Dividends & Income Digest: Can Dividends Be A Terrifying Proposition?

| About: Apple Inc. (AAPL)


Every issue, SA explores a dividends & income investing topic.

This time, SA technology editor Rocco Pendola and I discuss whether dividends portend an end to growth for their issuers.

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Last week, Seeking Alpha's editorial team was in Manhattan for our annual summit. While there, technology editor Rocco Pendola and I got to talking about ideas for this issue of the Digest, because frankly, my well was dry and I needed some inspiration.

Rocco was candid in noting that he uses Seeking Alpha's DGI community as a model (and inspiration) for how he would like to see our platform's tech section evolve. It's tight knit and the exchange of ideas flows unmatched on the financial web. From veteran contributors to new authors, frequent commenters to new SA users, and everybody in between, investors share strategies, track portfolios and, best of all, challenge one another critically and aggressively, yet constructively and professionally.

Within that context, we thought it would be great to stimulate our community's collective mind by exploring perspectives on how DGIers approach tech stocks. Specifically, how do investors, particularly those hyper-focused on income-dependent growth, make calls on tech stocks such as Google (NASDAQ:GOOG) (NASDAQ:GOOGL) (d'oh, I mean Alphabet) and Amazon (NASDAQ:AMZN)? Do they have to cross the Rubicon into Microsoft (NASDAQ:MSFT) and, more recently, Apple (NASDAQ:AAPL) territory to even get a look?

On the flip side, some investors contend that tech companies in particular enter less-exciting, "non-growth" phases when they begin paying dividends and/or buying back stock. But at that point, what does the company become...? Mature? Value? Dead money?

Rocco and I figured these questions make for an exceptional starting point for a lively debate in the DI community, and I know you all are good for it. To get this party started, here's a little Q&A we put together, where I grill Rocco on his tech sensibilities and elicit his thoughts on which of today's growth companies might be the potential dividend payers of tomorrow.

Robyn Conti: Well, let's start with the obvious ... in your opinion, what happens to a so-called growth company when management decides to pay a dividend and begins using excess cash for capital returns to shareholders versus investing in the business?

Rocco Pendola: While I can see both sides of this argument, it's really company-specific. In some situations, it's truly the case that management sees the writing on the wall and realizes it needs to provide additional incentive for investors to want to own its stock. I think that's what happened at Apple. And, frankly, through that prism, it's a pretty terrifying proposition.

RC: Why is this such a big deal?

RP: It all comes down to psychology -- from an investor standpoint, within the tech community and inside the company that is thinking about or ends up paying a dividend or buying back stock.

We argued about this psychology with respect to Apple for at least a year on Seeking Alpha. Consider what I wrote on SA in 2012:

If you want dividends, you should have been building positions, over time, in dividend-paying blue chip stocks. AAPL is not a dividend-paying blue chip stock. It is an innovative hyper-growth machine in perpetual start-up mode that needs to stay that way or die.

I honestly think Apple executives view the situation in that regard. Why in the world should we pay a dividend? It's not in our culture. It does nothing for everyday shareholders and it only makes the already rich (thanks to Apple) richer. As an AAPL bull, I hope Tim Cook and the Apple board does not give in.

So, I was wrong. But I would argue the same point today. Almost exactly four years later. And I think the pace of innovation at Apple (or lack thereof) supports my position. That's not to say the stock isn't a fantastic position for dividend investors (which is one contradiction from what I said in 2012), it's just that the psychological impact of the capital return plan doesn't bode well for company culture, even if on a subconscious level. And I firmly believe that this seemingly subtle erosion of culture, this implied pullback on startup mode plays a meaningful role in thwarting growth at the company and return on investment for shareholders.

RC: I'm wondering aloud here, and I hope they'll share their thoughts in the comments, but I wonder what some of our dyed-in-the-wool DGI evangelists (I mean that in the most positive sense) would have to say to that? Like David Van Knapp, who's known around here as "the godfather of DGI," and who's consistent in his philosophy of "not deviating from your process," and Regarded Solutions, who's really exceptional at tuning out market noise, and whose number-one priority, no matter what, is preserving and growing his dividend income stream. Obviously, I don't expect you to speak for them, but maybe you can speak to them, and to the community at large, about your thoughts on amassing positions in blue chips vs. these tech dynamos. It sounds kind of like you're on the same page as the DGI crowd, which I have to say, is a little surprising, because I'd take you for a growth guy, every time.

