Dividends vs Capital Growth

[idpickering]

OK, I get that we're all about income here, but this item from TMF might still prove of interest here;

Dividends vs capital growth

"Dividends are often misunderstood. Many investors view them as something which only a mature company that has run out of growth ideas will pay. Such investors may feel that dividends are only of real use for retirees who are living off the income return of their investments. However, this is not the case. Dividends provide an indication of the financial health of a business, its valuation and can act as a catalyst on future share price growth."

http://www.fool.co.uk/investing/2016/11 ... al-growth/

[andycowl]

Many investors view them as something which only a mature company that has run out of growth ideas will pay.

That is a very bizarre statement - and from a personal finance site that employs writers. Long, deep sigh.

[Breelander]

Many investors view them as something which only a mature company that has run out of growth ideas will pay.

That is a very bizarre statement...

Not really, it's a quite common thought-process amongst that type of trader that seeks pure growth stocks. Vodafone is the classic example : seen as a high-tech growth company in the dot-com boom years, they only turned into a significant dividend-payer in 2005 when they doubled their dividend - prompting comments like these in 2006...

... there was the nagging question hanging in the air: has Vodafone gone ex-growth and should it be rated in the same way as a defensive utility stock?

http://www.independent.co.uk/news/busin ... 10924.html

DESPITE INVESTORS' CONCERNS THAT VODAFONE Group has gone ex-growth, the U.K. mobile telecom operator hasn't. Thanks to its enlarged portfolio of assets in emerging markets, it's still growing.

http://www.barrons.com/articles/SB116562563558745186

Sarin also announced that the expected revenue growth rate for the company for the year ended March 31, 2007, would range between 5 percent and 6.5 percent. This was lower than the expected growth rate ... Analysts commented that the world's largest mobile company was going 'ex-growth'.

http://ibscdc.org/Case_Studies/Business ... rouble.htm

Bree. (holds VOD since 2006)

[andycowl]

When my Dad introduced me to the stock market (aged 14) I understood why companies might (or might not) pay dividends.

But then again, I'm not a 'value/day trader' or a journalist for the Independent. Thankfully.

[Lootman]

Dividends are one element of total return. You might sell some shares of a stock that pays no dividend at a time and to a amount you personally prefer in order to generate a DIY dividend ... as how Warren Buffett suggests. Or a dividend stock might have all of its dividends reinvested so as to in effect not have paid a dividend. Using dividend yields as a comparison measure isn't a good choice of measure, there are better choices, such as total returns, PE, book to price ... etc.

The rather arbitrary distinction between dividends and capital gains can be further deflated - it is possible to convert one into the other, and sometimes there is a tax benefit to doing that.

For example, you can sell at-the-money call options on a share holding that you hold (assuming you hold 1,000 shares anyway - one of the few cases where the number of shares you hold and the nominal price of them actually matters). When you do that you give up any future capital gains in your holding for the duration of that options contract, and in return you get an upfront premium. Although that premium is actually taxed as a capital gain, it's really a form of income - you traded the possibility of a gain for the certainty of a defined income.

Converting dividends into capital gains is a little trickier but can be done. You could sell the day before ex-dividend day and then re-purchase on ex-dividend day. You give up the dividend but would normally be able to buy back at a price lower than the sale price by the amount of the dividend. You can also not hold the share and instead be short an at-the-money put option whose price has the future expected dividends baked into it.

Then there is the rather arcane world of swaps where one set of cash flows is literally exchanged for another.

I am not recommending any of these strategies. I am merely using them to illustrate how making too much of the distinction between capital gains and dividends can be an illusory approach. Theoretically, at least, they are interchangeable.

[Jack]

While dividends may be categorised as somewhat dull and only of interest to retirees, the reality is that they provide a quick and simple means of assessing the financial strength, performance and valuation of a company

One of the most egregious statements about dividends I've ever read. And I've read some pretty bad ones.

Jack

[Arborbridge]

"Egregrious" can be read two ways, but I'm guessing you didn't mean it in the complimentary sense


Arb.

[Alaric]

You could sell the day before ex-dividend day and then re-purchase on ex-dividend day.

Is it sometimes done the other way round? You buy just before ex-dividend day and sell immediately afterwards. That's a fund managers trick which can boost the running income of their fund and gets round any rules which say they aren't allowed to sell to make income distributions. All things being equal, it creates a capital loss equivalent to the amount of artificial dividend.

[gadgetmind]

Many investors view them as something which only a mature company that has run out of growth ideas will pay.

That is a very bizarre statement - and from a personal finance site that employs writers. Long, deep sigh.

It's a statement that I have heard at least one CEO of a (non dividend-paying) growth company make in public.

