Are dividends evil?

I have been seeing talk from various people lately saying that dividends are evil or that they don't believe in them. I think this may be a quick judgment made without a lot of rationality/logical analysis. Let's look at some facts about dividends and I'll be glad to hear some counterpoints. 

1. Dividends are money earned from an investment. This should not seem like a strange concept or an evil. Bonds, CDs and savings accounts pay dividends. But the real point is, think about what you would do if you ran your own business (as I do). You sell something or provide a service for a certain amount of money. A certain amount of money that you make is (if you are lucky) more than your expenses to make it and any money you are reinvesting in your business in the hopes of making more money. That extra money is profit. You keep that money and use it to pay your bills, take your girlfriend out to dinner, and so on. A dividend is a company paying that extra money to its shareholders. If you ran your own business you would pay some of its earnings to yourself; in this case others are running the business for you and making that decision.

2. Dividends are double-taxed, 15% on your end. While this is true with the exception of trusts and REITs, keep in mind the following. Dividends are earnings that are, once they are in your possession, no longer subject to the following possibilities:

A. Being given to the company's CEO, founders, directors, and employees. An astounding amount of money is "lost" this way right out of the accounts of supposedly profitable companies. Some companies' P/E ratios (Price to Earnings ratios) are almost meaningless to me because so much of the money is being given to the company's CEO, directors and others with a "claim" on them. A lot of the time it's more like stealing than a rightful claim.

B. Being paid as taxes by the company next year or "written off" as an expense or depreciation of some kind (goodwill, etc.) -- or given to charity. I am fine with donations to charity and taking credits on my taxes, but I would like to handle them myself.

C. Being diluted by: Stock option grants, direct purchase programs, or issuance of stock to: Pay debt, buy other companies, or raise money for the company's use. Check the shares in circulation trends of your holdings, you may be rather surprised. I had to drop several otherwise great growth companies because their share base was growing almost as fast as their earnings.

D. Being eaten up by the company in a grand number of ways. Corporations spend money so fast and in so many ways that it would take several posts to describe them all, and many of them do not help shareholders.

E. Being given away to buy the company's own stock. This is the most absurd premise I have ever heard of. It was not done in the old days, and I think there's a reason for that: it's vaporware. The money spent only benefits former stockholders directly (since they are being paid for stock they're selling and will no longer own). The idea is that buying back some of the company's stock will make future earnings more valuable (there will be more earnings per share). What no one seems to want to talk about is that while that may be true, the fact is that after this is done the company now owns billions of dollars less than it did before, and you don't have that money either! Not to mention that this implies that every single company doing this will make more earnings in the future than they do now, over and above inflation and the percentage of cash they just paid out to make this worthwhile. I hate to tell you but that is not always going to be the case. The other sad thing about buybacks that some people are just starting to catch on to is that many corporations are buying back their shares in part to hide the share bloat they are causing by issuing billions of dollars worth of shares to their CEO, inside and outside directors, etc. Between the buybacks and the shares issued, do you really think the company's earnings are directly helping you? They're more like, you guessed it: Vaporware. But hey, as long as we all keep (literally) buying into this game, none of us can lose right? I think it's best to go back to number 1 above and compare that to what's happening to the money in A through E here.

If you're completely comfortable with how your companies are using their money, by all means let them keep investing and spending it however they want to. But otherwise--and I don't think that you'd think that of the majority of publicly traded companies if you gave a serious look into their workings; it's called Stewardship and there's a reason it's hard to get a high grade in it from Morningstar and other analysts--I wouldn't sneeze at earnings you can put in the bank, reinvest however you choose or buy a nice steak with. Letting earnings compound within a stock may be the most efficient way to grow them--if they are indeed compounding.

Tremendous post.  I read a good article recently that focused on the stock buyback issue and exactly what you mentioned. Per the article, the poster boy for this issue could be Cisco who plowed back huge sums to repurchase shares over the past six to seven years.  However, the net effect after new issues for stock options was basically nil.  All of those earnings had effectively been used to simply support options programs and maintaining the existing management and employee base.  As an investor, I would not call that a successful investment.

