The investment world often delights in turning a cliché or conventional wisdom on its head. And so it is with dividends, where the maxim may as well be “all good things come to a start.”
That’s because a new dividend signals the start of something presumably tasty for investors: steady quarterly payments that can be reinvested into buying more stock, or used any way the investor likes. To be sure, they’re more along the lines of something you’d see from a more mature company as opposed to, say, high-tech rockets like Amazon.com (ticker: AMZN) or Netflix ( NFLX).
“If a firm can make more with their achieved rate of return than their cost of capital, they should lower dividends and thus increase their reinvestment rate and vice versa,” says Charles Higgins, a finance professor at Loyola Marymount University on Los Angeles. In other words, companies on a growth spurt will want to pour money back into the business while in general, maturing companies will want to pay out dividends.
[See: 10 of the Best S&P Dividend Stocks in the First Half.]
But not all high-tech concerns fit the mold of dividends on hold.
One such company is Apple ( AAPL). “It currently has a new high price of about $218, a dividend yield of about 1.40 percent, and a price-earnings ratio of some 19 times — and a payout ratio of about 27 percent if you multiply the yield times the P/E ratio,” Higgins says.
In Apple’s case, past stinginess with a dividend was a function of late CEO Steve Jobs trying to get the company out of the weeds. Ten years prior to 2007 and first iPhone, Apple was so cash starved that it struck a deal with archenemy Microsoft Corp. ( MSFT), which invested $150 million in exchange for preferred stock.
Those days long behind, current CEO Tim Cook ushered Apple into the dividend era on March 19, 2012 — the first time the company had awarded such a payout since 1995. And it was definitely, positively about time, as Apple today is the first $1 trillion company in history. Assuming Cook wants to give away a $1,000 a second until the market cap is gone, he’ll likely not be around to finish the job: It would take roughly 32 years.
Apple also boasts an enormous cash reserve worth of roughly $244 billion as of this month: 22 percent higher than total market cap of the Coca-Cola Co. ( KO).
“Dividends and more specifically dividend growth are evidence that management sees strong future growth and the business’ financial strength is improving,” says Benjamin C. Halliburton, chief investment officer at Tradition Capital Management in Summit, New Jersey. In Apple’s case, “dividend growth is an indication of strength in Apple’s iPhone business; it was booming and had high margins.”
“Hawaiian Holdings ( HA), the parent company of Hawaiian Airlines, started paying a quarterly cash dividend in November of 2017,” says Robert Johnson, principal, Fed Policy Investment Research Group in Charlottesville, Virginia. “Of course, the management and board of directors hoped the initiation of the dividend would help the stock price. And it did help the price move from the low $30s when the dividend was announced to about $43 today.”
[See: 7 Travel Stocks for Income Investors.]
In contrast, dividend cuts indicate limited capital and poor profits.
“The last thing a dividend-paying company wants to do is to cut the dividend,” Johnson says. “Companies typically have a particular dividend policy and stick to it. This is what is known as the ‘clientele effect.'”
“Cutting a dividend usually indicates significant problems in the company’s operations,” says Jamie Ebersole, founder and CEO of Ebersole Financial in Wellesley Hills, Massachusetts. “Completely discontinuing a dividend usually means the company has concerns about its ability to continue as a going concern in its current form.”
Ebersole acknowledges that, “shareholders may feel shortchanged when a company ends a dividend program. But in reality, the cut in the dividend is necessary to pay for past sins.”
For example, dividend slashing may mean that the business “has paid out too much in dividends to current and past investors, thus weakening the firm’s balance sheet, which ultimately leads to the need to preserve cash at all cost,” Ebersole says.
The all-too-newsworthy case in point of a company in crisis is General Electric Co. ( GE), which currently offers a dividend of 12 cents per share, per quarter. That represents a cut of 50 percent from December 2017 — all told, “the biggest of all time on a dollar basis,” Johnson says.
And then, some companies simply refuse to get into the game at all, which in this case is to say, “all good things come from where they will.” Especially Nebraska.
[See: 9 Dividend Stocks to Sell Despite High Yield.]
“Warren Buffett’s Berkshire Hathaway ( BRK.A, BRK.B) has never paid a dividend,” Johnson says. “And the shareholders of Berkshire Hathaway are quite pleased that the firm hasn’t paid dividends, because it has averaged a 20.9 percent annual return from 1964 through 2017.”
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Why Companies Kick Off and Cut Dividends originally appeared on usnews.com
