When invest in stock market, why are people so hard up over dividends?

[Greenrookie]

My 2 cents worth.

Company need not be debt free or little debt to give out dividends. There is some truth in companies that give dividends consistently are already past the fast growing phase where they need a lot of capex to expand.

In this category of fast growing companies, valuation by means of dividend yield is illogical. But as with high growth fast expanding companies, the risk is high and returns if u get it right immense.

Then u have another category of companies at matured stage or slow growing stage, the management might be wiser to return cash that could not otherwise generate the growth through expansion.

Also, depending on the nature of business, e.g. High capex business, like construction and airlines, even telecom, they generate high cash flow through high gearing and return part of the cash back as dividends. I am not sure if a business can run or expand properly with cash only.

So in short, different valuation for different businesses at different stages. And dividend yield is one appriopate valuation although not the only one. It is a valid valuation and one where some are competent in, which in your words mean "hard up"

[d.o.g.]

I was thinking, dividends dont matter. The idea of receiving dividends every year sounds nice, but if you think carefully, its just left pocket right pocket. When you receive dividends, the share price will drop together with the dividend.

In fact, having no dividend is better because you are in control of when you receive your dividend.

Shouldnt other valuation ratios like PE, NAV, debt, gearing,growth be more important?

So really, why are people so hard up over dividends when they invest?

Many people have learnt the hard way that in investing, it is more important to avoid losers than to pick winners. As a result it makes sense to use indicators that suggest that a particular stock is unlikely to be a loser. Dividends have emerged as one of these indicators.

Franco Modigliani and Merton Miller developed a theorem that showed that all things being equal, there was no difference in market value between a firm that paid dividends and one that did not. In layman terms this is the "left pocket right pocket" idea where you can create your own dividend by selling a few shares.

However the theorem makes some important assumptions:

No taxes
No bankruptcy cost
No agency cost
No information asymmetry
Efficient market

All of the above assumptions are untrue to varying degrees in the real world, with the result that there IS a difference in market value between 2 companies that differ only in their dividend rate. Unsurprisingly the dividend payer is usually valued higher. A bird in the hand is worth two in the bush, as it were. In layman terms: "show me the money".

In theory, lousy businesses that generate a low return on their activities should pay out everything. Good businesses should reinvest everything.

In practice, lousy businesses cannot generate free cash and not only consume all the cash they produce but must also borrow more money to expand. Good businesses generate cash in excess of reinvestment opportunities and can afford to pay a dividend.

One might then ask - why do some low-return businesses still pay a dividend when their balance sheet suggests they should pay down debt? Because if they don't, their market value would fall and it would hamper their ability to raise money via a placement.

One might also ask - why don't the high-return businesses use their cash to expand more aggressively? Because if they did, their returns would fall, and they wouldn't be good businesses any more.

Look at Berkshire Hathaway - it has compounded at 20% for decades. But the companies within Berkshire did not compound at that rate. Instead they all generated cash that was sent to Warren Buffett to reinvest. He used that money to buy other businesses which sent him more cash, and so on.

Anyone hoping to emulate Buffett should study what he does - and what he does is buy dividend-paying companies.

As usual, YMMV.

Merry Christmas!

[Contrarian]

The businesses with highest valuations are those that are superior businesses AND have high dividend payout.

Is the guy who started this chain a trader?

[Dividend Warrior]

no offense to dividend warrior, just trying to have healthy debate so everyone become wiser. I know dividend warrior subscribe to the idea of dividend + growth. I dont agree with dividend, but I agree with growth.

No worries, my friend.
No offense taken.
Merry Christmas and a Happy New Year to you! ^^

[FatBoi]

John Neff is hard up on dividends.

In the book Money Masters of Our Time, Neff claims that the market usually overpays for the prospect of growth, but growth stocks have two drawbacks:
(1) They suffer from high mortality - often the growth doesn't continue long enough after it is recognised
(2) you can often get a better total return from a slower-growth company that is paying a high dividend right now

He used an example. Suppose you begin on Jan 1 with a stock whose earnings and thus, eventually, stock price will grow 15% a year, but which has to reinvest essentially all its free cash to finance that growth. So you get almost no income. On Dec 31, you hope to be 15% richer through capital gain.

