Dividends are a hot topic, usually because they’re associated with passive income. Bargaineering, a popular finance blog, asserts that dividends are good, and he even tackles a few common objections.
In the spirit of going deeper into every issue, here are a few reasons I don’t always dig dividends:
Why I don’t dig dividends:
- Risk – Dividends may soften the blow to share price during periods of economic contraction, but that doesn’t mean they’re always good. In fact, one of the best ways to kill a company’s share price (if only temporarily) is to cut a dividend. Investors who have become accustomed to dividend payments will sell off companies like seniors do to would-be entitlement-reforming politicians when the dividend gets cut. Many strategists have said that buying after a dividend cut makes a lot of sense as weak hands sell out, and bad news unfairly punishes stock prices. In many cases, the additional cash may provide for a better, quicker turnaround, as was the case with La-Z-Boy.
- Better Uses for the Money – Dividends are generally associated with slow-growing companies anyway, so we’re going to ignore that companies could make capital investments internally. Instead, I would prefer a company actively buy back their own stock with their cash on hand, which increases my percentage of ownership much like a DRIP would, but does not increase my tax bill. I’ll admit there are opposing views to this policy, mostly that buybacks aren’t always used to generate net decreases in available shares. In some cases, repurchased shares may just negate stock options given to executives. However, dollar for dollar, buybacks go 15% further than dividends.
- Higher Multiples – The name of the game on Wall Street is cash flow. Investors don’t want to carry assets that are negative carry—those that don’t pay out a stream of positive income and may sometimes require further injections of capital. Since Wall Street likes cash flow, it loves dividends, and often overpays for companies (on an earnings-multiple basis) that provide a stream of cash to their shareholders. This is especially true right now as blue chip dividend yields are virtually interchangeable with corporate debt yields. Distributing cash in the form of ownership with buybacks pushes away investors who are looking for an external return, and keeps all the goodies for investors like me who are cool with internal returns. 😀
- Taxes – Companies have a record amount of cash, but most of it is overseas. To bring cash to the US is costly; the US corporate tax rate isn’t exactly low. This is, among other reasons, why I think Google decided to issue $3 billion in bonds even though it has $37 billion in cash—they needed some US money on the cheap. I don’t want companies to be spending their highly-valuable cash (US-based cash) if they don’t have to.
- Dividends Increase Available Purchasers – One of the best ways to increase the value of something is to make it so that more people can afford to buy it, or buy more of it. In the United States, many mutual funds are limited to purchasing only companies that pay a dividend, which is why so many companies decide to pay out a $.01 quarterly dividend to maximize immediate shareholder value. (Citigroup recently declared a quarterly dividend to draw in mutual funds.) I want to buy companies other investors can’t buy because then I’m more likely to buy them at a cheaper price to their peers. Structural advantage strikes again!
- Dividend strategies are half-baked – The Dividend Aristocrats index might be a popular index for dividend investors, but it does throw off some errors. To be a so-called “Aristocrat,” a company must be a S&P500 stock, and raise its dividends for 25 years straight. This strategy might sound fool-proof, but it recently tossed aside one company, Nucor, because the firm paid out a special dividend in 2008 that couldn’t be matched in 2009.
There you have it: six reasons (that aren’t already plastered all over the internet) I don’t like dividends. This isn’t to say that dividends are bad; they’re just not criteria for a quality investment.
What do you think of dividends?
Do you like them, or would you prefer other incentives like share buybacks?
Are dividend stocks a large part of your portfolio? Do you live off the income; if not, would you like to?
Photo by: btk120