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How Important are Dividends?
by David Van Knapp,
author of
THE TOP 40 DIVIDEND STOCKS FOR 2010:
How to Generate Wealth or Income from Dividend Stocks
and
SENSIBLE STOCK INVESTING:
How to Pick, Value, and Manage Stocks
June, 2006
Dividends are transfers of cash by the corporation to its owners—portions of a
company’s profits paid out to the company’s shareholders.
Every company has to decide what to do with its earnings. It can plow them all
back into the company to fund growth; make acquisitions; or undertake special
projects. Or, it can siphon off some and return them as dividends to
shareholders.
Reasonable minds can differ as to which is better, dividend-payers or non-
payers. Those who think that a dividend-paying company is usually a better
company cite factors like these:
· The company must be financially solid; otherwise the Board of Directors
would not pay out the money.
· Cash flow must be plentiful. The dividend probably reflects management’
s confidence in the stability and growth of future earnings, quite possibly based
on information that is not publicly available.
· A company that pays dividends will probably invest the earnings it does
retain more carefully. The dividend program imposes discipline upon
management, which makes better decisions about what to do with the remaining
money.
· Dividends tend to put a “floor” under the price of a stock and to increase
the predictability of returns.
In contrast, these are the reasons most often given that companies which are
better investment opportunities do not pay dividends:
· Companies on a growth track need all the money they can to make
acquisitions and fund good internal projects. Therefore, it is in the long-term
interest of individual investors that the company not pay dividends but rather
that it reinvest in growth and improvement.
· The payment of dividends suggests that the company does not have
enough good reinvestment ideas—i.e., it is a maturing, mature, or stagnating
business.
While both sets of arguments make sense, The Sensible Stock Investor finds the
first set to be more compelling. That is, the payment of dividends, especially a
long history of not only paying but also of increasing dividends, probably points
to superior companies with a higher probability of sustaining their earnings
growth.
That said, great companies can come in either form. One of the greatest wealth-
generators of our time, Warren Buffett’s Berkshire Hathaway, has never paid a
dividend. Of course, with Buffett running the show, Berkshire’s many managers
probably do very few stupid things with the money at their disposal.
by David Van Knapp,
author of
THE TOP 40 DIVIDEND STOCKS FOR 2010:
How to Generate Wealth or Income from Dividend Stocks
and
SENSIBLE STOCK INVESTING:
How to Pick, Value, and Manage Stocks
June, 2006
Dividends are transfers of cash by the corporation to its owners—portions of a
company’s profits paid out to the company’s shareholders.
Every company has to decide what to do with its earnings. It can plow them all
back into the company to fund growth; make acquisitions; or undertake special
projects. Or, it can siphon off some and return them as dividends to
shareholders.
Reasonable minds can differ as to which is better, dividend-payers or non-
payers. Those who think that a dividend-paying company is usually a better
company cite factors like these:
· The company must be financially solid; otherwise the Board of Directors
would not pay out the money.
· Cash flow must be plentiful. The dividend probably reflects management’
s confidence in the stability and growth of future earnings, quite possibly based
on information that is not publicly available.
· A company that pays dividends will probably invest the earnings it does
retain more carefully. The dividend program imposes discipline upon
management, which makes better decisions about what to do with the remaining
money.
· Dividends tend to put a “floor” under the price of a stock and to increase
the predictability of returns.
In contrast, these are the reasons most often given that companies which are
better investment opportunities do not pay dividends:
· Companies on a growth track need all the money they can to make
acquisitions and fund good internal projects. Therefore, it is in the long-term
interest of individual investors that the company not pay dividends but rather
that it reinvest in growth and improvement.
· The payment of dividends suggests that the company does not have
enough good reinvestment ideas—i.e., it is a maturing, mature, or stagnating
business.
While both sets of arguments make sense, The Sensible Stock Investor finds the
first set to be more compelling. That is, the payment of dividends, especially a
long history of not only paying but also of increasing dividends, probably points
to superior companies with a higher probability of sustaining their earnings
growth.
That said, great companies can come in either form. One of the greatest wealth-
generators of our time, Warren Buffett’s Berkshire Hathaway, has never paid a
dividend. Of course, with Buffett running the show, Berkshire’s many managers
probably do very few stupid things with the money at their disposal.
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