While I love dividend-growth investing and follow the strategy in our retirement accounts, I prefer non-dividend payers in our taxable accounts (discussed in an earlier post). The main reason behind the idea is a preference for businesses that can reinvest earnings and earn a better return than is possible on my own. A secondary reason is to avoid losing a portion of dividends to taxes every year.
Mark Hulbert writes in The New York Times that new studies show that lower dividend payout ratios were associated with lower earnings growth going forward. The study’s authors point out that management does a poor job, on average, of investing retained earnings. They also point out that managements hate to cut existing dividends and are thus unlikely to increase them unless they are confident of future prospects.
As the column point out, the study is a reminder that if a business decides not to pay a portion of its profits in dividends, investors should keep a close eye on the company to see if it is able to achieve a high rate of return on reinvested profits.
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2 responses so far ↓
1 Phil S // Jun 3, 2006 at 9:59 am
You forgot a third scenario. Leveraged investors like me need to buy dividend paying stocks in order to lessen or eliminate the pain of the interest payments on the money borrowed to buy the stocks. It’s obviously a big gamble that is not for faint of heart as a distribution cut kills both the ability to pay down the interest as well as original investment value - so the downside risk is at least as large as the upside potential.
2 Dividend Growth Investor // Jul 26, 2008 at 6:17 pm
I agree that management typically doesn’t know how to reinvest profits back to the business. Thus they should reward shareholders for risking their hard earned money by giving them dividends. It’s that simple.
Otherwise, if management forgot that they should be working for the shareholders, they would do large risky bets which could only profit exectuvies compensations.. But would actually detract from long-term value of the corporations they are serving!
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