In recent times, large American technology companies such as Meta Platforms, Salesforce, and Alphabet have initiated a dividend.
It’s easy to imagine that their shareholders would be pleased about it, but this isn’t always the case. Some shareholders are actually disappointed about the dividend announcements. They think that the companies have nowhere else to invest their capital and are thus returning it to their shareholders. In other words, they think that the companies’ growth potential have stalled.
But I see things differently. Dividends are ultimately what we, as shareholders, invest in a company for. Long-term shareholders are here to earn a cash stream from investing in companies. This is akin to building your own business which generates profits which you can cash out and enjoy. As such, dividends are the fruits of our investment.
And just because a company has started paying a dividend does not mean it can’t grow its earnings. Just look at some of the dividend aristocrats that have grown their earnings over a long span of time. There are many companies that can generate high returns on invested capital. This means that they can pay out a high proportion of their earnings as dividends and still continue to grow.
Dividends can compound too
For investors who don’t want to spend the dividend a company is paying, they can put that dividend to use by reinvesting it.
When a company is not paying a dividend, its shareholders have to rely on management to invest the company’s profits. When there’s a dividend, shareholders can invest the dividend in a way that they believe give them the highest risk-adjusted return available. Moreover, a company’s management team may not be the best capital allocators around – in such a case, when the company generates excess cash, management may invest it in a way that does not generate good returns. When a company pays a dividend, shareholders can make their own decisions and do not have to rely on management’s capital allocation skills.
And if you think the company was better off buying back shares, you can simply buy shares of that company with your dividends. This will have a similar effect to share buybacks as it will increase your stake in the company.
What’s the catch?
Dividends have some downsides though.
Compared to buybacks, reinvesting dividends to buy more shares may be slightly less effective as shareholders may have to pay tax on those dividends. For example, Singapore-based investors who buy US stocks have to pay a 30% withholding tax on all US-company dividends.
The other downside is there’s more work for shareholders. If management was reinvesting prudently and not paying dividends, shareholders wouldn’t need to make a decision. But with dividends, shareholders have to decide where and when to reinvest that dividend. This said, it does give shareholders more options and opens up possibilities of where the dividend can be invested, instead of just relying on management. To me, I would happily take this tradeoff.
Don’t fret
Dividends are good. It’s funny that I even need to say this.
Dividends are the fruits of our investments and are what makes investing in companies so profitable. Without it, we will just be traders of companies, and not investors.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life. I currently have a vested interest in Alphabet, Meta Platforms, and Salesforce. Holdings are subject to change at any time.