RP: Here's the thing -- I have such great respect for so many of our D&I authors I can't possibly name them all. And I don't have their discipline. It's not in my DNA. I'm the kind of investor -- mostly to my detriment -- who can't resist a stock such as Pandora (NYSE:P) when it hits a certain point. So I'll buy some and write covered calls against it. That's a bit of an income strategy, but I'm sure guys like Van Knapp and Regarded would scoff at that. And rightfully so! Because what they do doesn't work if you fudge every once in a while. It's even worse if you deviate and see some success because it makes it more likely that you'll have triggered this false confidence that leads you to deviate from the plan again.

So I get it. But I'm all about not being married to one perspective. I like to explore them all and even support multiple, often competing perspectives at the same time. I find that's the best way for me to learn as an individual as well as the best way for me to provide value as a writer. So, in that spirit -- and I know some D&I-focused investors do this -- is there room within the framework for investing in companies that don't pay a dividend, but are too attractive to pass up from a growth and potential out-sized return standpoint?

Or look at this way -- and I'm sure Eli Inkrot, as one example, could do killer work analyzing this -- can you speculate more responsibly, if you will? In other words, instead of buying Pandora because you think you know how the stock trades and selling calls can be relatively lucrative, do you take a more focused approach and accumulate positions in companies with few weaknesses (the anti-Pandora in many ways) that have a good chance of eventually paying a dividend?

So, as the speculation about a potential dividend populates Seeking Alpha, you're buying Google every month or something. I wonder if an investor would be better off having purchased Apple when the dividend conjecture heated up or once the company made the official announcement that it would pay a dividend. I don't know the answer to that question, but it would be interesting to find out.

RC: Do you think Google, er, Alphabet, will ever pay a dividend? Do you think they should?

RP: I'll give two answers here. Because you asked two questions. And if I give two answers, I won't be wrong. Plus this is really just my perspective, which, again, is more useful than a prediction.

This might sound funny to a lot of people, but I have walked through Google's massive office in Manhattan. And sort of like you can feel the energy on the streets of New York City, with people milling in and out of bars at two in the morning, you can feel that vibrant Google attitude. And the Google attitude doesn't exude, "Let's do what Apple did and pay a dividend because everybody, seemingly, wants us to." I'd like to think Google has more Steve Jobs left in it than Apple does. And that it respects the notion many investors consider too lofty, abstract and impractical... the notion that the messages you send with respect to how you use your cash impacts company culture.

That said, Google hired a new CFO who practically everybody thinks is there to be the adult in the room in relation to Google's cash. So, if this assessment is correct, they'll pay the dividend. And, while I don't agree with it on this somewhat theoretical level I like to operate from, I see the point. The more pragmatic crowd says, "What's the big deal? Like Apple, Google has more cash than it could ever possibly spend or need. Why not give some of it back to the shareholders? (Or take out cheap debt to get the job done)." And that's certainly a perspective I can respect and appreciate.

RC: Are there other tech, growth-oriented companies that may be ripe to pay a dividend in the future? I know you're a market watcher in general, too, so are there growth companies in other spaces that you think might be potential candidates to pay dividends going forward?

RP: I really have no idea. I do think it's interesting, however, to consider management's attitude on other things as an indicator of whether or not they might pay a dividend.

Obviously, Netflix (NASDAQ:NFLX) is in absolutely no position to pay a dividend right now and probably won't be for quite a while, if ever, but Reed Hastings and his CFO David Wells strike me as guys who would never pay a dividend. They have resisted so many ways to amping up Netflix's revenue basically to preserve the integrity of their service. For example, they could have started doing ads a long time ago. But they haven't. And I respect that. I can extrapolate that out to say they want to preserve the integrity of their startup culture by not paying a dividend, providing copious amounts of stock options to their employees and delivering massive returns for their shareholders. I mean, do you think long-time NFLX investors are upset that there's no dividend?

Myriad examples exist like this. Can you see Jeff Bezos ever paying a dividend at Amazon? Again, it sounds laughable now, but, in our lifetime, there's a chance Amazon has a balance sheet as solid as Apple's or Google's. Not to be morbid, but to tell it as I see it -- Bezos would have to go the way of Jobs for Amazon to start paying a dividend.

That said -- because I like to take various perspectives -- consider Facebook (NASDAQ:FB). It could become the modern day General Electric (NYSE:GE) in that you don't work for Facebook forever, owning their stock and reinvesting their dividends, but the company is such a part of your everyday life -- you're so invested in it, so to speak -- that it functions like GE for long-term investors. You know -- a double in the stock price over a five-year period alongside an attractive dividend yield.

Now it's your turn to weigh in. Do you believe dividends signal the end of a company's growth phase? Are dividends likely not a part of Alphabet's DNA? In your opinion, which growth companies, if any, might be ripe to pay dividends in the near-ish future?

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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