Also, simply relying on share price appreciation leaves you totally vulnerable to PE ratio expansion or contraction.  GE and MSFT are much larger and more profitable today than five years ago but the share price is stagnant due to PE contraction.  So, if you bought fve years ago you were right about the performance expectations for the companies but still "lost" as they did not meet the "market" expectations.

 

Good points; Cisco is certainly one of the worst offenders in this area.  This has been the case with many of the dot-com companies that are still around; I think this is part of why their share prices are still stagnating even though their P/Es have come to down to justifiable levels.  They learned during the dot-com bubble that they didn't necessarily have to care about their fiduciary responsibilities (stewardship), and they are still being very irresponsible with extravagant share options, buybacks and shady accounting.  I own GE and owned MSFT until recently and know exactly what you're talking about; these are great companies but P/E ratios were completely outside of rational limits in 1999-2001.  If you owned GE's entire company, would you invest another $500,000 in it in order to make $10,000 a year?  Probably not, but that's what the market was doing at that time.  But at least these companies seem to know that they should reinvest their earnings and if they can't do that, pay them out.  Anyway thank you for your comments!

P.S.  I have read from a couple different sources that companies often actually pay a *premium* for buybacks.  Does anyone have any figures on this?  This is definitely an awful idea.  Why pay a premium?  Just buy the stock on the exchange like everyone else.  Isn't any premium paid for the stock actually company earnings that should have gone in YOUR (the one who still owns the stock and cares about the company's future) pocket?

Zenmonster

Way back in the stone ages when I first began to invest in stocks we bought stocks hoping they would increase in value but dividends were also a factor in most purchases. Dividends are a way of compensating a stock holder for  investing in the company. I still buy stocks that pay good dividends. One of the most lucrative is sea transportation and the ones I like best are the oil transports. Double Hull Tankers being one of the companies that has a fleet of the double hull oil tankers and has been declaring high dividends.  The single hull tankers are soon due to become obsolete. Oil transport will be around for some time to come and most of these companies are doing very well. Dividends will continue to be part of my reason for considering an investment, but I also enjoy the thrill of the gamble on fast trade volitle stocks on a limited basis. I'm a small fry in a large pan of traders.

Retired

 

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Retired.....

You also need to keep in mind that most companies which pay dividends are either companies with no room left to expand and have a low growth percentage i.e.Bank of America and GE, or they are high risk companies i.e.BP Prudhoe Bay Royalty Trust and FRO are the only two I can think of off the top of my head.

I would have to disagree there; sure that's the accepted notion, but basically dividends are to be paid out any time a company can't put that money to better use for the shareholders.  Look at WFMI, MSFT, TUES and GE; these companies are growing but simply have too much money coming in to invest properly, and/or they have a commitment to giving some of it back.  Yes I included GE there; I got their annual report last week and I think anyone who thinks they aren't going to grow at a 10-20% rate for the next 10 years is selling them short (perhaps literally).  Their approach to their companies ("forced growth" practically) is almost Buffett-like and I think it's great.  They're very involved in the emerging markets, infrastructure development and renewable energy.  But back to the point, most dividend-paying securities aren't high-risk; in fact their dividends help with that point.  Just because a few very high yielding stocks are high-risk is simply the nature of the game; the stocks with the lowest P/E ratios are probably on their way out of business, too.  The Canadian trusts often have yields that trounce BP Prudhoe and they're pretty solid; and I actually don't see how BP Prudhoe is very risky.  It's not like oil isn't going to keep flowing from Alaska, we need it too much to allow it to stop.  And when it ever does, I believe you'll get most of your principal back.  These are opinions based on previous research, not a recommendation to buy; I have positions in GE and WFMI, as well as clean energy out the wazoo.

I think we should not forget that the stockholders are the owners of the company.

We need to revisit how it use to be (and still is in some cases), when a small company needed an infusion of capital to expand, probably because the company was making a good product and gave good service and was growing. The owner began to look at options.

