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ForMyOwnAccount is a seasoned Wall Street veteran and former buy-side investment manager schooled in the Graham & Dodd approach. He now regularly employs the long-term investing principles he practiced for years. He will trade anything and everything for his own account on both the long and... More
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  • WHY I HATE DIVIDENDS 10 comments
    Dec 9, 2009 12:04 AM | about stocks: GE, BRK.A, BRK.B

    I see many articles, comments and blogs on Seeking Alpha that stress the importance of dividends and suggest that the dividend decision by boards of directors is a very important one and that a high or increased dividend is a good thing.  Just today, someone wrote "Earth to GE:  Boost Your Dividend."  You can read this article at seekingalpha.com/article/176927-earth-to....

    I could not disagree more.

    There is a long-standing controversy in the investment community about the relevance of dividends as opposed to earnings as the true source of value of a company's common stock.  However, economists Merton Miller and Franco Modigliani debunked the dividend argument in the 1960s with their Miller-Modigliani Financial Theory. 

    As the home page of Seeking Alpha today demonstrates, the love of dividends persists.  Why?  I can only attribute it to illiteracy about numbers (called "innumeracy") and a lack of knowledge of accounting.

    In the course of a firm's conducting business, that firm basically does only two things:  it generates revenues, and it incurs costs.  The difference -- the excess -- is called cash flow (if cash accounting is used) or earnings (if accrual accounting is used).  Dividends are paid out of these earnings or cash flow.  If dividends and new investment are greater than earnings, the firm may have to issue new equity, which is dilutive to existing shareholders. 

    If the firm has a stock price selling below its true value, or if it has investment opportunities where the net present value (NYSE:NPV) of the investment is positive, the firm should use those earnings to repurchase shares or invest in new projects that have a positive NPV.  By doing either of these, the firm INCREASES its value by retaining earnings instead of paying them out as a dividend.  Repurchasing its own stock increases the percentage of the company that each existing shareholder owns.  Investing in existing or new businesses that are profitable, i.e., have a positive NPV and high return on investment allow the firm to make more money with the money it did not pay out in dividends.  These are rational managerial decisions.  Paying dividends is seldom rational and often just a palliative for naive shareholders.  If those shareholders need cash, they would be better off selling off judiciously small amounts of stock at the more favorable long-term capital gains rate.

    As for GE, nothing could be more value destroying for the firm than a dividend increase.  GE should not merely have cut its dividend, it should completely eliminate it!  Mr. Immelt, drop the dividend entirely and buy back more of your own shares and invest in high return businesses!

    The dividend discount model has been discredited in most academic circles.  The dividend irrelevancy argument suggests that current stockholders are not better off -- or worse off -- receiving a dividend.  A company should not pay a dividend except when the firm has poor management that makes bad investment decisions with the retained earnings, or when management has a lack of positive NPV investment opportunities.  

    Dividends are not a tax-efficient way to return cash to taxable shareowners.  If you are a taxable investor, you pay a hefty (usually 35% or higher) tax on dividends received.  If instead, you let the company buy back its own shares, you effectively get that dividend in the form of increased ownership percentage -- without the accompanying tax liability.

    The founder of Seeking Alpha, David Jackson, in a great article opposing  dividends and written fully four years ago (http://seekingalpha.com/article/616-why-dividend-paying-stocks-are-a-mistake) asked the same question:  why do investors like dividends?  

    I simply do not know why.  There are strong tax reasons to avoid paying dividends.  There are deceptive signaling reasons why management likes to announce dividend payments and dividend increases. That is frequently misleading.  There is something called the "information content of dividends hypothesis" which suggests that management pays a dividend or increases a dividend because it has better information about the future of the firm.  

    For most taxable shareowners of most profitable companies, paying dividends is unwise.  Given how uneducated shareholders are, the paying of dividends strikes me as a kind of bribe and an exploitation of the ignorance of a firm's shareholder base.  An intelligent shareholder base, such as those of Berkshire Hathaway (BRK.A, BRK.B), know that they are far better off if the firm retains the earnings and reinvests them in high-return businesses.  [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].

