“Show Me the Dividend”
Sydney M. Williams
“A man’s got to know his limitations,” so spoke Harry Callahan (Clint Eastwood) to his superior, Lieutenant Neil Briggs (Hal Holbrook) in the iconic 1973 film, “Magnum Force.” So too, must businesses know where they are in the cycle of life.
Companies are born, become youths, enter adolescence, mature, age and eventually die. While the time frame varies based on management, industry and luck, how they handle that change is of enormous importance to shareholders. While most investors look for businesses in their lusty adolescence, there are distinct opportunities for investors and managements at aging businesses.
As companies mature, opportunities for growth (and therefore for reinvestment of cash flow) generally become less for a variety of reasons – size, competition, older technology, etc. As R&D spending and other investments decline, free cash flow tends to increase. Managements faced with such situations have a number of choices: they can re-invest for subpar returns; they can make acquisitions in areas of perceived growth; they can pay themselves better, or they can return money to shareholders (the actual owners of the business) either through share repurchases or – my preference – initiating or increasing dividends. My preference is for dividends for two reasons: 1) a dividend implies a commitment not inherent in stock repurchases and, 2) share repurchases require a management to do so on a disciplined basis, calculating the return on the invested capital versus alternatives. Not all managements can be trusted to do so in the interest of shareholders.
In a world of virtually zero returns to “safe” investments and uncertainty as to the inflationary effects of the enormous increase in the Fed’s balance sheet and in the nation’s debt, dividends on common stocks loom attractively. History has shown that over very long periods, dividends account for about half of total returns to stocks. Unless one is forecasting a cataclysmic depression, accompanied by deflation, buying Ten-Year Treasuries with a yield of 1.8% seems a sure way of losing purchasing power. In his lead article in the most recent Grant’s Interest Rate Observer discussing the topic of “nothing percent”, James Grant writes: “In preview, Grant’s is bearish on nothing, bullish on more than nothing.”
Jim Cullen, president of Schafer Cullen Management, in his year-end letter, noted that in the last seventy years and across a dozen recessions there have been only been two times since 1940 when S&P 500 dividends declined – during World War II and during the recent credit crisis. During the 1970s, a decade where markets essentially ended where they had begun, S&P dividends increased each year and ended about 50% above where they began. Over the long term, Mr. Cullen’s work shows, the consistency of dividend growth exceeds that of earnings.
Investors employing a strategy using dividends did well in 2011; thus the strategy has not gone unnoticed by investors. Last October, high dividend stocks were cited by one strategist, with undue exaggeration, as “the most crowded trade in the world.” The SPDR S&P Dividend ETF lagged the market in the month of January. Jeff Rubin of Birinyi Associates put out a bulletin yesterday noting that the highest yielding stocks in the S&P 500 were the worst performers in the month of January.
Nevertheless, investors do take notice when companies implement policies that are positive for shareholders. Last week Computer Associates – a company which we do not follow and with which we have no relationship – announced an initiative to return $2.5 billion to shareholders. The company announced that they will return 80% of cash flow to shareholders, versus a range of 40-50% today. The plan immediately boosted the dividend from $0.20 per share to $1.00 with an announcement that they will repurchase $1.5 billion in shares over the next two and a half years. The stock rose from 22 to 26 on the news.
It remains to be seen as to whether other companies will follow the lead of Computer Associates. It is no easier for managements to admit that they have left behind the lusty adolescence of their company’s fastest growing years than it is for most of us to acknowledge that we are aging. Eastman Kodak died an unnecessary death, by forgetting to adapt. On the other hand, Microsoft (another company with which we have no association) recognized ten years ago that shareholders deserved some of the spoils and that their growth prospects had diminished. A decade ago the stock was selling at 60X earnings with no dividend and had been issuing options on a regular basis to their employees. In 2004, they paid a special dividend of $3.00 and announced a repurchase agreement to buy $30 billion worth of stock. Today the company sells for less than 11X earnings, yields 2.7% and has been repurchasing stock. Over the past ten years, while the stock stood still, earnings have compounded at 15%, while the dividend has compounded at 22.2%.
The recognition by a few managements of the importance of sharing cash flow with the owners is occurring at an opportune time. Ten thousand baby boomers are reaching the age of 65 every day, and will continue to do so for the next eighteen years. With defined benefit retirement plans on the wane for most employees (the exception being public sector workers supported by the 51% of us who pay federal income taxes), the need for investment income has become more critical. Unfortunately, if President Obama has his way with tax policy, the top effective tax rate on dividends will more than triple – not the smartest move at this point in the lives of millions of retirees and potential retirees and at a time when the Fed continues to feel the economy is in need of life support.
As in most of us, there is a Peter Pan syndrome in many company managements – a denial of the aging process, a desire to stay forever young. The Latin term is puer aeternus and comes from Ovid’s Metamorphoses. It was represented in mythology by Dionysus, Adonis and Eros. While the symptom in mythology (and even in some of us) is harmless and can be charming, in businesses it can be fatal. Analysts and shareholders should be alert to any manifestation – investing in R&D or new projects with no or nominal returns, or foolish acquisitions.
At the same time, those companies that recognize the limits to their growth – the emergence from adolescence – can continue to do well for their shareholders by sharing an increasing percentage of the cash flow in the form of dividends.
