The Problem About Dividends

Providend

I love getting stuff for free. My word, I seriously love getting stuff for free. In fact, the only person I know who loves getting stuff for free more than me is my mother. The apple doesn’t fall far from the tree.

And isn’t it just wonderful that stocks would pay you to own them? Can you imagine the glee on my face when I saw that telecom shares are paying over 5% a year just to hold them? REITs are paying over 6%, some come close to 8%. There are so many to choose from. When I looked through the list of REITs available in the market, I was like a child in a candy store.

So what’s the problem? There’s no such thing as a free lunch.

Dividends represent cash leaving the company. Cash is like the lifeblood of a company. If you take a portion out to pay the shareholders, management better have a solid plan to replace it. Thankfully, most managements do, but it doesn’t make it any less traumatic on balance sheet strength. That’s not to say that paying a dividend is bad; dividends are how shareholders often crystalise a portion of their profits in the company they’ve invested in, without having to sell the shares. It just means that companies with high dividend yields tend to have to plan their cash positions well.

But if the company is paying a consistently strong dividend yield each year, doesn’t that prove that it has a solid track record in managing its cashflow? Yes. But that doesn’t mean that its future cash positions and balance sheet strength would be just as strong. Businesses are alive. They go through good times, they go through bad times. In bad times, it’s going to need all the strength it can muster. And sometimes, maintaining a strenuously high dividend payout takes away from that strength without adding much to the company. Never be confused about the past being a measure of the future – it’s just a guide; not a guarantee.

I often hear great stories about how the total return of the S&P 500 since 1929 is 43% dividends. This statistic is actually true. But those dividends are assumed to be reinvested, not taken out as cash. True, it’s still a dividend, but a reinvested dividend (especially one which takes advantage of a formal Dividend Reinvestment Plan from the company), may not strain the company’s cash position as much as actually having to pay out a cash dividend. Be careful with anecdotes and bar stories. Understanding the fine print is as important as understanding the story itself.

Whilst a dividend centric investing policy has its merits, it should never be taken as anything more than it is. It certainly should never replace the low-risk portion of a portfolio – even if the dividend yield of a share is higher than the bond yield you currently own. Risk is an insidious thing. You never realise how truly devastating it is under it materialises and completely ruins the value of your portfolio. A bond is often purchased because of its lower risk profile; not just because it has a yield.

Conversely, investing in stocks with a 0% dividend yield may also make complete sense. Legendary stock wizard Warren Buffett’s company, Berkshire Hathaway, does not usually pay a dividend. It’s actually only paid one once, in 1967. Its theory since then is that if it keeps all its cash and utilises it for investment purposes, its shareholders will benefit through greater share value. Perfectly legitimate. Just for reference purposes, Warren Buffett first bought Berkshire Hathaway stock at $7.50 a share in December 1962. As of 1 June 2018, each share is worth $289,200.00. It’s hard to argue against that kind of return.

So as you see, whilst I still love free stuff, I have to enter an investment with both eyes open, and ask difficult questions. Is it really free? How am I ultimately going to pay for this very nice benefit? Luckily for me, I can talk to the very friendly people here at Providend about these things. I highly recommend you give your Client Adviser a call if you have any questions. Meanwhile, I’m just glad that my mother is happy with her regular dividends, and to celebrate, she makes an extra-large serving of (non-crispy) rendang that weekend for the family lunch.

This is an original article contributed by Providend’s Editorial Team.


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