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Like many professional investors, I love companies that pay dividends. Dividends bring tangible and intangible benefits: Over the last hundred years, half of total stock returns came from dividends.
In a world where earnings often represent the creative output of CFOs’ imaginations, dividends are paid out of cash flows, and thus are proof that a company’s earnings are real.
Finally, a company that pays out a significant dividend has to have much greater discipline in managing its business, because a significant dividend creates another cash cost, so management has less cash to burn in empire-building acquisitions.
Over the last decade, however, artificially low interest rates have turned dividends into a cult, where if you own companies that pay dividends then you are a “serious” investor, while if dividends are not a centerpiece of your investment strategy you are a heretic and need to apologetically explain why you don’t pray in the high temple of dividends.
I completely understand why this cult has formed: Investors who used to rely on bonds for a constant flow of income are now forced to resort to dividend-paying companies.
The problem is that this cult creates the wrong incentives for leaders of publicly traded companies. If it’s dividends investors want, then dividends they’ll get. In recent years, companies started to game the system, squeezing out dividends even if it meant they had to borrow to pay for them.
The cult of dividends takes its toll
Take ExxonMobil for example. It’s a very mature company whose oil production has declined nine out of the last 10 quarters, and it is at the mercy of oil prices that have also been in decline. Despite all that, Exxon is putting on a brave face and raising its dividend every year. Never mind that it had to borrow money to pay the dividend in two out of the last four years.
I sympathize with ExxonMobil’s management, who feel they have to do that because their growing dividend puts them into the exclusive club of “dividend aristocrats” – companies that have consistently raised dividends over the last 25 years. They run a mature, over-the-hill company with very erratic earnings that have not grown in 10 years and that, based on its growth prospects, should not trade at its current 15-times earnings. ExxonMobil trades solely on being a dividend aristocrat.
It is assumed that a dividend that was raised for 25 years will continue to be raised (or at least maintained) for the next 25 years. GE, also a dividend aristocrat, raised its dividend until the very end, when it cut it by half and then cut it to a penny.
Read the full article here by Vitaliy Katsenelson, Advisor Perspectives
