Image Credit: Christophe Vorlet
By Jason Zweig | Dec. 28, 2012 1:09 p.m. ET
What if investors could have Christmas all year long?
Dividends are showering down on investors like sugarplums. In 2012, companies in the Standard & Poor’s 500-stock index will pay out regular cash dividends of $281 billion, predicts S&P Dow Jones Indices. That is 17% higher than 2011 and 13% above the previous record in 2008—without even counting all the dividends that companies might have paid in January but have shifted into 2012 to give their shareholders a tax break.
This could be just the beginning of a long-term change in the way companies treat cash and their outside shareholders. If it continues, investors will end up vastly better off than they are now.
Until recently, dividends have been in a long decline, replaced in popularity by share repurchases in which companies use excess cash to buy back their own stock. These “buybacks” reduce the number of shares outstanding, proportionately raising the earnings of the remaining shares. Unfortunately, too many companies buy their shares back when the price is inflated and shun buybacks when the stock is cheap—turning a strategy that can make the firm more valuable into one that fritters away shareholders’ wealth.
In the 1980s and especially the 1990s, investors came to believe that stocks were essentially risk-free if you held them long enough. With high returns seemingly assured, many investors felt no need for current dividend income to cushion them from potential losses.
But the two catastrophic bear markets since 2000 have changed all that. Individual and institutional investors alike have been turning their backs on the stock market.
Since the beginning of 2000, individual investors have pulled nearly $1 trillion more out of U.S. stock funds than they put in. A decade ago, the nation’s largest endowment funds had half their assets in U.S. stocks; now, it is less than one-fourth of their combined assets.
These days, if companies want to have investors at all, they might have to pay them—with much higher dividends. “Investors are saying, ‘If you want me to take the inherent risk of owning an equity, then I want a meaningful cash dividend to compensate me for that risk,”‘ says Lawrence Stranghoener, chief financial officer of Mosaic. This year, the supplier of phosphate and potash fertilizer, based in Plymouth, Minn., quintupled its dividend to an annual rate of $1 a share. That pushed Mosaic’s yield—the annual dividend rate divided by current share price—up to about 2%.
Other companies have been supplementing their regular quarterly payments with “special dividends” that distribute excess cash to shareholders. A special dividend can be one-time or recurring, at the discretion of the company’s directors.
Diamond Offshore Drilling, for instance, paid out 50 cents a share in regular dividends this year and a total of another $3 in quarterly special dividends—for a combined yield of roughly 5%.
While shareholders hate to see companies cut a regular dividend, they are more forgiving if a special dividend goes down or goes away. Diamond has paid 75 cents a share in special dividends for 10 consecutive quarters, although that is down from a peak of $1.875 a quarter in 2009 and early 2010.
Larry Dickerson, Diamond’s chief executive, thinks dividends frequently are better than buybacks, since cash is never overpriced, but shares often are. And dividends reward loyal shareholders, not sellers.
“Most companies say, ‘I’m going to retire shares, that’s part of my business, I don’t care what it costs,'” Mr. Dickerson says. “But we think by paying a dividend to a shareholder who keeps our shares, that goes directly into his pocket. In a buyback, the money ends up with someone who sells your shares.”
In pursuing this approach, companies like Diamond hark back to another age: the 19th century, when U.S. corporations sought to pay out high dividends, often ranging from 6% to 10% of their “par value,” or original issue price. As profits waxed and waned, the companies varied their dividends accordingly. As a result, “the stock price stayed relatively steady,” says economic historian Peter Rousseau of Vanderbilt University.
Nearly all the returns on U.S. stocks in the 19th century came from dividend income—much the way, over time, the yield on bonds tends to account for nearly all their investment performance. “Equities in the 19th century functioned much like bonds do today,” Prof. Rousseau says, “except that the dividends fluctuated much more.”
Richard Sylla, a financial historian at New York University, says that thanks to their high dividend yields, stock prices in the 19th century generally stayed within a band of 20% below to 50% above their par value. Contrast that with the 60% crash in stocks between 2007 and 2009, or the even deeper losses of many Internet stocks 10 to 12 years ago.
Long ago, people used to think of stocks as investments with high yields that fluctuated and principal value that didn’t vary wildly.
Today, bond yields are near zero, and the scars of stock-market crashes still are raw. If companies want to win back the hearts of the investing public, they shouldn’t just build for the future. They should also think about echoing the past.
Source: The Wall Street Journal, https://www.wsj.com/articles/SB10001424127887323291704578199632820722650
For further reading:
Definitions of DIVIDEND, TOTAL RETURN, YIELD in The Devil’s Financial Dictionary
Chapter Nineteen, “Shareholders and Managements: Dividend Policy,” in The Intelligent Investor