    Paying a dividend is to me a sign of management failure and/or bribery and exploitation of shareholder ignorance.  Attention all managers:  if your ROI is high, if a new project has a positive NPV, or if your stock is underpriced, PLEASE!  Don't send me a dividend check:  reinvest in the high return businesses or use the retained earnings to buy back as much of your own stock as possible.

    Now you know why I hate dividends -- and why you should too.  

    Happy investing.

     



    Disclosure: Long BRK.A and BRK.B. Long GE call options
    Stocks: GE, BRK.A, BRK.B
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Comments (10)
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  • Low Sweat Investing
    , contributor
    Comments (563) | Send Message
     
    Interesting stuff.

     

    And as the scurvy dog who wrote the offending article (“Earth To GE: Boost Your Dividend”), I won’t dispute your numeracy and accounting knowledge about dividends in general.

     

    But here’s a reason to own stocks that regularly increase their dividends: those stocks go up more.

     

    Good research shows that stocks with at least five years of dividend growth outperformed the S&P 500 every year from 1972 to 2008, a 36-year period covering economic conditions, market cycles and sector rotations of every flavor.

     

    And there seem to be good reasons for this. You can read this article at seekingalpha.com/artic...

     

    Any chance 2009 will make it 37 years? Nope. But I would propose a lot of that problem was a sector and industry problem, not a dividend stock problem.

     

    As far as GE goes, I guess that depends on one’s confidence in what their management will do with all that cash. They have enough of it to announce to the whole world they want to make some acquisitions, and maybe even return some to shareholders.

     

    My vote: show me the money.

     

    Thanks for your comment on my article and your point of view.
    9 Dec 2009, 02:47 PM Reply Like
  • David Jackson
    , contributor
    Comments (1279) | Send Message
     
    Low Sweat Investing, doesn't "Show me the money" really mean "Make a statement that you can't invest this money at a higher rate of return than I can earn in a savings account"?
    5 Feb 2010, 10:04 AM Reply Like
  • Low Sweat Investing
    , contributor
    Comments (563) | Send Message
     
    Interesting point, and maybe for some it would mean exactly that.

     

    But, in practice, virtually all the dividend-growth investors I know either re-invest their dividends in the best stocks they can find, or spend the money on their homes, cars, vacations, expensive lunches with interesting people, and so forth. Don’t know a single one who squirrels dividends away in a savings account, or keeps a high cash allocation for no other reason than recurring dividend payments.

     

    In the case of GE, my point was there’s not much credibility in whatever they say, so I’d prefer they just hand it over.

     

    The company did recently announce they believe they’ll start raising the dividend in 2011. Sooner would have been better, but they didn’t ask me.

     

    By the way, I’m a big Seeking Alpha fan. Congratulations on surpassing 400k registered users. I’m delighted to be among them.
    5 Feb 2010, 05:22 PM Reply Like
  • David Jackson
    , contributor
    Comments (1279) | Send Message
     
    Low Sweat Investing, thank you for your kind comment about Seeking Alpha - you should know that positive feedback makes a big difference to the entire team.

     

    On GE, if you believe "there’s not much credibility in whatever they say", surely you shouldn't own their stock? And that's exactly the point: if you believe in management, you believe that they will allocate capital only to projects that earn an adequate rate of return. If you don't believe that, and want them to return money to you in the form of dividends, why would you want to own their stock?

     

    Take Warren Buffett as an example. Would you have wanted him to pay dividends since Berkshire Hathaway was founded? Imagine how much less the stock would be worth now if he hadn't been able to invest that money; and imagine how much lower the total return of BRK.A investors would have been.
    6 Feb 2010, 05:22 PM Reply Like
  • Low Sweat Investing
    , contributor
    Comments (563) | Send Message
     
    All too true in the specific cases of GE and Buffett.

