Dividends and dividend-paying stocks are getting renewed attention in recent months. This brief white paper seeks to survey the dividend paying stock questions and issues and provide some observations and historical data.
Dividend policy is a matter of capital structure in that companies use dividends to repatriate cash to shareholders or choose not to pay dividends in order to reinvest in their business. Some companies even borrow to sustain or increase dividends as part of a decision to include more debt in their capital structures, others just to sustain dividends in down years.
In general, mature, slower-growing companies tend to pay regular dividends, while younger, faster-growing companies would rather reinvest the money toward growth. Some market pundits claim that dividends are irrelevant to the overall performance of a stock. On the theoretical side, Franco Modigliani and Merton Miller posited in their famous article on the “irrelevance” of dividend policy, that the underlying expected earnings and cash flow of companies, not their dividend payouts, determine market values. However, back-tested history indicates that public companies with dividends (especially rising dividends) produce higher overall returns for their shareholders and experience lower volatility over a long-term investment horizon. Rising dividends over an extended period indicates efficient capital management, as well as sufficiently strong cash flow and profits to support the growing dividend payouts.
Rising dividends over the long-term indicates that a company is able to withstand changing economic conditions. A company that can effectively get through the up-anddown cycles of the market and maintain its rising dividends clearly is well-managed and will provide dividend income, dividend growth and asset appreciation. Like so many things in stock market analysis, there are no standards in dividend analysis. However, many would argue that a company that can maintain a 25-year record of consecutive dividends without a cut is a Dividend Aristocrat. Reinvesting rising dividends from good quality growing companies can have a significant positive impact on a portfolio. Didn’t Albert Einstein coin the phrase that compound interest is the eighth wonder of the world?
Dividend paying stocks provide a way for investors to get paid during rocky market periods, when capital gains are hard to achieve. Dividend-paying stocks, on average, tend to be less volatile than non-dividend paying stocks. And a dividend stream, especially when reinvested to take advantage of the power of compounding, can help build wealth over time. However, dividends do have a cost. A company cannot payout dividends to shareholders without affecting its market value. Cash that a company pays out to shareholders is cash that is no longer part of the asset base of the corporation. This cash can no longer be used to reinvest and grow the company. A stock price adjusts downward when a dividend is paid.