Multifaceted Dividends

Pay out dividends, yes, or no? “It depends”, is my clear answer. As long as management can invest the free cash flow back in the company more sensibly than I can, I’d rather it not pay me a dividend. But before it starts building castles with the money, I'd rather receive it, please. 

Established business models have often reinvested sufficiently in the core business and still have some money left over. What to do with it? A handful number of options remain:

1.    Acquisitions of other companies
2.    Reduction of debt
3.    Buy-back of own shares
4.    Payment of dividends 

Sometimes, from this perspective, it's not such a bad thing when companies have to reduce their debt. Because perhaps they have overdone it with the takeovers and must therefore step on the debt brake. Then I at least know the itinerary as a shareholder. 

This forced hand of capital allocation reduces the error rate. After all, those who have surplus money in their hands sometimes tend to be creative without thinking. The decisive factor is then whether management can make good capital allocation decisions. Because before any nonsense is done with the money, it is better for the shareholders to receive it as a dividend. 

Steady as clockwork

Interestingly, there is also the curse of the constantly rising dividend. Classics in this area are, for example, manufacturers of toothpaste, shampoo, sodas or chips. The best companies in this segment increase their operating results above the world GPD in the long term. Coupled with the consistency of their business model, some of them have been raising their dividends every year for decades. 

But these regular increases in clockwork pattern are also a problem. Who wants to be the new corporate leader to be  the first in a long line to cut the dividend? Here comes the temptation to increase debt in order to keep up the implicit promise. It only becomes dangerous when the supposedly short bridging triggers a long spiral of over-indebtedness. 

Another aspect of the dividend should not be underestimated. If a company is able to send money to investors every year, this is proof of quality. After all, the money must be generated from operating cash flow. Profit is merely an opinion, but the hard cash of the dividend is a fact.