Now suppose on the contrary you have a stock with a much more modest growth rate, such as 10%, but which, because it does not have to finance high growth, can afford to pay a comfortable dividend - 5%, say. Here again, at end of the year you are 15% richer - partly because the stock is 10% more valuable through earnings growth, and partly because you have put 5% in your pocket from dividends.

Which of these strategies is the best? Neff is convinced that is the latter because it is more certain.

[smallcaps]

Here's Graham's view on the topic (extracted from 'The Intelligent Investor'). Such perceptions appear to change with time/environment and might differ from stock to stock. IMO, dividend should by no means be the single factor (nor most important) used for deciding investments in common stocks.

The market’s appraisal of cash dividend policy appears to be developing in the following direction:Where prime emphasis is not placed on growth the stock is rated as an “income issue,” and the dividend rate retains its long-held importance as the prime determinant of market price. At the other extreme,stocks clearly recognized to be in the rapid-growth category are valued primarily in terms of the expected growth rate over, say, the next decade, and the cash-dividend rate is more or less left out of the reckoning.

While the above statement may properly describe present tendencies, it is by no means a clear-cut guide to the situation in all common stocks, and perhaps not in the majority of them. For one thing, many companies occupy an intermediate position between growth and no growth enterprise. It is hard to say how much importance should be ascribed to the growth factor in such cases, and the market’s view thereof may change radically from year-to-year. Secondly, there seems to be something paradoxical about requiring the companies showing slower growth to be more liberal with their cash dividends. For these are generally the less prosperous concerns, and in the past the more prosperous the company the greater was the expectation of both liberal and increasing payments.

http://www.scribd.com/doc/75491721/Divid...alue-Vault

[fat al]

Look at Berkshire Hathaway - it has compounded at 20% for decades. But the companies within Berkshire did not compound at that rate. Instead they all generated cash that was sent to Warren Buffett to reinvest. He used that money to buy other businesses which sent him more cash, and so on.

Anyone hoping to emulate Buffett should study what he does - and what he does is buy dividend-paying companies.

Agree with you but just for laughs:
To emulate Buffett, I screened for dividend stocks. To avoid missing out a potential BH, I do not avoid non-dividend-paying stocks.

[Boon]

Why Dividends Matter
By Investopedia Staff on February 20, 2010

"The only thing that gives me pleasure is to see my dividend coming in." --John D. Rockefeller.

One of the simplest ways for companies to communicate financial well-being and shareholder value is to say "the dividend check is in the mail." Dividends, those cash distributions that many companies pay out regularly to shareholders from earnings, send a clear, powerful message about future prospects and performance. A company's willingness and ability to pay steady dividends over time - and its power to increase them - provide good clues about its fundamentals.

Dividends Signal Fundamentals
Before corporations were required by law to disclose financial information in the 1930s, a company's ability to pay dividends was one of the few signs of its financial health. Despite the Securities and Exchange Act of 1934 and the increased transparency it brought to the industry, dividends still remain a worthwhile yardstick of a company's prospects.

Typically, mature, profitable companies pay dividends. However, companies that do not pay dividends are not necessarily without profits. If a company thinks that its own growth opportunities are better than investment opportunities available to shareholders elsewhere, the company should keep the profits and reinvest them into the business. For these reasons, few "growth" companies pay dividends. But even mature companies, while much of their profits may be distributed as dividends, still need to retain enough cash to fund business activity and handle contingencies.

The progression of Microsoft through its life cycle demonstrates the relationship between dividends and growth. When Bill Gates' brainchild was a high-flying growth company, it paid no dividends, but reinvested all earnings to fuel further growth. Eventually, this 800-pound software "gorilla" reached a point where it could no longer grow at the unprecedented rate it had maintained for so long. So, instead of rewarding shareholders through capital appreciation, the company began to use dividends and share buybacks as a way of keeping investors interested. The plan was announced in July 2004, nearly 18 years after the company's IPO. The cash distribution plan put nearly $75 billion worth of value into the pockets of investors through a new 8 cent quarterly dividend, a special $3 one-time dividend, and a $30 billion share buyback program spanning four years. In 2010, the company is still paying dividends of 1.8%

The Dividend Yield
Many investors like to watch the dividend yield, which is calculated as the annual dividend income per share divided by the current share price. The dividend yield measures the amount of income received in proportion to the share price. If a company has a low dividend yield compared to other companies in its sector, it can mean two things: (1) the share price is high because the market reckons the company has impressive prospects and isn't overly worried about the company's dividend payments, or (2) the company is in trouble and cannot afford to pay reasonable dividends. At the same time, however, a high dividend yield can signal a sick company with a depressed share price.