     

    But the general case for dividend growth remains solid, in my own view, based on the superb long-term performance of this class of stocks, and the immediate investor benefits of receiving those cash flows -- particularly important for investors living on their portfolios during deep or extended down markets when selling may be ill-advised.

     

    And now … back to today’s Super Bowl preview!
    7 Feb 2010, 01:48 PM Reply Like
  • Profitcripper
    , contributor
    Comments (280) | Send Message
     
    It depends on the industry......Not all businesses are made the same..
    17 Dec 2009, 07:24 AM Reply Like
  • David Van Knapp
    , contributor
    Comments (13319) | Send Message
     
    Disclosure: I love dividends.

     

    I'm interested in why you see the need to bash all dividend-paying companies and to bring in suggestions of innumeracy, lack of knowledge, naivete, lack of education, bribery, and ignorance of shareholders who favor dividends. You have, in effect, called me all of these things. I don't like that, and it is unnecessary. This is business, not personal.

     

    I'll try to be more civil to you. I am not stupid, innumerate, naive, uneducated, nor ignorant. Instead, I am experienced, observant, well-educated, and successful in three fields that require informed judgements based upon facts. I believe in making fact-based, well-reasoned investment decisions.

     

    Here are the facts as I see them:

     

    --As Low Sweat points out, stocks with regularly increasing dividends tend to do better.
    --Most share buybacks are undertaken when stock prices are high, not low. Companies tend to buy their own shares not when their valuations are the best, they tend to do it when their valuations are the worst. This is well documented.
    --Many well-run companies are well-run partly because of the discipline that a strong dividend program imposes. There is less cash to waste, so less cash is wasted.
    --If you don't think that companies waste cash, from the trivial (extravagent corporate events and palatial offices) to the meaningful (paying billions too much for acquisitions), then...well, I won't go there, I said I was going to be civil.

     

    Your use of the term "true value" suggests that you believe in the EMT. I do not, and in fact I consider it as discredited a hypothesis as the pro-dividend theories that you cite. I'll go with the facts as I see them: Companies with long histories of paying and increasing dividends have, as a group, produced better total returns than companies without such programs. And as a careful dividend investor, I'll add that I do not just invest in the category of companies with well-established dividend programs. I select my few investments one-by-one after careful analysis of the individual companies. I have a thoughtful strategy for doing this, and it works.
    1 Feb 2010, 03:10 PM Reply Like
  • TLassen
    , contributor
    Comments (198) | Send Message
     
    "There is a long-standing controversy in the investment community about the relevance of dividends as opposed to earnings as the true source of value of a company's common stock"

     

    Be it as it may, but to investors looking for true source of value to their investments, there is little argument against holding dividend paying companies.
    1 Feb 2010, 08:35 PM Reply Like
  • David Jackson
    , contributor
    Comments (1279) | Send Message
     
    Outstanding! And thank you for the link to the article I wrote so long ago.

     

    Perhaps the one justification for companies paying dividends is if they are in no-growth businesses where there's no ROI on new projects, and where the tax treatment of dividends for investors is the same as for capital gains.
    5 Feb 2010, 10:01 AM Reply Like
  • ForMyOwnAccount
    , contributor
    Comments (19) | Send Message
     
    Author’s reply » The above series of comments are all excellent. The greatest way to really test one's hypothesis or prejudices is, as Einstein said, "invert, always invert." In other words, if I am against the death penalty and you are pro death penalty, were we to be forced to get up on a stage in front of thousands of people and argue the OTHER side's case, then we may begin to understand the other side's position better if we had to make the argument for them. It is important to stay flexible, to move away from snap judgments and stubborn adherence to a view once it's been discredited. With all due respect to the "I love dividends" crowd, I still see greater long term value created by high ROI firms if they retain their earnings than if they pay them out. Therefore, I am solidly in agreement with Mr. Jackson's position yet still do not see the argument FOR paying dividends except when there is no ROI on new projects. Again, thanks to all for creating this lively and useful debate....To Div or not to Div, that is the question!
    9 Feb 2010, 01:58 PM Reply Like
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