YEAH, THE BIG DIVIDEND PAYERS ARE GETTING RICH, BUT…

4/29/13

I’ve already written extensively on the virtues, or lack thereof, in investing in stocks that pay big dividends; see, most recently, my 4/16/13 piece, S&P YIELDS VS. BOND YIELDS:  I’M YOUR MAN WHEN IT COMES TO STATING THE OBVIOUS.   However, a page C1 article in today’s (i.e., Monday, 4/29/13, “In Stocks, Payouts Trump Potential,” by Jonathan Cheng) Wall Street Journal, which argues that, in at least some smart people’s minds, the dividend payers are getting rich, prompted a few more thoughts.

First, as I have said in the past, buying the dividend payers has become a crowded trade.  See my 2/2/13 post, YES, I’M STILL HOLDING ONTO MY TIPS, in which I revisited this even then old argument in something of a sidebar.   Nonetheless, I am maintaining a large portion of my equity holdings in big dividend payers.   Why?   Because, after much consideration and reflection, I have determined that companies that pay big dividends, and especially companies that consistently increase their dividends, are sounder long term investments, at least for people with my risk preferences and investment goals, than companies that pay either no or low dividends and have no consistent record of increasing those dividends.  Not only is it nice to receive cash on a regular basis, even if one immediately reinvests that cash, but, as I tell my students, companies can fake net income all they want with the help of a creative accountant.   It is very difficult, on the other hand, to fake dividends.   In order to pay and grow dividends, an enterprise has to generate cash, do so consistently, and come up with ideas for consistently generating more cash.   That is why I like dividend payers for the long run.   That these stocks appear rich at the moment does nothing to detract from that argument. 

Second, the aforementioned Wall Street Journal article states, using Procter and Gamble (“P&G”) as a kind of surrogate for all big dividend payers,

Investors are attracted by P&G’s sturdy dividend yield of 3.1%, ASSURING THEM AT LEAST A MODEST RETURN ON A STOCK KNOWN FOR ITS RELIABLE PERFORMANCE.  (Emphasis mine)

Wrong.  No dividend yield assures “at least a modest return” to investors.  If the price of the stock falls by more than the dividend yield, the shareholder generates a negative return.  A dividend provides a modest buffer against losing money, but provides no assurance of even a modest return.  See again my 4/16 piece.

Third (and I am not the first observer to say this), this near obsession with dividend yield is probably a negative for our economy.   Shareholders demand dividend income due to what I like to call Ben Bernanke’s War on the Elderly and thus bid up the prices, and hence the price earnings ratios (“P/E”s), of dividend paying stocks.   Managements, wanting to do their jobs and keep stock prices and valuations high, thus look for ways to maintain and increase dividends.

If managements increase dividends by returning to shareholders money that would otherwise be blown on unproductive “investments” like acquisitions that make little sense from either a strategic or financial perspective or airplanes, cars, and other ego trips for corporate bigwigs, such a search for dividends is desirable; after all, a company’s profits are its shareholders’ money.  

However, if managements, out of desire to keep dividends high at all costs, forgo productive investments that would enable their companies to grow and thus continue to pay dividends, the results could be deleterious, even disastrous, from the standpoint of the companies involved and their shareholders.   And if this practice is followed throughout the economy as investors demand more immediate income in the form of dividends, the consequences for the growth potential of our economy would be dire.