Dividend yield is of little importance for growth companies because, as we discussed above, retained earnings will be reinvested in expansion opportunities, giving shareholders profits in the form of capital gains (think Microsoft).

Dividend Coverage Ratio
When you evaluate a company's dividend-paying practices, ask yourself if the company can afford to pay the dividend. The ratio between a company's earnings and net dividend paid to shareholders - known as dividend coverage - remains a well-used tool for measuring whether earnings are sufficient to cover dividend obligations. The ratio is calculated as earnings per share divided by the dividend per share. When coverage is getting thin, odds are good that there will be a dividend cut, which can have a dire impact on valuation. Investors can feel safe with a coverage ratio of 2 or 3. In practice, however, the coverage ratio becomes a pressing indicator when coverage slips below about 1.5, at which point prospects start to look risky. If the ratio is under 1, the company is using its retained earnings from last year to pay this year's dividend.

At the same time, if the payout gets very high, say above 5, investors should ask whether management is withholding excess earnings, not paying enough cash to shareholders. Managers who raise their dividends are telling investors that the course of business over the coming 12 months or more will be stable.

The Dreaded Dividend Cut
If a company with a history of consistently rising dividend payments suddenly cuts its payments, investors should treat this as a signal that trouble is looming.

While a history of steady or increasing dividends is certainly reassuring, investors need to be wary of companies that rely on borrowings to finance those payments. Again, take the utilities industry, which once attracted investors with reliable earnings and fat dividends. As some of those companies were diverting cash into expansion opportunities while trying to maintain dividend levels, they had to take on greater debt levels. Watch out for companies with debt-to-equity ratios greater than 60%. Higher debt levels often lead to pressure from Wall Street as well as debt-rating agencies. That, in turn, can hamper a company's ability to pay its dividend.

Great Disciplinarian
Dividends bring more discipline to management's investment decision-making. Holding onto profits might lead to excessive executive compensation, sloppy management, and unproductive use of assets. Studies show that the more cash a company keeps, the more likely it is that it will overpay for acquisitions and, in turn, damage shareholder value. In fact, companies that pay dividends tend to be more efficient in their use of capital than similar companies that do not pay dividends. Furthermore, companies that pay dividends are less likely to be cooking the books. Let's face it, managers can be awfully creative when it comes to making earnings look good. But with dividend obligations to meet twice a year, manipulation becomes that much more challenging.

Finally, dividends are public promises. Breaking them is both embarrassing to management and damaging to share prices. To tarry over raising dividends, never mind suspending them, is seen as a confession of failure.

A Way to Calculate Value
Dividends can give investors a sense of what a company is really worth. The dividend discount model is a classic formula that explains the underlying value of a share, and it is a staple of the capital asset pricing model which, in turn, is the basis of corporate finance theory. According to the model, a share is worth the sum of all its prospective dividend payments, 'discounted back' to their net present value. As dividends are a form of cash flow to the investor, they are an important reflection of a company's value.

It is important to note also that stocks with dividends are less likely to reach unsustainable values. Investors have long known that dividends put a ceiling on market declines.

Conclusion
The bottom line is that dividends matter. Evidence of profitability in the form of a dividend check can help investors sleep easily. Profits on paper say one thing about a company's prospects; profits that produce cash dividends say another thing entirely.

http://www.investopedia.com/articles/fun...102903.asp

[Drizzt]

- maturing business whose having problems reinvesting to meet cost of capital should pay out to be accretive to shareholders.
- growth business that when reinvest enhances share holders value because if they have consistent high ROIC increasing product mix, encrouching competitors domain brings high value.
- in all cases, if the management is so proven that they are good capital allocators i.e. FF Wong, John Malone, Markel, Berkshire, Transdigm, Colfax, St******, it makes sense to keep money with them, since they have more opportunities to better deploy the money. why take dividends when you have freaking trouble every time you need to reinvest during wealth accumulation
- we take dividend when we are not super confident if management is the kind of capital allocator mentioned in the previous point

- What your friend should be looking for are sustainable EBIT or Free Cash flow NOT dividends.

[jaykay]

Sometimes paying dividend means the cash stated in the annual report is there and accessible.