Last week, fellow Seeking Alpha contributor Arnold Landry wrote an excellent piece on the perceived value of dividend paying stocks. His argument discusses what he thinks is a "misplaced mania" over dividends and the companies that issue them - more specifically, they are no better or worse than stocks that don't issue a dividend. He started the article by saying:
The proper way to view most stocks' rate of return is to look attotal return. And it is irrelevant, except for personal income tax implications, how much of that total return comes from dividends versus stock price gains.
Like the quote "you had me at hello" from the movie Jerry Maguire, in Arnold's article, I was immediately hooked after reading the first sentence. Some of the other points made in the article supported ideas and (admittedly) some misguided perceptions that I once struggled with about companies that pay out dividends - one of which being that they are no longer growing or more specifically, have run out of strategic ideas of how to grow.
I used Apple (NASDAQ:AAPL) as the perfect example - it is viewed as a cash hoarding company and because of this, analysts and investors implores it for a dividend. Though my stance has changed (somewhat) on the issue of dividends itself, I remain steadfast in that Apple (in particular) should not go this route just yet as it has many more markets to challenge. This goes back to my original point of "running out of ways to strategically use capital"; to me, paying out a dividend is somewhat of an indirect admission of non-competitiveness by management.
A recent example is Sirius XM (NASDAQ:SIRI) - which is now in such a position and I think that the company should really first consider what it is up against and follow the model of companies such as Apple that has resisted the temptation or pressure from shareholders. Sirius wants to reward shareholders in some way to the extent that it has discussed (amongst other things) a dividend. As great of an idea as it sounds, I just don't think that it should. CEO Mel Karmazin recently made the following statements during the company's Q1 earnings report last May.
Since we will be close to that 3x target by the end of this year, the management and board will be considering all of the options for our cash. While we will always continue to invest in our business, the options are further internal investments or acquisitions and share buybacks or dividends. From my perspective, there is a clear ability to return capital to shareholders, although the timing and quantity of such return is not yet determined. I, for one, am looking forward to rewarding our loyal shareholders this way.
Sirius made certain that investors heard correctly in regards to a dividend when again during the company Q3 earnings announcement in November, CEO, Mel Karmazin made the following statements:
We just turned EBITDA positive 3 years ago, and we are very pleased where we have been able to move our margin at this stage of our development. Growing EBITDA is really a precursor to driving free cash flow, which we believe is the primary driver of SiriusXM's value. We are focused on growing our free cash flow substantially in the future. Free cash flow will enable us to invest in our business, which will increase growth, reward shareholders via dividends or share repurchases and make accretive acquisitions to improve the value of our company.
The question is not whether or not dividends are bad - fundamentally the idea is sound. After all, it makes sense to reward the people that support the operation of the company by virtue of their capital infusion. Rather, the question is, should it be something that the company does strategically with all things considered? In other words, does it make sense? For Sirius XM that answer is a resounding no and I think that its investors should be wise and not encourage this. Instead, I believe the company should use its excess cash to pay down debts, address its perceived lack of marketing, and/or make an acquisition that furthers its long term growth potential - one that does not place increase dependency on neither the automobile nor subscriber acquisitions.
However, despite how I or anyone else view the idea of a dividend, it remains clear that the unifying quality of the companies that pays out or evens those that are considering doing so such as Sirius is that (in these companies) there are increasing levels of operational success. It goes without saying that companies that are paying out cash as a way to reward shareholders are better run than those that are in a constant need to borrow. In Arnold's article, he also made the following points - two of which directly hit home. He said:
There are cases in which a dividend can hurt total return - as when a failing company continues to pay dividends, which worsens its financial weakness and threatens its very survival. An example would be General Motors (NYSE:GM) during the years leading up to its bankruptcy. Likewise, there are some cases in which payment of a dividend truly benefits investors, such as with Microsoft (NASDAQ:MSFT) or Cisco (NASDAQ:CSCO). Both companies have proven unable to invest their huge cash hoards effectively in recent years. Instead they pay out increasing dividends, which investors can then reinvest in the shares of the same or additional companies, rather than lose out as both companies' invest their excess cash at near-zero interest rates in the money markets.
As a long time investor in both Microsoft and Cisco, I really appreciated his comments above - particularly from the standpoints of effectively investing their capital. Though both companies issue modest dividends their standing amongst the best technology companies on the market have dropped considerably in recent years and it has shown in their stock performance of the last decade. But the question is, has the dividend really hurt either company?
I really can't answer that question definitively considering that both firms, while in addition to paying out dividends, have also mismanaged their operations considerably for quite some time. I'm inclined to think that both languishing stocks and perceived irrelevance has been the consequence of the latter - to the extent that Cisco in particular recently discontinued a decent majority of these failed investments. So in essence, it goes back to execution. But one of the article's most important point was as follows:
Clearly, the current low interest rate environment has "forced" some conservative investors into buying high dividend paying stocks as a bond substitute. This has likely propped up the stock prices of such high dividend payers as Verizon (NYSE:VZ), AT & T (NYSE:T), Merck (NYSE:MRK) and Pfizer (NYSE:PFE). Therefore, these high dividend payers are likely somewhat overvalued at the present time because this premium surely will disappear.
I find that to be very interesting because it implies that these stocks are "bubbles" or have become inflated due to their perceived bond substitutes. I have to disagree with that, because as I've stated previously it goes back to execution and the company's performance. Regardless of whether or not companies issue a dividend, they have to live up to (or sometimes exceed) growth expectations in order for investors to buy-in. I will concede that dividend paying companies, by virtue of their payments are able to "buy time" - more so than their non-paying peers, but they are not immune to poor execution or worse, failed expectations - two of the things that Wall Street often does not forgive.
While I can't realistically make excuses for any company's failed decisions, I do appreciate the position that many are in and the inherent pressures of returning value to shareholders. The question continues to be, how can a company do this effectively since it has been argued that dividends really have no effect on investors' total return since the payment itself reduces the company's value by the exact amount. This is what the market always decides and "the thumbs up or thumbs down" with each decision are in the buy and sell orders.