The owner is seeing orders coming in faster than the company can handle without expanding, but needed more capital to do so. He would have gone to family, friends and others he knew, showed them his financials and opened the books to them, telling them how the future looked for the company. He would have told them that if they would each invest in the company to help the company grow, he would issue certificates of their divided ownership interest in the company. He would also have told them "if the profits continue, (we) the now owners should pay ourselves a percentage of the net profits determined by the division of ownership", in other words - a divided interest.

Some of them, at some point, may have sold their interest to other share holders or friends. The original owner may have bought some of their shares. 

Coming later, Board of Directors, CEO's, and Stock Exchanges and with that, complicated interest.

A simple reminder that the stockholders are the owners of the company and a good reason to pay dividends. 

Retired.....

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Retired.....

I don't belive Dividends are evil and it seems stupid for individuals to feel that way.  IT is usually those who have no money or have severe saving issues that may feel that way.  Dividends are our return of capital just as you stated interest baring account return income to those who loan out money to Banks and S&L's.  I belive the Dividend tax rate is still to high.  In order to reduce the crisis we have of Savings in this country we need to increase the incentives for the low and middle class to save more.  With the JGTRRA of 2003 and the TIPRA.  Here is some interesting information I have dug up for you and others who enjoy dividends.  In California we have double taxation or infinite taxation on used car sales.  You can sell a car one hundred times and pay sales tax on that car that it could possibly exceed the orginal cost of the car.  John K. Galbraith had brought up that we as US residents or citizens can expect to pay 60-80 percent of our money in some form of taxes.  Dividends are a great way for us to save with their lower taxation rate and we need to take back our savings and maximize these wonderful returns of capital to us. No Taxes on Dividends as they help the Economy!

Dividends

[on edit, I withdraw my remarks on the grounds that later posts by others address the same aspects either more thoroughly or more accurately]

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Regards,
cjo27bp

I think the current tax rates are (these are off the top of my head here, help me out if they're wrong) 18% on long-term capital gains and 28% on short-term capital gains, and you have to hold a stock for 18 months to get the lower long-term capital gains rate.  So you pay a lot less tax on dividends than short-term capital gains, but it evens out with long-term cap gains and of course over a very long horizon (5, 10, 30 years) you will make out better on the long-term capital gains since they are able to grow within the stock without being taxed each year--but that is of course only if the company is truly compounding its earnings and not wasting them.  I would like to see some figures on how much of its earnings a company can "waste" and still stay ahead of what you would make if they paid out the earnings as dividends.  I'm going to try to work this out one of these days, but the prospect is a bit daunting.

And -- you're right, return of capital -- when a company pays out more than they're earning or have earned in the last few years -- is very bad.  (Your comments help me come up with this topic, but I've been seeing those comments from a lot of people, not just you!)  Vote against it if you can, and drop any stock that you know is doing it.  Unless it's for your retirement and that's what you want/need. 

I sometimes pick companies based on dividends. However, I like to know that their fundamentals back up their dividend. If there is no fundamentals to back up those dividend payments, it is more like a liquidating dividend as the company cannot afford to make such a dividend payment. I have the same dismay over companies that issue buybacks where the motive is simply to follow the herd and not because the company can afford it. I think it is a prudent move if you're intentionally buying back stock to reissue later at a higher price.

I think there has been a chokehold of company buybacks and share prices have gone up even for companies that have bad fundamentals. I am a value investor who likes to choose my stocks on the basis of fundamental analysis. If the market is using fundamental analysis in the same manner that I do, the activity will already be priced into the stock and thus there will be no advantage or less advantage to fundamental analysis. I think fundamental analysis is a good way to see if a company has a strong capital structure or if either solvency or liqudity is a problem. It also shows what its growth potential is and whether it is growing at a decent pace, too fast, or too slow.

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Aqua

Dividends can be good or bad, for me early in my investing career i could care less about dividends, there nice but i wouldn't put stocks solely into a company based off them.  I try to be more aggressive while I am younger then when I get older maybe look for companies that cut dividends or have a high dividend cutting percentage.  However, it really just depends on what you want to do, but be leary of new companies cutting dividends and you want to know the fundamentals of the company like aquaswim47 mentions.

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