“We’ve pressured Cisco, saying, ‘We would like a share. You don’t need all that money.'”
– Susan Byrne, chief investment officer of Westwood Holdings
Cisco Systems recently joined tech titans Microsoft and Oracle in breaking the industry’s long tradition of paying regular cash dividends only rarely. Companies are regaining enough confidence to pay dividends after viciously slashing them in 2009. So far in 2010, there have been 179 dividend increases and three cuts among Standard and Poor’s 500 companies. In 2009, through September, there were 110 increases and 72 cuts.
Companies are sitting on record amounts of cash. According to the Federal Reserve’s first quarter flow-of-funds data, U.S. corporations have more than $1.8 trillion in cash. S&P 500 have accumulated $837 billion.
Cash dividends are welcomed by investors, who have been disappointed by mediocre stock performance and low bond yields. The dividend yield for the S&P 500 is 2.42 percent, comparable to that of the 10-year U.S. Treasury.
A company’s willingness and ability to pay steady dividends provide good clues about its fundamentals.
Josh Peters, in the book “The Ultimate Dividend Playbook,” argued that a dividend payment is the ultimate sign of corporate strength, because it shows that the company’s board has not only direct interest in the shareholders — the ultimate owners of the business — but also the ability to pay out cash.
Companies paying dividends are usually stable, rather than “fast growers.” Dividends should be maintainable — they imply management’s willingness to pay cash into the indefinite future, because they believe the company’s business prospects are bright.
Can high cash balances or low dividend payouts detract from equity values? Tavis McCourt of Morgan Keegan wrote in a research report, “Why Cash Hoards are Destroying Public Equity Value in Tech,” that companies — to bolster their stock prices and reward their shareholders — should “radically alter their capital-allocation strategies.”
McCourt advocated that companies allocate as much as 70 percent of their net income to dividends. He predicted that increasing dividend to that level could boost the company’s shares by as much as 90 percent.
McCourt’s recommendation seems over the top. To remain competitive, companies must allocate a significant portion of their cash flow to spending on the plant, equipment and research.
Currently, consumer and drug companies dole out close to 40 percent of their profits in dividends. Tech companies pay out approximately 20 percent.
The cash buildup of many American companies is drawing a lot of attention, some of it critical. To raise cash, companies lowered costs — principally by employee layoffs — sold shares and reduced dividends. Employers have eliminated 8.4 million jobs since the U.S. slipped into recession in December 2007.
The 1919 case of Dodge vs. Ford Motor Co. illustrated the perennial tension between investors and management over appropriate dividend payouts. In 1919, the Michigan Supreme Court held that the company was required to pay out special dividends from the capital surplus in lieu of spending on Henry Ford’s proposed plant-expansion investments. The court held that a business corporation is organized primarily for the profit of the stockholders, as opposed to the community or its employees.
Unlike Henry Ford, who saw robust prospects for his business, today’s corporate managers, such as Wade Miquelon, chief financial officer of Walgreen, want to keep corporate coffers rich because slack demand implies poor prospects for profit. Miquelon said, “A lack of investment opportunity has caused some companies to accumulate cash. It’s not great having money in the bank earning almost no interest, but we also want to be very smart and very driven by return on invested capital.”
The case for cash dividends is compelling. If corporations are not going to spend money on good investments, they should return the money to the investors. It makes sense to pressure companies, such as Cisco, to pay or increase dividends.
Originally published in the Sarasota Herald-Tribune
