Whatever Happened to Dividends?

Yesterday I told you about the Beardstown Ladies who, though sweet, little and old, may not be quite the tycoons they cracked themselves up to be.

Today let me mention Floyd Norris, Market Watch columnist for the New York Times. He holds forth incisively on the state of various markets and on issues of shareholder rights — and management abuse of those rights. He is someone on whose savvy you can rely. One of the very best.

All of which leads up to my topic for the day, dividends, inspired by a recent Norris column.

When I was growing up, Uncle Lew gave my brother and me 10 shares each in a handful of blue chips. These stocks rarely went up or down more than an eighth or a quarter of a point in a day; they paid 4% or 5% in annual dividends (savings account paid 3%) . . . life was simple.

Nor was America back then in such sad shape. The economy was growing as fast as now; technology was moving along nicely (a vaccine for polio had been discovered; some kids’ folks were getting color TVs; miraculous electric typewriters were on the drawing board). We weren’t the only superpower, but we were certainly the big man on campus. (And somehow all this was possible without paying our CEOs a hundred or a thousand times as much as we paid the guy on the assembly line. And despite the Eisenhower-era 90% top federal tax bracket.)

It was very boring, aged 10, to see these 5% dividends trickle in, 1.25% a quarter. What were my brother and I going to do with a check for $5, even then? (There were no dividend reinvestment plans: the cash was ours.)

Yet that was, theoretically, the reason for buying stocks: you’d get a share in the profit of the enterprise. A dividend.

Today the reason for buying stocks is: they go up. Profits are good if they meet or exceed Wall Street analyst expectations; but if a company makes a $400 million profit and the Street was expecting $435 million, that is a very bad profit. Ick! Don’t want to be anywhere near that $400 million.

Otherwise, there’s little connection these days between a company’s profits and its shareholders. Most of the stocks people are interested in don’t pay dividends or else pay tiny ones.

There is a very good side to this: we are reinvesting our profits, and that’s what builds economies and a bright future.

There is also a tax side to this: when paid out as dividends, our share in a company’s profits are subject to income tax (unless held in a retirement plan); when reinvested for the future, they may ultimately provide us with a less heavily taxed capital gain (or just bigger dividends down the road).

But there are less positive sides to this as well. As Floyd Norris reminds us, CEOs often own relatively little stock (and so get little by way of dividends) but hold gigantic stock option packages (and so care deeply about getting the stock price up). Why pay out dividends when the same money could be used to buy back shares of company stock?

Buying back the company stock adds to the demand for the stock, driving up the price; shrinks the supply, driving up its price; and increases the all-important earnings-per-share (because there are fewer shares to divide the earnings among), driving up its price.

And so far, everyone seems pretty happy with this arrangement.

But there could come a time when, as part owner in the enterprise, you’d like to start getting your hands on a slice of the profits. I guess you’ll just sell a few shares now and then — that will become the retiree’s new monthly income: not bond interest or dividends, but the proceeds from the sale of 10 shares a month.

It could work.

Yet if stocks ever stop rising so fast, people might begin to focus more on dividends — as they used to. If so, given the skimpy dividends so many companies pay, they may decide to invest in something that pays a bit more. Bonds, even.

I’m not predicting this, just trying to make sense of a world in which Amazon.com (a great company, of which I am an enthusiastic supporter) has sales of $147 million, no profit, and is valued by the stock market at $2.8 billion. Is the idea that some distant day it will be paying out $280 million a year in dividends? Or is the idea that it’s an exciting company in an exciting world and the price may continue to go up?