[Bubblesofearth]

No market is unlimited in size. This means that any business looking to exploit a particular market will face limits to growth. Or at the very least limits to the rate of growth. The law of diminishing returns if you will. Payment of dividends, like any shareholder return, should be based on what represents the best value to those shareholders. If a company is close to the limits of growth then it may well be best to pay a dividend rather than to invest for growth.

Hence why mature companies tend to pay the most generous divis. I would be very disappointed if a small company with a largely untapped market decided to throw off money in divis. That's certainly not the reason I would be investing in such a company.

BofE

[Gengulphus]

Many investors view them as something which only a mature company that has run out of growth ideas will pay.

That is a very bizarre statement - and from a personal finance site that employs writers. Long, deep sigh.

No, a statement that dividends are something which only a mature company that has run out of growth ideas will pay would indeed be a very bizarre statement in my view. But a statement that many investors regard them that way is a simple matter of fact: I've encountered exactly that argument from quite a few investors on both TMF and other investment sites.

Gengulphus

[Gengulphus]

No market is unlimited in size. This means that any business looking to exploit a particular market will face limits to growth. Or at the very least limits to the rate of growth. The law of diminishing returns if you will. Payment of dividends, like any shareholder return, should be based on what represents the best value to those shareholders. If a company is close to the limits of growth then it may well be best to pay a dividend rather than to invest for growth.

Hence why mature companies tend to pay the most generous divis. I would be very disappointed if a small company with a largely untapped market decided to throw off money in divis. That's certainly not the reason I would be investing in such a company.

A successful company with a largely untapped market can face other limits to its growth than the availability of cash. For example, if it requires staff with a good technical understanding of its products and those products are very complicated, bringing new staff sufficiently up to speed on them may be more of a limit than the ability to recruit and pay them. Especially if those staff are going into researching and developing products further, this may be storing up considerable amounts of trouble for the future...

Basically, one should bite off as much as one can chew - not more! If one's cash exceeds the amount needed for that, then certainly build up a decent reserve against future needs, but after one has that, give the shareholders the job of getting a decent return from it!

Gengulphus

[Lootman]

You could sell the day before ex-dividend day and then re-purchase on ex-dividend day.

Is it sometimes done the other way round? You buy just before ex-dividend day and sell immediately afterwards. That's a fund managers trick which can boost the running income of their fund and gets round any rules which say they aren't allowed to sell to make income distributions. All things being equal, it creates a capital loss equivalent to the amount of artificial dividend.

Yes, and buying to "harvest" a dividend in that way is probably more common, because it boosts the headline yield of the fund, and that's a good selling point even though it's somewhat a piece of trickery. I gave the example of doing the opposite just to show how it's possible to depress the income stream and boost the capital performance, as a way of highlighting that the distinction between income and capital can be fuzzy.

In practice it costs you the stamp duty (plus spread and commission) to play such games, and so I'd question whether it adds value. It could be worthwhile perhaps on an ETF (no stamp duty) and a single annual payout?

[Alaric]

Equity finance can usually be replaced by debt. Interest on the debt is then the payment to the providers of capital for that loan. From that viewpoint dividends also represent payments for use of capital, being more flexible in downturns that debt, but sharing the rewards of success with shareholders. If a Company needs more money, it will have to borrow more, raise more equity capital, or not pay dividends.

[Bubblesofearth]

A successful company with a largely untapped market can face other limits to its growth than the availability of cash. For example, if it requires staff with a good technical understanding of its products and those products are very complicated, bringing new staff sufficiently up to speed on them may be more of a limit than the ability to recruit and pay them. Especially if those staff are going into researching and developing products further, this may be storing up considerable amounts of trouble for the future...

Gengulphus

Can you give an example?

Once a product has been developed sales and marketing drive growth and I'm struggling to think of a business where the salesforce require that high a level of technical understanding. Hope I'm not being unkind to salespeople but in my experience as long as they can explain the benefits that's usually enough. I can't recall ever asking for, or getting, an in-depth analysis of how a product I'm buying works. If I want that level of understanding (usually I don't) I can research it myself or contact the companies tech division.

BofE

[daveh]

A successful company with a largely untapped market can face other limits to its growth than the availability of cash. For example, if it requires staff with a good technical understanding of its products and those products are very complicated, bringing new staff sufficiently up to speed on them may be more of a limit than the ability to recruit and pay them. Especially if those staff are going into researching and developing products further, this may be storing up considerable amounts of trouble for the future...

Gengulphus

Can you give an example?

