60.7 billion of shares this quarter, reducing the claim existing shareholders have on earnings by more than 20 percent, data compiled by Bloomberg show.

“Most people are not talking about dilution, only the balance sheet,” Hantho said. “The fact that they’re putting money to work in solving the problem is creating a lift in the equity as a result of fixing the balance sheet. Even though it’s at the expense of dilution, it’s better than the alternative.”

San Francisco-based Wells Fargo and New York-based Morgan Stanley were among the banks required to sell stock after the Federal Reserve determined in a report on May 7 that 10 of the country’s 19 largest banks needed to raise a combined $74.6 billion.

Raising Cash

Wells Fargo’s $8.63 billion secondary sale on May 8 increased its share count by about 10 percent. The fourth- largest U.S. bank by assets got more than the $6 billion it had estimated, selling shares at an 11 percent discount to the previous day’s closing price.

Banks not among those told to raise capital, including New York-based Goldman Sachs Group Inc. and JPMorgan Chase & Co. and U.S. Bancorp in Minneapolis have sold more than $20 billion, mostly to repay government funds they were ordered to accept after New York-based Lehman Brothers Holdings Inc. collapsed in September.

“The financial ones do make me angry because in some cases, particularly JPMorgan, they were forced to take the damn money to begin with, they didn’t need it, and now they’re forced to dilute the shareholders,” said James Barrow, president of Barrow Hanley Mewhinney & Strauss in Dallas, which manages $40 billion, including JPMorgan shares.

Previous Record

Stock sales picked up as the S&P 500 rallied 39 percent from a 12-year low in March and surpassed the record $65.6 billion from the first quarter of 2000, just as the gauge started a 49 percent plunge. The 153 companies that have sold equity since March increased their outstanding shares by an average of 23 percent, according to data compiled by Bloomberg.

Florence Barjou, strategist at Societe Generale SA’s Lyxor Asset Management in Paris, says the record share sales are coming at the worst possible time.

The U.S. will shrink by the most since 1946 this year, according to a Bloomberg survey of 61 economists. The jobless rate rose to 9.4 percent in May, a government report showed June 5. Corporate earnings are forecast to decline for two more quarters after dropping the last seven, the longest streak since the Great Depression, analysts’ estimates compiled by Bloomberg show.

“Investors have been discounting a very rapid return to growth, so maybe the market is getting a bit complacent,” said Lyxor Asset’s Barjou, who helps oversees about $100 billion.

Shareholders say the decision by executives to sell shares now means prices may already be too high.

“What we find is that secondary-equity offerings frequently signal a view in management suites that prices are rich,” said Robert Arnott, chairman and founder of Research Affiliates, which oversees $32 billion in Newport Beach, California. “Does that mean this is an interim top? Who knows, but it would be unsurprising.”

To contact the reporters for this story: Elizabeth Stanton in New York at estanton@bloomberg.net; Michael Tsang in New York at mtsang1@bloomberg.net; Eric Martin in New York at emartin21@bloomberg.net.