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On Tech Company Dividends

There’s a lousy idea floating out there, that it is a bad thing for a tech company to pay dividends (also here).  Not true!  Companies that pay dividends treat their capital more carefully, because now their equity has an explicit cost.  Studies that I have read indicate that dividend-paying stocks do better then those that do not pay dividends, in the long run.

That said, it doesn’t mean that companies that pay high dividends do better than those with low dividends.  It is well-known in REIT stocks that those that pay low but growing dividends have outperformed those with high dividends that grow slowly.  The right combination is that a small dividend is paid, and the company uses the retained earnings wisely, in order to grow the business profitably, leading to increases in dividends.

When Microsoft started paying a dividend I was a skeptic, because Microsoft was overvalued at the time.  No degree of financial engineering would change that.  Dividends are at most a modest positive for any stock.  Better you should look at the underlying ability to grow free cash flow and be able to reinvest it well.

That’s where investors should focus.  Dividends are good, but growing dividends are better.






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4 Responses to On Tech Company Dividends

  1. acamus says:

    I Agree.

    Microsoft has grown just fine over the last decade. Similarly, I talked with a long term investor in Cisco today, another dividend paying tech stock, and the person expressed a disappointment about the lack of growth. Not true if you look at the financials; the issue was the initial valuation, at the height of the tech bubble. The trouble is not the dividend; it was their initial valuation, or lack thereof. Correlation is not causation.

    On REITs though, are they not required to pay 90% of income to shareholders to retain their REIT status? Is a higher retention ratio, given its relatively narrow range for a REIT, really a likely dividend growth driver?

    I would agree immediately for a company that is not a REIT or a BDC. I’m not arguing since I don’t invest in REITs much. I’m interested because some of them do grow book and my only explanation is it’s because some issue new shares and because some (but not all) REITs might be expected to move somewhat with inflation over the long term.

    Kind regards,

    Al

  2. Conscience of a Conservative says:

    I would say the converse is true. I tend to pick on Microsoft for this example. Other than Windows I find it hard to see examples where cash has been widely spent, Microsoft should follow the Tobacco model and treat the business as a liquidating enterprise , invest just enough to keep the main business going and pay out all cash as liquidating dividends. Every time they buy a company instead of paying out dividends they are committing a capital affront.

  3. [...] David Merkel, “Dividends are good, but growing dividends are better.”  (Aleph Blog) [...]

Disclaimer


David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures.


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