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Arnold Landy is a registered investment advisor, managing clients' funds since January, 2006. His previous careers include: small business owner, analyst for "The Value line Investment Survey," urban planner/analyst for State of New Jersey, school teacher in Jersey City, carny at state... More
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  • THE DUMBNESS OF DIVIDENDS 9 comments
    Nov 21, 2009 6:32 AM | about stocks: DO, INTC, LMT, LOW, MSFT, JNJ, MMM, SYK, WMT, WAG

    Dividends are not a positive factor in deciding whether or not to own particular stocks. That’s because dividends reduce the value of the underlying shares by the amount of the dividend. Suppose there exists a corporation that consists of a broken hot dog cart, with no regular place to sell hot dogs, and it has no other assets or liabilities. This company would not be worth much. But, suppose this corporation had $1 million dollars in its corporate bank account. Then, the company would be worth nearly $1 million.  A person could do very well buying the company for less than $1 million, then disposing of the hot dog stand, closing the business, then withdrawing the $1 million from the bank account. But, if the current owner of this business paid out in dividends to herself the $1 million that was in the bank account, the business would be left with roughly zero value. So, the business is worth a great deal before the dividend, but not much afterward. Likewise, publicly traded stocks trade at prices set by investors’ evaluation of what the company is worth. The value of any company depends on its earnings, prospects for the future, assets and liabilities. Cash is part of the assets. And each dividend paid out translates into either more borrowing or less cash on the balance sheet.

    Clearly, dividends do NOT provide a cushion under the stock price, as investors have found out painfully in recent years. And their payment has further weakened many companies already suffering from declining profits.

    However, paying dividends does make great sense when a financially strong company earns more than it needs to use for working capital or for its capital budget. Here, the cash would just continue to grow.  An example would be Microsoft (NASDAQ:MSFT).   Better to pay out the excess cash in a dividend to shareholders (your maximum tax rate on dividends is only 15%) than to let it pile up in the company treasury while incurring the high corporate income tax rate on the interest that it earns.

    Dividend payments are fine for companies that are strong, financially.  Examples are:  Diamond Offshore (NYSE:DO),  Intel (NASDAQ:INTC), Lockheed-Martin (NYSE:LMT), Lowe's (NYSE:LOW), Microsoft (MSFT), Johnson & Johnson (NYSE:JNJ), 3M Company (NYSE:MMM), Stryker (NYSE:SYK), Wal-Mart WMT), and Walgreen (NYSE:WAG).   But cash is part of a company’s assets. Once paid out in a dividend, that cash is no longer part of what the company is worth. The bottom line: dividends are efficient and appropriate when companies have excess cash, but a dividend payment does not increase shareholder value because it subtracts a like amount from the what the company is worth, which is expressed in its stock price. Therefore, investors should not consider a dividend as a positive factor, in and of itself, in evaluating whether or not to own a particular stock.

    Disclosure: My clients or I own shares in: Intel (INTC), Microsoft (MSFT), Lockheed-Martin (LMT), Lowe's (LOW), Johnson and Johnson (JNJ), Stryker (SYK), 3M Co (MMM), Wal-Mart (NYSE:WMT), and Walgreen (WAG).

    Themes: DIVIDENDS Stocks: DO, INTC, LMT, LOW, MSFT, JNJ, MMM, SYK, WMT, WAG
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Comments (9)
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  • TradingHelpDesk
    , contributor
    Comments (538) | Send Message
     
    But haven't dividend paying stocks outperformed non-dividend paying stocks over the long term?

     

    Maybe better run companies can consistently make profits and share those profits with shareholders annually?
    21 Nov 2009, 09:13 AM Reply Like
  • Arnold Landy
    , contributor
    Comments (30) | Send Message
     
    Author’s reply » That is an interesting question. I am not aware of studies that have compared dividend-paying stocks with those do not pay dividends. Even if a difference were found, the two groups are so diverse that knowing if one group outperformed the other would not be very useful. After all, among dividend payers there are many fine companies, but many clunkers, too. Companies in decline often keep paying a dividend even as their financial situation worsens. AIG even raised its dividend a few short months before its demise in order to reassure investors. GM paid a dividend thoughout most of its many years of decline. Likewise, among non-dividend payers, there are stocks heading for oblivion, but many young, fast growing companies on their way to becoming tomorrow's dividend-paying blue chips. And don't forget success stories like Warren Buffett's Berkshire-Hathaway, which has never paid a dividend. Just knowing whether or not a company pays a dividend is, by itself, not very useful. Thanks for your comment.

     

    On Nov 21 09:13 AM TradingHelpDesk wrote:

     

    > But haven't dividend paying stocks outperformed non-dividend paying
    > stocks over the long term?
    >
    > Maybe better run companies can consistently make profits and share
    > those profits with shareholders annually?
    21 Nov 2009, 07:45 PM Reply Like
  • richjoy403
    , contributor
    Comments (9621) | Send Message
     
    I am not a dividend investor, however...