Thought of the Day
“Show Me the Dividend”
February 2, 2012“A man’s got to know his limitations,” so spoke Harry Callahan (Clint Eastwood) to his superior, Lieutenant Neil Briggs (Hal Holbrook) in the iconic 1973 film, “Magnum Force.” So too, must businesses know where they are in the cycle of life.
Companies are born, become youths, enter adolescence, mature, age and eventually die. While the time frame varies based on management, industry and luck, how they handle that change is of enormous importance to shareholders. While most investors look for businesses in their lusty adolescence, there are distinct opportunities for investors and managements at aging businesses.
As companies mature, opportunities for growth (and therefore for reinvestment of cash flow) generally become less for a variety of reasons – size, competition, older technology, etc. As R&D spending and other investments decline, free cash flow tends to increase. Managements faced with such situations have a number of choices: they can re-invest for subpar returns; they can make acquisitions in areas of perceived growth; they can pay themselves better, or they can return money to shareholders (the actual owners of the business) either through share repurchases or – my preference – initiating or increasing dividends. My preference is for dividends for two reasons: 1) a dividend implies a commitment not inherent in stock repurchases and, 2) share repurchases require a management to do so on a disciplined basis, calculating the return on the invested capital versus alternatives. Not all managements can be trusted to do so in the interest of shareholders.
In a world of virtually zero returns to “safe” investments and uncertainty as to the inflationary effects of the enormous increase in the Fed’s balance sheet and in the nation’s debt, dividends on common stocks loom attractively. History has shown that over very long periods, dividends account for about half of total returns to stocks. Unless one is forecasting a cataclysmic depression, accompanied by deflation, buying Ten-Year Treasuries with a yield of 1.8% seems a sure way of losing purchasing power. In his lead article in the most recent Grant’s Interest Rate Observer discussing the topic of “nothing percent”, James Grant writes: “In preview, Grant’s is bearish on nothing, bullish on more than nothing.”
Jim Cullen, president of Schafer Cullen Management, in his year-end letter, noted that in the last seventy years and across a dozen recessions there have been only been two times since 1940 when S&P 500 dividends declined – during World War II and during the recent credit crisis. During the 1970s, a decade where markets essentially ended where they had begun, S&P dividends increased each year and ended about 50% above where they began. Over the long term, Mr. Cullen’s work shows, the consistency of dividend growth exceeds that of earnings.
Investors employing a strategy using dividends did well in 2011; thus the strategy has not gone unnoticed by investors. Last October, high dividend stocks were cited by one strategist, with undue exaggeration, as “the most crowded trade in the world.” The SPDR S&P Dividend ETF lagged the market in the month of January. Jeff Rubin of Birinyi Associates put out a bulletin yesterday noting that the highest yielding stocks in the S&P 500 were the worst performers in the month of January.
Nevertheless, investors do take notice when companies implement policies that are positive for shareholders. Last week Computer Associates – a company which we do not follow and with which we have no relationship – announced an initiative to return $2.5 billion to shareholders. The company announced that they will return 80% of cash flow to shareholders, versus a range of 40-50% today. The plan immediately boosted the dividend from $0.20 per share to $1.00 with an announcement that they will repurchase $1.5 billion in shares over the next two and a half years. The stock rose from 22 to 26 on the news.
It remains to be seen as to whether other companies will follow the lead of Computer Associates. It is no easier for managements to admit that they have left behind the lusty adolescence of their company’s fastest growing years than it is for most of us to acknowledge that we are aging. Eastman Kodak died an unnecessary death, by forgetting to adapt. On the other hand, Microsoft (another company with which we have no association) recognized ten years ago that shareholders deserved some of the spoils and that their growth prospects had diminished. A decade ago the stock was selling at 60X earnings with no dividend and had been issuing options on a regular basis to their employees. In 2004, they paid a special dividend of $3.00 and announced a repurchase agreement to buy $30 billion worth of stock. Today the company sells for less than 11X earnings, yields 2.7% and has been repurchasing stock. Over the past ten years, while the stock stood still, earnings have compounded at 15%, while the dividend has compounded at 22.2%.
The recognition by a few managements of the importance of sharing cash flow with the owners is occurring at an opportune time. Ten thousand baby boomers are reaching the age of 65 every day, and will continue to do so for the next eighteen years. With defined benefit retirement plans on the wane for most employees (the exception being public sector workers supported by the 51% of us who pay federal income taxes), the need for investment income has become more critical. Unfortunately, if President Obama has his way with tax policy, the top effective tax rate on dividends will more than triple – not the smartest move at this point in the lives of millions of retirees and potential retirees and at a time when the Fed continues to feel the economy is in need of life support.
As in most of us, there is a Peter Pan syndrome in many company managements – a denial of the aging process, a desire to stay forever young. The Latin term is puer aeternus and comes from Ovid’s Metamorphoses. It was represented in mythology by Dionysus, Adonis and Eros. While the symptom in mythology (and even in some of us) is harmless and can be charming, in businesses it can be fatal. Analysts and shareholders should be alert to any manifestation – investing in R&D or new projects with no or nominal returns, or foolish acquisitions.
At the same time, those companies that recognize the limits to their growth – the emergence from adolescence – can continue to do well for their shareholders by sharing an increasing percentage of the cash flow in the form of dividends.
Labels: TOTD
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