Once a product has been developed sales and marketing drive growth and I'm struggling to think of a business where the salesforce require that high a level of technical understanding. Hope I'm not being unkind to salespeople but in my experience as long as they can explain the benefits that's usually enough. I can't recall ever asking for, or getting, an in-depth analysis of how a product I'm buying works. If I want that level of understanding (usually I don't) I can research it myself or contact the companies tech division.

BofE

How about Arm holdings. They had a continual cycle of new product development, and the company was throwing off a lot of cash. At some point more cash was been produced than was needed or could be employed in developing new chips etc. and they started paying a dividend. I assume there was a limited pool of talented developers they could employ to develop new product.

[Gengulphus]

Can you give an example?

Yes, there are a number in the computing industry in Cambridge. As an example, Acorn Computers had an enormous success with the BBC micro in the 1980s - and got into trouble when they overinvested in stock for one of the follow-up products (the "Electron" if anyone remembers it) and in research: I believe that when the crunch came and they had to rationalise what they were doing, they actually had more R&D projects than employees!

Much more recently, ARM Holdings was taken over by SoftBank in September, and part of the rationale given was that SoftBank would provide access to additional funding. But the company had had a growing cash pile for years, despite growing at a good rate (they'd roughly doubled their workforce in the last five years IIRC) and paying for 'bolt-on' acquisitions along the way. And their one big acquisition to date had been Artisan (in 2004 IIRC) and is generally reckoned not to have been a success - not an outright failure, but rather mediocre.

I seriously doubt that it will end up using that additional funding, and if it does, I suspect it will end up being a case of biting off more than they can chew...

Once a product has been developed sales and marketing drive growth and I'm struggling to think of a business where the salesforce require that high a level of technical understanding. Hope I'm not being unkind to salespeople but in my experience as long as they can explain the benefits that's usually enough. I can't recall ever asking for, or getting, an in-depth analysis of how a product I'm buying works. If I want that level of understanding (usually I don't) I can research it myself or contact the companies tech division.

Not in an industry where you have to run pretty hard to stay still! ARM Holdings has been researching and developing new generations of microprocessors since it was founded in 1990 (as a joint venture between Apple, Acorn (who had developed the first couple of generations) and their semiconductor manufacturer), and they've needed to do so both to stay in their existing markets and to try to expand into others. In 2015, R&D was about half of their entire costs between revenues and operating profit, while sales & marketing were a bit under 20% of them - i.e. the cost of the salesforce was not the dominant factor in the company's growth... And while getting a new sales & marketing person up to speed is probably quite a bit easier than getting a new R&D person up to speed, there's still a significant learning curve involved - among other things, to be able to recognise when a customer has novel needs that should be referred to R&D as something the company could try to address...

I'm not saying that it's common, but R&D-led-growth companies do happen and compared with sales-and-marketing-led-growth companies, they present a different environment from the point of view of the company being able to invest cash quickly and effectively.

Gengulphus

[Gengulphus]

How about Arm holdings. They had a continual cycle of new product development, and the company was throwing off a lot of cash. At some point more cash was been produced than was needed or could be employed in developing new chips etc. and they started paying a dividend. I assume there was a limited pool of talented developers they could employ to develop new product.

Snap!

Not so much a limited pool of talented developers, by the way, so much as a limited pool of talented developers who are thoroughly familiar with how the company's existing products work. New people will have ideas of what works well that turn out not to work so well with those products or vice versa. And helping them (un)learn those things mustn't be too much of a distraction for the existing R&D staff from the existing job...

There's much more on this sort of stuff in "The Mythical Man-Month", but basically, there's a limit to how fast a technical project can absorb extra resources even if unbounded supplies of them are available...

Gengulphus

[tabhair]

Personally, I am very wary of this investing climate that we're in, where I feel there is almost an obsession towards the growth and yield of dividends. Don't get me wrong, I love getting dividends, and am very grateful they exist, but I think that the investing climate is just so heavily focused on dividends that some people just aren't seeing the woods from the trees. For example, look at the likes of BP and Royal Dutch Shell. These two companies are both having to borrow billions just to cover their dividend. If management were focused on the business, rather than supporting the stock price, they should instead be looking at cutting the dividend and redeploying any available capital that's available to buying their competitors that are going bankrupt all around them. If oil is supposedly as cheap as they claim, then the best return is buying capacity at lower prices now that you can sell on for higher prices in the future. Instead, management are probably so afraid that if they cut the dividend that the shareholders will kill the stock, they'll do anything to keep the payout.

Look at this forum, there are quite a few people (not everyone) whose sole criteria for investing is the yield and cover of a stock. In a low rate environment, this strategy has worked wonderfully, but now with long-term bond yields starting to rise, this could change (and so far, it is changing, stocks that trade as proxies for long-term bonds are getting crushed).