19. Dividend Policy
The author has advocated since 1934 that shareholders should take an "intelligent and energetic attitude" toward those who manage their firms: to be generous to those who are demonstrably doing a good job, and to demand clear and satisfactory explanations when results are worse than they should be.
As such, shareholders are justified in raising questions when the performance of a firm is inherently unsatisfactory, is poorer than other firms "similarly situated," and result in an unsatisfactory market price over a long period of time.
However, for all that time, very little has been done by shareholders to govern the management of their firms, though an extraneous development has done much to encourage them in the proper direction: the prospect of a hostile takeover. Where the management has become egregious and shareholders have abandoned all faith, there is the threat the firm will be acquired by a "corporate raider" for its salvage value.
This fear had briefly restored some vigilance to the boards of public companies, and some fear on the part of managers that operating results and the resulting market value of their firms must be in order to defend against the desertion of shareholders and a plummeting stock price that will attract vultures to finish off what they had essentially begun.
Shareholders and Dividend Policy
In general, divided policy has been a point of contention between shareholders who demand to be paid out a share of the profits of the firm they own, and management who wished to retain as much of it as possible to reinvest in the company to improve its stock price in the long-term.
In past years, a company that was forced to hold onto its profits to remain viable was considered weak - it was expected that 60% to 75% of corporate earnings would be paid out as dividends, which generally had a negative effect on the price of shares.
Investors also sought out dividend-paying stocks as a means of producing income to themselves - particularly retirees planned to use dividends to cover their living expenses, with a modicum to be retained by the firm to give it the means to grow moderately to increase the amount of income over time.
There was little proof that reinvesting profits in a business could be counted upon to produce an increase in the earnings that exceeded, or even equaled, the value of funds released from the firms. Simply sated, the retained funds were wasted, or invested in unprofitable ventures by a firm, and no significant improvement was made to the overall performance.
Nowadays, the attitude has shifted, and the theory of profitable reinvestment has been gaining ground. Investors have become inclined to accept low dividend payouts, and the practice of paying little to no dividend has become so commonplace that it seems to have virtually no effect on the market price of shares.
One striking example is Texas Instruments, whose stock rose from $5 in 1953 to $356 in 1960 while no dividends were paid. Superior oil also rose from $235 to $600 while reducing its dividends from $3 to $1 per share, then to $2000 per share in a year it paid no dividend at all. However, examples exist of firms whose prices tumbled when they decreased their dividend rates, such as AT&T and IBM, demonstrating that the trend is not universal and opinion among stockholders remains divided.
(EN: The author does not mention the effects of taxation. Since dividends are taxable on payment and capital gains only on the sale of shares, investors may be motivated to manage their tax bill by favoring firms that follow the course of reinvestment. Individuals in lower tax brackets and pension funds are less affected by taxation, so the preference differs among individuals - and I suspect that examining the demographics of a given companies shareholders would reveal certain patterns that would make the preference for dividends more or less pronounced.)
The author believes that shareholders should demand either a normal payout of earnings, on the order of around two-thirds, or some clear-cut demonstration that the funds can be profitably reinvested to yield an equal or greater increase in share value. Should the argument be made that the funds are needed to bolster the financial strength of the firm, shareholders should be quick to remind management that they bear the blame of running the firm in a manner that bolsters are required.
Stock Dividends and Splits
Stock dividends or stock splits are often misinterpreted as a growth in the firm, though this is not the case. The investor who receives additional shares as a "dividend" does not gain additional value, merely more units that have less value. This is merely a manipulation of share price, which is done to decrease the price of individual shares on the notion that certain investors set share price as a criteria for purchasing a firm, and will refuse to purchase a firm whose shares are above a certain price.
The author suggests that there can be a "proper stock dividend" when a company has benefited from a specific earnings that are reinvested in the firm, and the dividend can be paid out in shares without decreasing the value of existing ones. This rarely occurs, and when it has it has not exceeded 5%.
The NYSE has set a limit of 25% for stock dividends, such that any company that offers more than that figure will be publicly regarded as having split its stock. This is meant to discourage the practice, but some companies are in the habit of declaring a stock dividend in any amount they please. Banks are notorious for this behavior.
Others have suggested the benefit of stock dividends is to pay out what would have been granted as a cash dividend, but sparing the stockholders the tax liability. There is no apparent benefit to this as compared to merely retaining the funds for reinvestment in the firm.
Most credible analysts disapprove of stock dividends and recognize them as mere accounting maneuvers that grant stockholders nothing they did not have before, and that the expense and inconvenience of issuing them is entirely needless. The author agrees completely.