Dividends, does it matter to investors?

When I started out investing in shares, I didn’t pay much attention to the dividend.

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.