What stocks to invest in
In its most common form, a dividend is a distribution of a portion of a corporation’s profits to shareholders in cash.
Yesterday, the Financial Times published an article titled “Alarm grows as investors get bulk of listed groups’ profits: Unusual situation that tends to occur only in periods of widespread economic weakness.”
The thrust of the article is that companies in the large-cap MSCI Global index are now paying out 51% of their profits in dividends. That’s up from 43% two years ago (when presumably income for everyone not in natural resources was lower). It’s also higher than the long-run median of 46%.
Suggested but not stated is the idea that these companies are mortgaging their long-term future by skimping on capital investment to satisfy myopic income-oriented investors. The subtitle of the article suggests the high payout ratio may be a harbinger of recession.
Personally, I’m not alarmed. And I’m not sure the current situation is that unusual. In fact, my experience is that corporate attitudes toward, and investor preferences about, dividends vary widely over different time periods and in different parts of the world.
That’s what I’ll be writing about over the next few days.
Some preliminaries today:
–dividends are supposed to be paid out of earnings. If a company has no current or past profits, it can still make a distribution (why it would is a different question–although some fixed income funds do do this). That kind of distribution is called a return of capital. The main practical difference is that a return of capital isn’t subject to income tax.
–sometimes a stock split is structured as a dividend. In the US, this typically happens when the split is very small, like 21 for 20, which would be a 5% stock dividend. In most countries, managements doing so as a substitute for a cash dividend and appear to be hoping that shareholders accept this number shuffling instead of money it (a) wants to retain …or (b) doesn’t have.
–spinoffs of assets are sometimes structured as dividends, as well.
–managements of dividend-paying companies tend to want to at least maintain the current level of recurring dividend payments. If a company is feeling especially flush in a given year, it may decide to declare an extra one-time dividend payment. It will label the payment as “special” or “extraordinary,” to make sure shareholders understand this is not a recurring event.
–unlike the case with preferred shares or coupon-bearing debt, management makes no promises to maintain the current level of dividend payments, or even to pay a dividend at all. Around the world, however, a dividend cut, meaning reduction or elimination of the dividend payout, is regarded as a very bad thing. It usually provokes a sharp negative reaction in the stock price …more so outside the US than inside. That’s because it signals either very poor management planning or a sharp deterioration in a company’s business. Investors also tend to have very long memories when it comes to dividend reductions.
–in my experience, the best indicator of a possible future dividend cut is that the company has cut the dividend in the past. The next best is a close analysis of the sources and uses of funds section of the financial statements.
– What stocks to invest in