Dividends are company-paid cash distributions. Many firms deliver them to shareholders out of their quarterly earnings on a regular basis. Investors love them for many reasons. First and foremost, they provide a potent message about the surety of the company in its current performance and ongoing prospects. When a company can say with confidence that it will be able to maintain payouts on stable dividends consistently and continuously, what they are really declaring is that the fundamentals of their business are strong.
What About Successful Companies that Do Not Pay Dividends?
Apple and Amazon.com are two sterling examples of high flying shares that do not offer investors any dividends (or did not for decades). Apple went literally multiple decades without paying out a penny. Amazon keeps the booty for its own internal expansion and acquisition efforts. Sometimes a large and successful (or up and coming aggressively growing) corporation will evaluate their overall prospects and determine that their own investments are better than those shareholders have available anywhere else. In these cases, the management of the board will commonly decide to retain their earnings to reinvest them in growing and improving the business and gaining market share.
This is the simple explanation for why these growth companies rarely pay out dividends. There are also many documented success stories of major corporations that chose to not pay dividends until they reached a certain point in their life cycle. Microsoft is the poster child for these. The brainchild of founder Bill Gates enjoyed several decades of soaring growth. In all this time it did not deliver dividends, preferring to aggressively reinvest all cash flow in multiple iterations on its ubiquitous Microsoft Windows flagship product.
Yet the writing was finally on the wall after 18 years of phenomenal success. The company could no longer sustain the old rapid growth rates and aggressive expansion anymore. In July of 2004, they made the corporate decision to initiate a return of massive amounts of retained earnings and capital to shareholders who were growing bored with the company.
Almost $75 billion found its way back into the pockets of investors with a brand new eight cents per quarter dividend and a lump sum single dividend payment of $3 per share. They coupled this with a massive share buyback program amounting to $30 billion running over the quarters of four years. Today the firm still pays out a quarterly dividend of several percent. Microsoft evolved into a model dividend investing guide corporation in two decades time.
Sameer Samana of Wells Fargo Investment Institute has pointed out a problem with companies starting to offer dividends. Such dividend payouts quickly become expected by investors, making it difficult for the issuers to eliminate or even decrease the dividend amounts. It explains why some firms will instead opt for a one-time special dividend or share buybacks instead. They can opt to only offer these when it suits their purposes on a completely discretionary basis.
Alternate Corporate Uses for Earnings and Dividend Money
Companies have so many other activities that they can pursue and fund in lieu of paying dividends consistently with their earnings. Some of these include the following:
- Reinvest for growth in the company’s business lines
- Increase research and development
- Expand marketing and distribution arrangements
There are a number of well-known companies that successfully make the case for growing the business instead of paying out dividends. These include the likes of Facebook, Google, and Warren Buffet’s Berkshire Hathaway. Other mega companies like BP depend on dividends to help them keep their investors on board.
BP had a number of poor quarters from June of 2013 through May of 2018. The stock only increased in value (over this practically five-year-long period) by a paltry 12 percent even as the DJIA Dow Jones gained 25 percent in 2017 alone. What kept BP going with many of its investors was the fact that it paid a generous and stable dividend quarter in and out. Between the dividend and the smaller capital appreciation, the return was significant and dependable enough to keep investors on the team. This is a classic example of why dividends are important for investors.
Dividend Paying Companies Are More Efficient and Responsible
Investors like another thing about corporations that pay consistent and growing dividends. It forces management teams to be more effective with their deployment of capital than the management of corporations that pay none. These profit sharing companies have far fewer incidents of faking their financial statements.
It is all too easy for management to display “creativity” when it comes to massaging earnings into the appearance of optimal health. Yet for those who must meet quarterly or semi-annual dividend payouts, convincing manipulation becomes nigh on impossible. Besides this, dividend-paying stocks rarely soar to unsustainable levels. Investors can sleep better secure in the knowledge that dividend payouts also put a floor under share price declines as the dividend yield goes up when share price declines. Stock price declines only make the consistent and growing dividend payouts appear that much more attractive to new investors.It all helps to explain why dividends are so important in the world of stock market investing today. Proof of a company’s profits in the shape of a dividend payment makes it easier for investors to rest easy at night. Paper profits may make a statement, but money itself always talks, as do the cash dividend payments. This is why a smart way to make money on the side is with dividend-paying stocks.