Dividends not dead yet. See this.
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The Return of the Dividend?
After the Bust, the Old-Fashioned Stock Payout Is Sounding Better and Better
By Carol Vinzant
Washington Post Staff Writer
Sunday, August 5, 2001; Page H01
NEW YORK -- When Unisys Corp., then the third-largest computer maker, omitted its common-stock dividend in 1990, the stock fell 23 percent in one day -- and kept falling.
Last month, Corning Inc. decided to stop dividends, ending a tradition dating to the 1940s. Instead of giving each shareholder 6 cents per share each quarter, the company said it would "reinvest all cash generated by Corning's businesses into the future growth of the company to create greater long-term shareholder value."
Yet Corning stock, which has been highly volatile this year, ended that week down only 3.9 percent; the Standard & Poor's 500-stock index rose 2.1 percent.
It was a clear demonstration of how dividends have gone out of fashion as companies and their investors turned to focus almost exclusively on increasing the stock price. To be sure, dividend-paying stocks still exist, but the latest downturn and profit squeeze are not making those dividends any more generous. As percentages of both stock price and profit, dividends are near all-time lows, and payments by S&P 500 companies are down 7.1 percent so far this year, said Arthur Kaufman, editor of Standard & Poor's Outlook newsletter.
But now that investors can't count on stock prices to go straight up, some academics and value investors are predicting a resurgence in the dowdy dividend, a sort of investor backlash over failed investments in boom-and-bust technology companies.
"As people start ratcheting down their expectations of hitting a home run with tech stocks, that will take them toward a new emphasis on dividend payments," said Jim Paulsen, chief investment officer with Wells Capital Management.
For many years, dividends were considered vital to stockholders' interests and a key signal of a company's financial health. Then, in the 1960s, Nobel Prize-winning economics duo Franco Modigliani and Merton Miller challenged that idea. They argued that corporate structure, the way a company cuts up its money pie, cannot change how big the pie is. They considered offering dividends as just one way to slice the pie and therefore irrelevant to a company's value.
By the 1990s, with the economy booming, companies came to believe they could make more money for investors by holding on to the cash. Many firms, especially those in the increasingly dominant tech sector, used the money for growth projects such as research and development. Others used the money to buy back stock, which makes the remaining shares worth more because there are fewer of them. Many investors hailed buybacks as a clever improvement on dividends.
In some quarters of corporate America, sending shareholders a check came to be seen as an admission not only that the company had no ambition but also that it was financially unsophisticated.
Michael Goldstein, an associate professor of finance at Babson College in Wellesley, Mass., ties the decline in dividends through the '90s to the simultaneous rise in MBAs running companies. "We teach MBAs in our basic finance classes that firms would be better off not paying dividends. So that's what happened," he said.
Tax considerations weigh heavily in these calculations, for both the companies and investors. Investors would rather have $1 in capital gains than $1 in dividend income, because income usually is taxed at a higher rate. Because of the tax benefits of corporate debt financing, "delivering $1 in capital gains can cost a company less than delivering $1 of dividends," said John Edmunds, chairman of the finance faculty at Babson College and author of "The Wealthy World." For example, he said, a company would have to earn $1.40 to pay $1 in dividends, which would be worth only around 66 cents to a typical investor after taxes.
So companies bet they could reinvest what they would have paid out in dividends and get their investors at least the same returns -- at the lower capital gains tax rate.
Between 1980 and 2000, the dividend yield on the S&P 500 companies dropped from 5.4 percent to 1.1 percent, and the percentage of profits that companies pay in dividends reached an all-time low.
"A lot of investors bought into the argument that the smaller dividends, the better it was for them," Kaufman said.
But turning the dividend savings into a stock price increase proved tricky.
Now, as troubled companies such as Corning, Xerox Corp. and AT&T Corp. chop their dividends, Paulsen predicts that healthy companies will begin to switch back to paying dividends as a safer way to deliver to shareholders than investing in high-risk technology schemes. And companies that stubbornly held on to a tradition of paying, and even increasing, their dividends are getting renewed respect.
