The Case For Dividend Stocks
December 25, 2017
Why Dividend Stocks Outperform
“I hate dividends,” wrote tech investor Andy Kessler in a Wall Street Journal op-ed.
“When [companies] pay a dividend, they are admitting they have nothing better to do with their money. If they won’t invest in themselves, why should I?” (Source: “I Hate Dividends,” The Wall Street Journal, December 30, 2002.)
Vox executive editor Matthew Yglesias called dividends “a triumph of short-term thinking.”
“Bad for the economy, bad for business, and surprisingly unfavorable to investors,” he said. “A barbarous relic of a less financially sophisticated era.” (Source: “Dividends Are Evil,” Slate, December 13, 2013.)
Pity the humble dividend.
The hot and new has replaced the tried and true. Why bother with dividends when you can strike it rich overnight on the next cryptocurrency?
Wall Street hates distributions. Money paid out to shareholders, after all, doesn’t fund fee-generating mergers and acquisitions. Investing in the next big thing also makes for great banter around the water cooler.
I disagree with the prevailing view. Yes, dividend stocks don’t make for the most riveting conversation. Yet focusing on the staid and stodgy can pay off for patient investors.
Here’s why.
Dividends Provide a Signal to Shareholders: All firms say they put investors first. And if you believe that, I have a saying about bridges and Brooklyn or something. In reality, most businesses operate for the benefit of insiders. Dividends, however, show that executives know who owns the place: their shareholders. They indicate management’s willingness to reward investors rather than just themselves.
Dividends Encourage Long-Term Thinking: Once a company starts paying dividends, investors expect them to stay steady over time. This forces management to consider their actions far into the future—years, if not decades. Moreover, income investors, in contrast to fast-money growth traders, don’t tend to jump ship at the first sign of trouble. This gives executives more room to consider long-term projects, even at the expense of short-term profits.
Dividends Limit Bad Investments: If they can earn a good return, companies should plow profits back into their business. But in most cases, firms have only a few good ideas in front of them. With a restaurant on every corner, does McDonald’s Corporation (NYSE:MCD) need to build more locations? With three cars in the average American’s driveway, does General Motors Company (NYSE:GM) need to build more plants? With smoking rates on the decline, why would Altria Group Inc (NYSE:MO) need more factories? In mature industries, returning profits to shareholders makes the most sense.
Dividends Limit Acquisitions: Firms searching for growth can turn to acquisitions. These work out great for managers, who get paid more to run a larger business. Not to mention the big paydays for any bankers, lawyers, and consultants involved; these guys collect a big commission. Shareholders, though, should look at these deals skeptically. For one thing, growth often comes with a big price tag. For another, integrating and managing a new business can lead to mistakes. For these reasons, investors often prefer cash in the bank over risky acquisitions.
Dividends Limit “Diworsification:” Companies can expand into new businesses to grow earnings. In most cases, however, this only dilutes shareholder returns. Worse, expertise in one business might not translate to another. For example, consumer products maker Clorox Co (NYSE:CLX) does a great good producing bleach. These talents, however, might not translate into building electric cars. It’s far better for executives to stick to their knitting, milk existing operations, and pay out dividends to owners.
Dividend Stocks Outperform: Between 1972 and 2014, dividend-paying stocks delivered a nearly 15-fold better return than their non-dividend-paying peers. Moreover, a portfolio of dividend stocks accomplished this feat with far less volatility. Success, it seems, doesn’t come from short bursts of big profits, but rather from sustaining modest returns over long periods of time. (Source: “Building Wealth Through Rising Dividends,” Goldman Sachs Group Inc, last accessed December 3, 2017.)
Dividends Boost the Economy: Critics see dividend payments like a kind of cash incinerator, a black hole where capital disappears into oblivion. Of course, distributions just move money around. One-fifth of each dividend payment goes to the government in taxes, which funds our social programs. Some of this money gets spent on goods and services, which keeps the economy humming. Some of this money gets reinvested, which funds the next round of exciting businesses.
In other words, much of the cash paid out by old tech giants like Yahoo!, Microsoft Corporation (NASDAQ:MSFT), and Cisco Systems, Inc. (NASDAQ:CSCO) didn’t vanish. It funded the next generation of innovators like Tesla Inc (NASDAQ:TSLA), Facebook, Inc. (NASDAQ:FB), and Alphabet Inc. (NASDAQ:GOOG).
