I am much focusing on whether the company is safe, how the
company does operates and earn its money, and is the company growing are my
chief concern. And to date they still are.
If the company is safe, growing, and profitable, with or
without a dividend, I am sure the company will, somehow, become valuable enough
and I will profit it from one way or another. Either I profit from that
company’s related selling options or a capital gain if I got the shares.
As I carry on reading and learning into more books and
blogs. Turns out, I have underestimated this decision to give dividends. I
learn that this decision isn’t to be taken lightly.
Why is that so?
Berkshire Hathaway Inc. has never given a dividend and it
has grown to be one of the biggest insurance companies in the world.
In face of such a wonderful result, does that mean companies
should follow Warren Buffett and never give a dividend?
Well… the answer isn’t so straightforward.
Before a company gives a dividend. Maybe we can have a look
at what the company can do with the money first.
Have cash, do what?
So, when the company manages to gather all this cash, they
usually can do the following actions:
1.
Clear their debt
2.
Buy other business or assets
3.
Buy Assets
4.
Buyback the company own shares
5.
Keep the cash, hoard them
6.
Pay dividend
Clear Debt
Paying back the debt is a good idea because it reduces the
risk of default. Naturally, if the company wishes to be in business for years
to come, low or zero debt maybe a good idea. I mean, you can’t go bankrupt if
you have zero debt.
However, this doesn’t provide instant value to the
shareholders. Although clearing debt does make the company safer.
Buy Other Business
The acquisition of a business can create value for the
shareholder. But the problem with this route is that it is possible to destroy
value too, as not all acquisitions are good. Moreover, statistically speaking,
most acquisitions destroy value.
Although there are some good business acquirers, Warren
Buffett is one of the finest examples, not all business management can pull off
great deals all the time.
Buyback company’s shares
Buying back company shares is very popular, as the
shareholders do not have to pay a single cent to increase their holding of the
company.
However, the management has to ensure that the price they
buyback is under-value. If they buy the company shares recklessly and at any
price, the management may not make full use of the money to provide value for
the shareholders.
As you reading this, you probably figure the crux of the
issue, at what price is the share price consider overvalued or undervalued?
As such, this valuation is subjective, and to make matters
worse, everyone will have a different valuation on the same company. Warren
Buffett admitted that between Charlie Munger and him, they will have a
different intrinsic value on the same company.
So, although buying back the company’s share is no doubt
good for shareholders, the price the management buys back makes the difference.
Cash Hoarding
I love cash. Especially in a period of economic crisis,
(thanks to Lehman Brothers and Covid-19), everyone knows how important cash in
hand (or in a bank account) is. As such, a conservative company will keep
sizable cash and equivalent.
However, hoarding cash over time will worthless. Not
worthless, but worth lesser.
Thanks to inflation.
However, if the company needs to keep a certain amount of
cash because it is worrying about certain operational uncertainty, that cash isn’t
free to be used for other purposes. For example, they are reserving the cash to
buy machinery parts in case of a breakdown. As such, are those cash are
‘locked’ in a certain way and are truly not ‘free’ to use.
Secondly, if the company doesn’t have such concerns, yet
hoard a lot of cash. Then it is important to raise the question, is the
management able to allocate capital efficiently?
Pay Dividends
Look back at the above options. Although all of these
actions have their merits, some of them can be misused or used poorly by the
company management.
As such, paying dividends to shareholders is the only way
and also the most direct, to provide value to the shareholders.
By simply giving cash.
As such, this also means, the company has the cash to pay a dividend.
This is one of the best ways to give value to shareholders most
transparently and directly.
Does it mean anything?
Giving cash back to the shareholder; does it mean anything?
What does it tell investors?
Some investors believe it means the following reasons:
1.
Reward Shareholders
The management is willing to reward its shareholders. Maybe
they are shareholders themselves, which is a good thing. Nevertheless, this
could mean that the company has matured to a certain point that their earning
power and financial stability are good.
2.
Management’s Discipline
The long-term discipline imposed on management. Because the
market expects the dividend to remain either the same or increases over time,
the management can’t simply cancel the dividend if they found good use of the
cash.
If the management found a good deal and need to raise cash,
they will employ other means first, before cutting or cancel dividends. It
isn’t an easy decision as this dividend policy is meant for years to come.
3.
Less likely to sell
Because the shareholders are reward by the dividends, they
are less likely to sell their shares. It may make more sense to hold on to the
shares. Meanwhile, the management has more time to pursue other agendas, for
example expanding the business.
Personal Note
I am humbled by this newfound perspective regarding dividends.
It turns not so straightforward as I assumed when I first started learning
about investing.
Management has to weigh in quite a lot of factors and
considerations to reward shareholders in this manner.
But does that mean a company that gives dividends means it
is a good company? The answer is not necessary. It isn’t a ‘silver bullet’ sign
of a good company.
Although I admit it is an important trait to look at, as it
could mean the company is moving in a certain direction that may benefit the
shareholder in the long run.
