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The year of the dividend

By Arthur Goldstuck

At a time when most corporate results are a tale of desolation, one would think
that those companies that continue to deliver solid results would be lionized,
or at least held out as the true champions of the business world.

The problem, however, is how to decide what constitutes success in this era of accounting gimmickry, where ebitda (earnings before interest, tax, depreciation and
amortisation) has become a substitute for profit, and “off balance-sheet” has
become a euphemism for “lying through our teeth”.

It can be argued that the only real measure is what a company gives back to its
shareholders. No, not the speculative returns that result from runs on the
market and enable shareholders to cash in. Those are really gambling returns, as
they only become real when the shares are sold. The obvious, traditional but
out-of-fashion method of giving something back to shareholders is in the simple
mechanism of dividends.

The dividend yield of a stock tells something precise about shareholder returns.
The wonder measure of the dot.com era, the price-earnings ratio, tells only of
the so-called irrational exuberance of the investor market that is willing to
drive a share price up to many multiples of the profits that a company is able
to achieve.

So who are the companies paying dividends, and who are the companies with
anything like a decent dividend yield? In South Africa, the hi-tech players in
these categories can be counted on one hand. No wonder: during the dot.com era,
much was made of the idea that all profits (when they were made) should be
ploughed into acquisitions in order to ensure growth. Investors in hi-tech
stocks bought this nonsense based on the promise that share prices would shoot
through the roof and stay there, never mind all the extra shares that were
issued to pay for the acquisitions and the drain on companies that now had to
integrate their acquisition and pay off the departing directors.

But shareholders and directors alike are beginning to appreciate what dividends
say about the business.

In 2002 major US companies like FedEx introduced quarterly dividends for the
first time. According to Fortune, dividend payouts by S&P 500 stocks rose half a
percentage point for the first nine months of 2002. That, apparently, is the
first time dividends have risen more than earnings coming out of a recession.

In South Africa, both IT giants like Altech and minnows like Moneweb declared
dividends in 2002. In between, the likes of ERP.com, Infowave, Enterprise
Outsourcing Holdings and Paracon climbed aboard the dividend train. Some have
questioned the benefits, with Moneyweb’s 1c a share dividend coming under close
scrutiny and Paracon’s 2.5c representing a similar dividend yield in relation to
its share price. But the reality is, the dividend tells us two things about a
company: it really is profitable, something you can’t always tell from the
balance sheet, and it really is giving something back to the long-term
shareholder.

On the other hand, Money magazine in the USA likes to refer to this as the
dividend myth, arguing that dividends can never be more attractive than a
company’s prospects:

“Think of the dividend as part of a company’s diversification of capital. Is the
company really making money? If so, what is it doing with it? How much is going
to investors in dividends or stock buybacks? How much is going to capital
spending?

A company that doesn’t pay dividends may be using the money to grow, a move that
may ultimately pay off more than a cash payment. A perfect example: Microsoft.”

That’s fine for the people who bought Microsoft in 1995, but what about those
who bought in 2000? It will be years before they see the share price back above
$120 (it was languishing below $60 towards the end of 2002), and in the meantime
dividends would be a great way not only of telling them that this company is
still solid, but that there is some return on investment.

As Fortune points out, “investors – deeply suspicious of management, the
earnings guidance it provides, and even reported profits – are demanding cash in
hand and discounting promises of future earnings”. In other words, the dividend
myth is itself a myth in the eyes of the investor.

Proof, in South Africa, came with the boardroom coup at Comparex, when Alan Gray
led a revolt by institutional shareholders over their frustration at directors’
insistence on hoarding the company’s cash rather than distributing it to
shareholders.

Want further proof? In the first 11 months of 2002 US investors poured $3.8
billion into equity-income funds, which focus on yield-bearing shares – up from
$2.6 billion for all of 2001 and an outflow of $16.7 billion in 2000.

This article is excerpted from Arthur Goldstuck’s review of 2002 for the
December/January annual edition of Intelligence: Total Business. Contact him on
mailto:arthurg@internet.org.za

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The Big Change is a business strategy blog and newsletter published by Arthur Goldstuck, managing director of World Wide Worx, a leading technology research organisation based in Johannesburg, South Africa.

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