     

    Mr. Landry's view of dividends is interesting, but I'm not yet convinced;I would think there would be many studies comparing dividend paying stocks to those that pay no dividend.

     

    I do believe I have read many times that over a period of years, buying dividend paying stocks (especially those that grow their dividends), and reinvesting those dividends, has produced far greater returns than owning bonds...still, that does not negate Mr. Landry's thesis (which is that investors should not consider a dividend as a positive when evaluating the purchase of a stock) .

     

    If one can equate dividends to "value" stocks, I also understand that over the long run, value stocks have historically outperformed growth stocks...again, this does not directly address Mr. Landry's thesis.
    21 Nov 2009, 08:01 PM Reply Like
  • StockMasterFlash
    , contributor
    Comments (69) | Send Message
     
    A dividend is a good thing for any company that regularly earns cash above its expenses and any possible expansion/growth expenses if they have a stable business and good balance sheet.
    22 Nov 2009, 02:56 AM Reply Like
  • Low Sweat Investing
    , contributor
    Comments (563) | Send Message
     
    Your hot dog cart analogy makes a fair point – avoid investing in broken businesses with no revenues or earnings, and that are paying out the last of their cash pile. (For the record, I’d avoid eating their last hot dogs, too.)

     

    But dividend stocks, in particular those with a record of increasing dividends, can be smart investments. As for research, I wrote an article on the consistent outperformance of dividend-growers. The research findings are quite clear: these stocks outperform.

     

    Additionally, with regard to your point about the pain of recent years and dividends not cushioning stock prices: hold the mustard.

     

    The pain was real, but I would propose it was a sector and industry problem, not a dividend stock problem. Check out this weekend’s Wall St. Journal: in 2008 dividend payers’ total return was 6 percentage points ahead of non-payers.

     

    So financials were the disaster, not dividend stocks. And not to belabor this, but I also wrote articles on dividend-growers in healthcare, industrials and technology that outperformed the market, as well as their sector benchmarks, over a number of trailing time-periods. (And other authors on the site have written far more than I have.)

     

    All that said, I enjoyed reading your post. Your points about cash generation and assets are insightful; your headline is a guaranteed traffic-stopper; and your disclosure shows you know how to pick good dividend stocks.

     

    I hope you submitted this post for publication as an article. If so, I think you’ll get plenty more comments; I’ll even re-post this one.

     

    But I’m still going to avoid those hot dogs.
    22 Nov 2009, 01:16 PM Reply Like
  • Michael D.
    , contributor
    Comments (173) | Send Message
     
    Growing companies, growing cash flows, who grow their dividends at a rate which keeps their payout ratio relatively low (less than 40%) are the dividend investments with value. You should write an article about these companies (INTC, JNJ, etc.)

     

    Your 'hot dog' analogy is of the broken, mature business being raided for its cash (there were a few 'special dividends' announced last month intended to scare off corporate raiders).
    22 Nov 2009, 05:50 PM Reply Like
  • David Jackson
    , contributor
    Comments (1235) | Send Message
     
    Arnold, thank you for a stimulating article about a topic I'm personally interested in (seekingalpha.com/artic...).

     

    Two additional issues about paying out cash to investors are:

     

    1. Do companies that return profits to shareholders produce larger total returns to investors than companies that reinvest their profits in their businesses? Warren Buffett, for example, *never* returns cash to investors.

     

    2. Even if companies do decide to return cash to shareholders, are dividends superior to share buy backs? Buy backs are usually more tax efficient (they leave it up to the investor whether to realize the gain by selling stock), but they also benefit those who own options as well as those who own stock. In companies where options issuance is problematic, returning cash to shareholders by paying dividends may be better.
    5 Feb 2010, 09:01 AM Reply Like
  • Will Menzies
    , contributor
    Comments (7) | Send Message
     
    Warren Buffet does, however, invest heavily in dividend growth stocks (KO, PG, JNJ, WMT, etc.)
    9 Feb 2010, 05:49 PM Reply Like
  • David Jackson
    , contributor
    Comments (1235) | Send Message
     
    Will, you're right about that Buffett likes dividend paying stocks, but this is what ForMyOwnAccount wrote about this in his article Why I Hate Dividends (seekingalpha.com/insta...):

     

    "Note that Berkshire's own love of dividend-paying investments such as Goldman and GE stem from the favorable tax treatment that corporations get from preferred-stock dividends, namely that federal tax law requires corporations to pay tax only on 30% of a preferred stock dividend, while individual investors must pay tax on all 100% of the preferred dividend. This means that fully 70% of the dividend that Goldman and GE pays Berkshire is tax free. Mr. Buffett knows how to use tax laws to his advantage"

     

    I'd add that Warren Buffett is a better capital allocator than the CEOs of the publicly traded stocks he invests in -- so he's happy for them to pay him dividends rather than invest the capital themselves. But that's not true of most individual who receive dividends.
    9 Feb 2010, 07:55 PM Reply Like
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