Abnormal Dividend Payments Aren’t Good

The dominant conversation that prospective clients are having with me is about their desire to earn a higher yield on their money.

I’m talking yield in terms of income.

A couple years ago they were earning 6% on their Australian Dollar cash held in the bank but now they are earning 2.7% and so the chase for yield begins, mainly via sub-standard, riskier assets in order to satisfy their single, blinding and qualifying criteria of income yield.

Surely, I must have written about that particular angle previously.

But the current trend amongst listed companies who are holding excess cash or re-generating pre-crisis levels of free cash flow – is to return cash to their shareholders.

We know that over the past couple years companies have “returned cash” by re-purchasing company shares. Appropriately, they have also re-financed debt at cheaper rates. This has also improved their “earnings per share” data which the stock market and analysts have loved.

Today’s trend is to return cash by increasing the company’s dividends at larger increments than in the past. Some companies are even making interim (or extraordinary) dividends in addition to their normal payment schedule.

Is this corporate board room’s new “increasing the share price” strategy? Raise your dividends abnormally, so those who are chasing yield will buy your shares and thus send your share price higher.

This also serves management handsomely, especially if they have share price performance linked remuneration (options, bonuses etc.), but I think this is also exhibits management’s laziness for their lack of ability to find ideas on how to use their company’s money to grow the business.

Company management would be quick to suggest that “this is in the best interest of shareholders”.

I don’t like this strategy, whether it’s from a corporate or an investing perspective.Historically, I have seen this occur before.

Today, the company appeases the market by handing out the cash and Tomorrow, it needs cash again; which is when they either issue new shares (which dilutes existing holders) or borrow money (often at interest rates higher than a couple years ago) which usually equates to a higher gearing ratio in their balance sheet.

One of our investing themes is to look for companies that are retaining their earnings. Our preference is to keep the money in the balance sheet and then deploy that capital to grow the business.

All this talk of corporate activists demanding cash being returned and balance sheets being lazy – blah, blah, blah.

I’d rather see the excess money left in the company’s bank accounts instead of leaving. If the board and management can’t develop a strategy on how to use that money appropriately, then they should be leaving, not the company’s money.

I think this is better for shareholders.