"We've had our 255th consecutive dividend. We're proud of that in an old-fashioned kind of way," said spokesman Gary Corrigan of Toledo-based car-parts maker Dana Corp. The stock, which trounced the S&P 500 in the first half of the '90s but then got killed in the late '90s, is now taking its revenge: Dana stock has generated a total return of 72.44 percent so far this year, compared with a 7.3 percent loss for the S&P 500.
The company consistently raises the dividend but, even more important, "we've never reduced or missed a payment -- that's the key." Corrigan thinks the last decade has seen too much emphasis on a growing company and growing stock price. "Does anything grow forever?" he asks.
Indeed, Babson professor Goldstein, along with Kathleen Fuller, an assistant professor of finance at the University of Georgia, has found that investors are better off -- especially during market downturns -- sticking with companies that pay dividends.
Over the past 30 years, the average dividend-paying company offered investors double the total returns of non-dividend-paying companies, they found. Among the riskiest companies, dividends made a 113 percent difference. Even among the safest companies, the returns investors received on dividend-paying companies were 20 percent higher.
Moreover, Goldstein notes, the tax considerations that drove investors away from dividends are less relevant today because more and more investors are saving in tax-deferred accounts.
Because of the popularity of tax-deferred plans such as individual retirement accounts and 401(k)s, "the tax benefit of not paying dividends goes away," Goldstein said. "But all the good reasons for paying dividends remain."
In the bull market of the past decade, the John Hancock Sovereign Investors Fund, which emphasizes companies that are increasing their dividends, returned 12 percent -- respectable, but less than the 15 percent the S&P 500 offered. The down market of the past 12 months, however, has been this fund's time to shine: It returned 4.8 percent while the S&P lost 14.8 percent.
Because fewer companies are increasing their dividends, Sovereign Investors recently cut the required percentage of dividend-growing companies in its portfolio from 100 percent to 65 percent. But John Snyder III, who has managed the fund for about 20 years, still believes in the concept. Dividends often create a floor for a stock, he said, and investors tend not to sell the stock if it is paying more in dividends than corporate bonds would pay in interest.
"When you think of companies that have rising dividends, a couple things stand out," Snyder said. "One, they're not IPOs [initial public offerings]. They tend to be somewhat immune to what's going on in the economy. If the company paid dividends consistently, then you would also expect earnings to be fairly predictable."
Paul Vance has hunted for solid dividend-paying companies for the Morgan Stanley Dean Witter Dividend Growth Fund for about 20 years. Unlike some investors, Vance does not find dividends -- or the companies that pay them -- old-fashioned.
"Some people call them old-economy companies. I prefer to call them real-economy companies," Vance said.
The dividend payout is a good indicator of where the company is going, Vance said. If a company cuts its dividend, he looks for a cash-flow problem.
During an economic slowdown, companies will have less profit to take dividends from, but they may be more generous with what they've got, said Ken Lehn, a finance professor at the University of Pittsburgh. That's because during slow times a company is less likely to have any good projects or investments to spend the money on, he said.
"It makes sense for companies to pay more of their profits to dividends" during slow times, Lehn said. "They keep more cash during high growth and pay out more cash during slow growth, when the company has fewer projects."
During the '90s, investors tolerated no current profits for the prospect of future ones, Vance said, but now they are more skeptical.
"As those companies prove there was a reason there was no profit, I think people will shift emphasis to companies that do pay dividends," Vance said. "I think people are coming back."
A shift in investor attitude may be needed to push companies back to paying dividends, however. Many investors may have to be retrained to think about dividends instead of just big stock price increases. Kaufman thinks companies will be content to keep the cash as long as shareholders play along.
"Until shareholders start screaming, I don't think you'll see an increase in dividends," Kaufman predicted.
© 2001 The Washington Post Company |
