Parsing Out the President's Policy
Page 2
Fourth, nontaxation of dividends will likely accelerate the flight to corporate conservatism and will reduce corporations' propensity to buy back stock or grow via acquisitions. And corporate buybacks and M&A activity were fundamental to the rapid earnings growth of the 1990s. Moreover, corporate buybacks have historically buoyed the demand side for stocks; with the president's proposal, it will now be absent or less conspicuous. The same can be said for acquisitions, which have not only produced a one-time gain for investors but also have reduced the supply of equities. This all could have a negative effect on long-term corporate-profit growth, a negative for equity-price appreciation.
Fifth, regardless of one's politics, nontaxation will benefit the wealthiest in our country. Sixty-three percent of total dividend income was reported by the 8.4% of tax filers who earned more than $100,000 a year. The average American owns most of his or her stock in accounts that are already shielded from taxes, such as IRAs and pension plans. In my view, the proposal will have only a limited impact on unemployment, which remains a fundamental obstacle to an environment of better consumer spending.
Sixth, many are buying large-cap tech stocks, despite eroding fundamentals, on the basis that their large cash hoards will enable larger or special dividend payouts. But will they?
Let's look at Cisco (CSCO:Nasdaq - news - commentary - research - analysis), for example. Say Cisco is expected to earn 55 cents a share next year. If Cisco decided to pay out 30% of profits, or 16.5 cents a share, this would produce a modest 1.1% dividend yield. In light of Cisco's frequent daily moves of 5%, does a 1.1% yield compensate for the risk of owning Cisco stock? Already Cisco and Microsoft (MSFT:Nasdaq - news - commentary - research - analysis) stated yesterday that they have no intention of changing their dividend policies.
Seventh, and an addendum to the previous point, the notion that tech companies have immense cash hoards that are readily returnable to shareholders is largely exaggerated. Most tech companies have accumulated their cash owing to the tax savings from the tax-advantaged release of large option programs. Nevertheless, there's less cash than meets the eye. On average, the cash positions of the major tech entities is equivalent to less than 10% of their equity capitalizations:
Intel (INTC:Nasdaq - news - commentary - research - analysis): $11 billion, or $1.70 per share, 10% of market value
Oracle (ORCL:Nasdaq - news - commentary - research - analysis): $5 billion, or $1.00 per share, 9% of market value
Microsoft: $40 billion, or $7.50 per share, 12% of market value
Dell (DELL:Nasdaq - news - commentary - research - analysis): $4 billion, or $1.65 per share, 6% of market value
Cisco: $10 billion, or $1.40 per share, 10% of market value
Finally, not all (or even much) of the cash positions can be upstreamed to shareholders owing to the capital-intensive nature of these companies. Probably only about a third would be available in special dividend form! Regardless, as mentioned in point 6, the potential payouts are modest and don't compensate for the volatility of the underlying tech shares. Don't forget that earnings will be reduced by the lost interest that the companies are earning on their cash, and such exercises would sharply limit companies' ability to buy back stock to compensate for large option issuance.
Eighth, the dividend yield on the S&P 500 is a lowly 1.7%. With the exception of the bubble period of 1999-2001, this yield is about as low as it's ever been and less than one-half the average 3.6% over the past 50 years. Moreover, for 2002, the dividend payout is a high 57.5% of total earnings, exactly the same as the average since 1950. However, since 1950, the average S&P 500 P/E has stood at 16.2. By contrast, we are now trading at 29 times estimated 2002 earnings. Ergo, the problem isn't that dividends are so low, but that stocks are overvalued. And with the prospects for sluggish corporate-profit growth in 2003-2004, it is unrealistic to see much higher payouts.
In summary, the president's proposal might have a number of unintended consequences -- all of which might produce a countering effect to the dividend taxation proposal that forms the cornerstone of his plan.
I agree with Tuesday's New York Times editorial: "It's the wrong move at the wrong time for the benefit of the wrong people." |
