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By John Waggoner
July 18, 2017
A video board displays the numbers after the closing bell of the Dow Industrial Average at the New York Stock Exchange, April 20, 2017 in New York.
A video board displays the numbers after the closing bell of the Dow Industrial Average at the New York Stock Exchange, April 20, 2017 in New York.
Bryan R. Smith—AFP/Getty Images

Stocks that routinely throw off income to their shareholders have been the market’s darlings over the past decade, as nervous investors sought the comfort only regular cash payments can deliver. But as a result, dividend stocks—which have historically outpaced the market—are now expensive.

High-yielding utility shares, for instance, have grown 70% more expensive in just this past year based on their price/earnings ratios, a common gauge of stock valuations. This makes it less likely that dividend payers can continue to produce market-beating returns.

So maybe it’s time to look at firms that don’t throw off income but reinvest in themselves instead.

Corporations have amassed an astonishing amount of cash: Nearly $1.5 trillion sits on the books of U.S. companies (not counting banks). Apple alone has $247 billion.

In addition to issuing dividends, companies can use cash to buy back their stock (reducing shares outstanding will boost a firm’s earnings per share). But “if a company can’t think of anything to do with its cash but buy back stock, we hope that’s not the decision tree they’re following,” says Oakmark Fund co-manager Win Murray.

Source: Morningstar

Reinvesting money in the business to promote future growth, however, can have a profound impact. “Smart capital spending can have a multidecade payback period,” Murray says. The key word here is “smart.” Plenty of companies waste money on unnecessary buildings, such as lavish new offices, that don’t pay off.

One place to look for companies that don’t make such mistakes is the S&P Capex Efficiency index, which has gained 17.3% over the past 12 months, vs. 10% for the S&P Dividend Aristocrats index.

The Capex, which beat the S&P by more than a percentage point a year over the past decade, focuses on firms where capital expenditures have boo sted sales. Among its top names: Regeneron Pharmaceuticals (REGN) and Alphabet (GOOGL).

To be sure, businesses sometimes buy plants and equipment rather than build their own. So look for firms with an eye for bargains, says Wallace Weitz, manager of the value-minded Weitz Funds. “Making bad acquisitions can be a terrible use of capital,” he says.

Among the top holdings in his Weitz Partners Value Fund (WPVLX) are Alphabet and Warren Buffett’s Berkshire Hathaway (BRK.B), which, contrary to popular belief, issues no dividends to its shareholders.

As Buffett wrote in 2013, “Our first priority with available funds will always be to examine whether they can be intelligently deployed in our various businesses.” While he admits he has made plenty of mistakes, Berkshire has posted twice the annual gains of the S&P 500 since 1965. And that’s factoring in reinvested S&P dividends.

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The purpose of this disclosure is to explain how we make money without charging you for our content.

Our mission is to help people at any stage of life make smart financial decisions through research, reporting, reviews, recommendations, and tools.

Earning your trust is essential to our success, and we believe transparency is critical to creating that trust. To that end, you should know that many or all of the companies featured here are partners who advertise with us.

Our content is free because our partners pay us a referral fee if you click on links or call any of the phone numbers on our site. If you choose to interact with the content on our site, we will likely receive compensation. If you don't, we will not be compensated. Ultimately the choice is yours.

Opinions are our own and our editors and staff writers are instructed to maintain editorial integrity, but compensation along with in-depth research will determine where, how, and in what order they appear on the page.

To find out more about our editorial process and how we make money, click here.

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