Posted on 08/01/2002 8:44:52 AM PDT by razorback-bert
Quite a few stock investors, it's now clear, had the wool pulled over their eyes in recent years by corporate crooks playing shell games with inflated profit statements and the like. But quite a few more - by several orders of magnitude, in fact - were taken in by a subtler kind of deception. It's a practice that is perfectly legal, and is likely to remain so. Nothing in the big corporate-fraud bill that President Bush signed yesterday even addresses it. I'm talking about dividends. Payouts that companies make to their shareholders in cash - cold, hard, unfudgeable U.S. dollars. That may be an unfamiliar concept. Unless you have been around the market a while, you may never have run into a dividend. Certainly you won't find any among the formerly high-flying tech stocks that so dominated the financial news in the last half-decade. Cisco and AOL never offered a dividend. Intel does, but just barely. And the dot-coms? Don't even ask. Why don't those companies pay dividends - even when, like Microsoft, they are virtually swimming in profits? There are several factors, some quite reasonable and some less so. But at the most basic level, companies that choose not to pay dividends are sending their shareholders the same implicit message: We can use the money better than you can. That is sometimes true. A young firm in a growing market is likely to need all its cash for expansion, and it can plausibly promise investors bigger returns down the road if they forgo a dividend today. At a time of great technological and commercial change, that's not such a hard case to make. In the '90s, in fact, it was what investors mainly wanted to hear. Companies with large dividends were considered stodgy and uninteresting. Investors wanted growth, in the form of constantly rising prices for their shares. Corporations generally were happy to comply - whether or not they really did have better uses for the cash. For one thing, pumping share prices up rewarded those (such as corporate executives) with large numbers of stock options. Paying dividends did not. Even federal tax law discouraged dividends (and still does). Dividends are taxed at regular income rates of up to 38.6 percent, while capital gains are taxed at a maximum of 20 percent for shares held at least a year. Ordinary stock investors, moreover, can't control the timing of their dividend income; they can, however, time capital gains to minimize taxes or for other reasons. In that light, it made even less sense for companies to offer dividends. Many chose to return cash to investors by buying back their own stock instead. Yet dividends could be making a comeback, or so some market gurus think. And as time clarifies our vision regarding the big '90s bubble, it seems more and more as if dividends were the dog that didn't bark; that is, the clue whose absence should have indicated that something was out of whack. For most of the 20th century, U.S. stocks offered investors a dividend yield averaging 5.8 percent, according to Wharton finance professor Jeremy Siegel. (The yield is the annual payout divided by the stock price.) But in the 1990s, the average dividend yield dropped to barely more than 1 percent. That made valuing stocks a much dicier game. Traditional investment theory says the logical price to pay for a share of stock is the present value of future returns. Without a dividend, investors have to do a lot more guesswork about what those future returns will be. Moreover, as Siegel points out, dividends also serve to promote what government regulators and the public are now clamoring for: honest and transparent reporting of companies' financial condition. In other words, investors who have been spooked by all the revelations about phantom profits may find it more effective to make one simple demand of their companies: Show us the money.
Amen to both posts. No dividends, no stock. And the gub'ment isn't helping. Dividends are also taxed twice, once from the payor, and next from the payee. The tax pressures put on stocks has forced this reliance on "growth", rather than earnings.
I'm not buying regardless. Half of the companies paying dividends are borrowing money to do it.
Richard W.
Not the best way to pick stocks. If you need income, dividends are great. If you want you portfolio to grow, dividends suck.
Anyways, I'm curious what you and the gang think about this.
I like it. I think it would be a welcome change toward real economics, rather than the cut and paste system intellectuals have encumbered the economy with.
As someone else pointed out: you want income, you want dividends -- but if you want growth, dividends get in the company's way. Over the past 20 years or so, it would be impossible to find a bad time to buy Microsoft stock (if "long-term" hold means more than 2 years). Some companies grow reliably over long periods of time. The fact that they don't pay dividends is inconsequential.
Articles like this are easy to write after the fact. I take 'em with a heap of salt.
Explain WMT then, dividends and growth, with dividend reinvestment even more portfolio growth.
I just think that if dividends were taxed like capital gains, even more money would flow to the better run companies with real earnings, not speculative ones promising pie in the sky by and by.
In times past, a high dividend often correlated with a shaky balance sheet, just as the "high-yield" bonds popularized by Michael Milken reflected above-normal risk to the investor. Likewise, the now-discredited Universal Life policies were sold with a promise of guaranteed above-market interest rates, adding 12-14% to the cash value annually. High risk must be compensated with a high return.
In today's tax environment, where individual investors pay anywhere from 0% to 38% on income resulting from dividends, corporations must be sensitive to the fact that any money paid out will enrich Uncle Sam first, the stockholders later. A strong case can be made that the company can find better uses for the taxable portion than the federal government can.
Your no-dividend, no-buy filter may be appropriate if you are seeking income. However, being pragmatic about it, aren't you also forgoing the potential of much larger gains through price appreciation? As I recall, the average price gain over the past several decades has been greater than the 5.8% nominal dividend rate cited in this article.
Ron Reagan admitted he made a mistake when he signed the 1985 tax increase bill that included making dividends taxable to both the corporation and then again to the individual, and eliminating the $100 dividend exclusion.
This article has a worthless statistic about historic dividend yields in the 20th century. Stocks actually yielded more than 30 year treasuries in the 50's to compensate for the additional risk, supposedly.
The tax change has soured the payment of dividends and made it more sensible to buyback stock (common) and eliminate preferred stocks. This is why stock yields are at record lows -- a fundamental shift in the tax code.
I still have stocks like MRK who continue to increase the dividend, but most are NOT increasing the payout -- Simple math -- 2/3 or more of the dividends end up in the IRS.
Ron made a mistake in '85 and was a big enough man to admit it.
P.S. The tax law on mutual funds was screwed up too (I don't remember when) and I once heard the founder of Vanguard, John Bogle, state that they were inappropriate for Non-Tax exempt positions.
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