Business World

Monday 27 January 2020

Savvy investors know when companies pay dividends, it's not always a good thing

Laura Noonan

APPLE'S decision to pay its first cash dividend to shareholders in more than 20 years has put payout policy firmly back in the spotlight, but savvy investors know it's far from a simple case of "dividend-paying stocks good, dividend-free stocks bad"

Think dividends are the best thing ever? Then consider this: maybe you should just pay yourself a 100pc dividend return and not invest in shares in the first place.

Dividends are effectively the opposite of investment. It's not free money; it's cash that's being stripped out of your company, reducing the value of your investment.

If you get a dividend of €400, then in the textbook world you have an extra €400 of cash to replace the €400 that's been wiped off the value of your stock portfolio.

In the real world, it's not that simple. The price shares trade at almost never perfectly reflects their 'book' or 'true' value, so it's likely that a €400 dividend will not trigger a long-term fall of €400 in your share value.

An analysis of share price performance by the Iseq's zero-dividend stocks and the others over the past five years illustrates that point.

In 2007 and 2008, when the ISEQ was trending sharply downwards, the value of zero-dividend stocks and non-dividend stocks moved in a similar direction with no discernible trend. (Sometimes the performance of dividend paying stocks was marginally better, sometimes marginally worse).

But in early 2009, when values began to rebound, non-dividend paying stocks consistently outperformed those who were doling out some of their cash to investors. So in the worst of times, dividend value theory goes out the window (and dividend-paying stocks are good value), but in more 'normal' times investors seem to favour companies that take a more prudent approach by building cash buffers.

What we can say with certainty is that dividends aren't without cost. They curb opportunities to grow, because firms are paying cash out to shareholders instead of reinvesting it in new opportunities.

By extension, paying out too much in dividends could threaten earnings growth and damage a firm's value. That sounds like a bad thing for shareholders, but it isn't always.

Earnings growth doesn't always reward shareholders -- an analysis of the earnings per share on the ISEQ and prices for the past five years shows an alarming lack of correlation.

Until December 2008, EPS was on the way up, but share prices were on the way down. Then, from December 2009 to last December, earnings went sharply up and down while share prices stayed largely stable.

In a world where the performance of your company isn't always accurately reflected by share price, the attractiveness of dividends is markedly enhanced.

A clearly signalled dividend policy gives shareholders certainty that they'll get some reward from their investment even in the most irrational markets.

Dividend policy can also tell you a lot about a company itself. A pessimist might take the view that firms paying dividends are firms that ran out of growth opportunities to reinvest their cash in.

The argument goes that if a company has something worth investing in, they'd use the money for that. So the fact they're handing cash back to shareholders indicates that the company has run out of road.

There's certainly an element of truth in it, but there's something else to consider, too.

Recognising that now isn't the time to pursue aggressive growth can be a marker of a mature company.

Consider the cases of FBD and Ryanair. FBD, one of the ISEQ's most consistent and generous dividend-payers, has repeatedly told shareholders it will not chase growth in markets where insurance premiums are uneconomically low.

Ryanair paid its first dividend in 2010 (giving investors a special payment of €500m) after failing to agree a price with Boeing for 200 planes -- had management been fixated on the top line instead of the bottom line, they could have kept the cash, done a more expensive plane deal and watched as revenues rose while profit margins dwindled.

So in that sense, dividends can be a positive signal about a company's strategic cop-on.

The other frequently cited positive about dividends is that they give you access to some of your money now, which isn't so great for a corporate that will have to reinvest, but is quite a positive for an old-age pensioner who wants cash for living expenses.

The counter-argument to that is the (not entirely unreasonable) contention that if you want fixed income, buy Fixed Income, ie, buy a bond from the traditional fixed income family that makes guaranteed payments over its lifetime. And leave the equities game to those yield-hungry players with no pocket money requirements.

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