Friday, January 8, 2010


Floyd Norris has a short article (reprinted below) this morning in the New York Times talking about dividends. The piece describes how companies have been cutting dividends aggressively during the past year, often citing the need to conserve cash in the troubled financial markets as a rationale.

While I understand what happened last year, I also believe that we will see investors begin to demand higher dividend payouts in the future, especially as the economy begins to recover.

Dividend yields for much of the first half of the 20th century were considerably higher than bond yields. Investors did not view stocks as vehicles for capital appreciation, but rather investments in businesses that were expected to return cash to the owners (i.e., the shareholders).

When I was in business school, we were taught that the value of a stock could be derived from something called a "dividend discount model". This model essentially discounted back to the present the value of all dividends (including growth rates) that were expected to be earned in the future.

Put another way, the idea that someone would plunk a large chunk of their hard-earned savings into investments which did not return cash was thought to be appropriate for only the more speculative investors.

I think we will return to an emphasis on dividends for a couple of reasons. First, the dismal track record of stocks over the past decade means that companies will need to offer some inducement to prospective investors. Second, investors depending on stock investments for retirement need cash for living.

By the way, I understand that in theory it is more tax-advantaged for companies to buy back stock in the open market (which should raise the value of stocks) as opposed to paying dividends (which are currently taxed at 15%, but this will probably rise). Unfortunately, too many companies have used stock buybacks to offset large stock grants to senior management (e.g Cisco), and in the end shareholders did not benefit.

Off the Charts

As Dividends Have Fallen, So May They Rise

For the first time in at least half a century, American companies announced more dividend cuts than increases in 2009.

In a normal year, companies announce 10 to 20 times more favorable than unfavorable dividend changes, but the last two years have been anything but normal. The financial crisis forced many financial companies to reduce or suspend payments, and the ensuing credit crisis and recession led many other companies to cut back wherever they could.

But by the end of the year, there were indications that the recession was over and the number of negative dividend decisions began to decline, according to statistics compiled by Standard & Poor’s.

“The fourth quarter was in no way a good period for dividends, but compared to recent history it marks a significant improvement, and when added to the stabilization in increases, supports our belief that the worst is over for dividends,” said Howard Silverblatt, the senior index analyst at S.& P.

“Standard & Poor’s believes that the dividend recovery will be slow, and that it will take until 2012 to 2013 to return to where we were in 2007 and 2008,” he added.

Over all, Mr. Silverblatt said, dividend cuts in 2009 cost investors $58 billion.

The figures shown in the accompanying graphics compare the number of companies announcing either a resumption of dividend payments or an increase in the payout to the number announcing either a reduction or elimination of the dividend.

S.& P. also counts declarations of extra dividends, but does not keep track of whether such dividends are higher or lower than the company paid the previous year. Those figures are excluded from the calculations.

In 2009, just 778 companies announced either increases or resumptions of payouts, the smallest number since S.& P. began keeping track of the figures in 1955. The previous low was 786 in 1958, another recession year and the only previous year when the number of negative moves came close to the number of positive ones.

Similarly, the number of negative moves in 2009, at 804, was the highest ever, surpassing the 738 figure of 1958.

On a quarterly basis, the first three months of 2009 were the worst of this cycle, with 64 percent of dividend announcements being negative. But that figure fell a little short of the record of 67 percent, set in the second quarter of 1958.

The stock market hit bottom in March 2009, at a time when there was talk of a new Great Depression. In that one month, a record 144 companies announced reductions in or eliminations of dividends. Before the current cycle, that total had topped 100 in only one other month, May 1958. But the number surpassed 100 in five of the six months from November 2008 through April 2009.

The sheer rapidity of the plunge could provide an indication that the dividend recovery will be faster than many expect. It is possible that some companies made cuts fearing much worse conditions than actually arrived, and will therefore be able to raise payouts even without much improvement in business.