The Dark Side of Dividends

In life there are precious few things that are lily pure in which nothing negative could rightfully be said about them. I am not foolish enough to believe that dividends are the ultimate panacea. Join me today as I don myself in black and explore the the Dark Side of Dividends.

Here are the top five reasons for not paying a dividend:

1. In the U.S. and some other countries, dividends are double taxed. Corporations pay taxes on their earnings, then when dividends are paid to shareholders they must then also pay taxes these distributed earnings.
2. When an individual pays taxes on a dividend distribution, the future earnings associated with the taxes are forever lost. Some would argue that capital gains are better for this reason, since the investor chooses when to incur the tax.
3. Companies in new and growing industries need every cent for future growth, thus can't afford to pay dividends. In fact they are usually issuing stock and debt to raise additional capital.
4. If a company has old debt with a very high interest rate, it might be better off to reduce the debt prior to initiating a dividend program.
5. It puts pressure on management to sustain the dividend in the future.

Black is just not my color. I prefer my white hat (with a crimson script A, of course). Here are my five responses to the above:

1. It is true that dividends are double taxed in some countries. Many governments, including the U.S. have recognized this, and have provided tax breaks to minimize the double taxation. In the U.S., qualified dividends are taxed at a reduced rate of 15%.
2. It is true that when an individual pays taxes on a dividend distribution, the future earnings associated with the taxes are forever lost. Ultimately, we will need to convert our investments to cash either through dividends or capital gains. Dividend consistency is related to the quality of the company we have invested it, while capital gains are often at the mercy of the market (good companies are often punished in a down market).
3. It is true that companies in new and growing industries need every cent for future growth, thus can't afford to pay dividends. New companies rarely ever qualify as a good dividend company. Get back with me once you are grown and mature.
4. It is true that a company with old debt with a very high interest rate might be better off reducing the debt prior to initiating a dividend program. Again, this is likely to be a new or middle aged company, not yet mature enough to be a good dividend company.
5. It is true that paying an ever-increasing dividend puts pressure on management to sustain the dividend in the future. Isn't that why we shareholders pay them the mega-bucks to generate value for us by running a superior operation?

Though not perfect, dividend distributions meet a very specific need for investors looking for a reliable and growing revenue stream. Not all companies that pay a dividend are good dividend investments. Investors must do their due diligence prior to purchase.

Comments

[notsosmart]

i have no connection to wall st. or "fro" but anyone interested in a well run dividend paying co. should check this out.no one has figured out a way to pave over the ocean.

[mariposa]

Diana and Eagle, and most other shippers good too.
Someday we will realize expensive to ship things back and forth, but that is a long way off.

[User 164258]

Regardless of whether the investor needs the cash, dividends give an investor the choice of how he wants to reallocate the earnings of the business. The investor can buy more shares of the company or purchase shares or bonds of another company. Cash in the hands of the investor is a good thing as it allows him to make his own reinvestment decisions.

The other thing that has to be discussed when debating dividends is share repurchases. Many managers elect to spend their excess free cash flow buying back their company's shares. While, in principal, this can be a good thing as it eliminates taxes in dividend distributions, managers have not proven to be the best judges of when their shares are cheep and have bought shares at high prices destroying shareholder value. Share repurchase theoretically gives managers flexibility to buy in shares in periods when they have extra free cash flow and not when they have investment opportunites while maintaining their regualar dividend payout. They feel that if they were to pay out a large dividend one year when they had extra cash and then reduce it the following, investors would see this as a problem and the share price would drop. Personally, I would rather have the cash and pay the taxes rather than trust managers to always know when their stock is undervalued and should be repurchased. So give me the money. After all it is mine. I am a big boy let me make my own reinvestment decisions!

[User 173635]

WHAT ABOUT TAX FREE DIVIDENS. WHAT IS YOUR TAKE ON THIS?

[grampz]

Why do some consider a 3%-5% taxable dividend a good investment when one can get a 5% taxable dividend on a 1-year CD with no risk to capital?

[kurt walter]

I want dividends. I don't trust managements to re-invest all the potential dividends into the business. There are too many stupid errors produced by overpaid managements that treat the company like their personal kingdom.

[jlounsbury59]

Reply to grampz - - -

The CD has no risk to principal and also has no possibility of principal appreciation. If you have no need for capital growth and no fear of inflation, go for the CD. By the way, it is very hard to find a 5% CD right now.

[blah-blah]

@grampz

1) Dividends are taxed at a low rate. Interest is taxed as full income.
2) Dividends increase over time, intererest does not - hence the inflation risk.

It's a no brainer

[skwestorange]

I for one would rather have the dividend cash in my hand than trusting managements of corporations. Over the last two decades, they mostly bought back back high. Adding insult to injury, the banks are now selling stocks at deep discount to raise capital while diluting existing sharehaolders. What guarantee is there other such as PFE won't do the same in the next couple of years? Finally don't forget the stock buybacks are usually timed and quanitities adjusted to reward managements thru option grants. One more thing, if managements are concerned about increasing dividens one yeara and cutting dividend the next, they can always set a two part dividend pattern. The first could be a small percentage of the expected net earnings followed by a variable bonus at the year end after the full year earnings are in.