Dividends or Capital Appreciation? Results Are In!

Remember this the next time some CEO says they are not focused on dividends because they can achieve higher growth by reinvesting earnings. This is a study by Deutsche Bank which shows that dividends are the most important part of the total return for investors. From the Economist:

Take the widespread belief that investors should be indifferent, except for tax reasons, as to whether cash is paid out to them as dividends, or reinvested in the company. If the money is reinvested, then earnings will grow faster; after all, isn't a dividend payout a sign that management has no ideas? Technology companies often don't bother to pay one.

But a look at history should disabuse investors of that notion. The key period is the late 1950s where, in America and Britain, the dividend yield on the market dropped below the government bond yield for the first time. Institutional investors reasoned at that time that the dividends on a diversified pool of equities would grow sufficiently to offset the loss in immediate income. From that point, the payout ratio also started to fall; from 69% pre-1958 to 46% since then.

So did earnings grow faster once companies cut their payouts? Up to a point. The real rate of earnings growth edged up from 1.3% to 1.8% a year but that failed to compensate investors for the fall in the average dividend yield from 5.2% to 3.2%. Rather than using the spare cash to boost earnings, companies wasted it (probably by paying it to executives, who have become massively richer over the period.) A high dividend is a good discipline on managers.

A related issue is that, in real terms, equity prices can fail to rise for an extended period; in 1982, the S&P 500 index was no higher, after adjusting for inflation, than it had been in 1929. All the real return over that period would have come from dividends so the starting yield is very important to future returns. And the yield is currently low.

That last paragraph is the key for the current market environment where stock prices remain flat for an extended period (secular bear market). The reason investors abandoned dividends was because of increased taxation and the argument but forth by management that they could increase earnings at a faster rate by reinvesting earnings. Well, the results are in, and that is simply not true (unless you consider an extra 0.5% growth meaningful). What has happened is that executive compensation has skyrocketed, and top management spend most of their time looting money from shareholders. Back in the good old days of investing (pre-1930 or so) mature companies used to pay out 66% of earnings to shareholders and retain 33% to grow the company. Management could not pay itself $60 million a year and get away with it. But today you have companies like Microsoft which hoard 10's of billions to waste on executive compensation and capital destroying acquisitions. We need to go back to the old days when companies were run for shareholders rather than top management. The only types of companies which act responsibly are the tobacco companies which pay out 60-80% of earnings to shareholders.

Black Swan Insights
FD: I own shares in Altria (MO)

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Corporate Governance: What a Joke
Corporate Integrity--- Can you trust company earnings?

Dividends or Capital Appreciation? Results Are In!