Should Companies Pay Dividends?

There are multiple school of thoughts on how companies should use the dollar generated with primary business activity (i.e. selling a product and/or services). Should the company pay back certain amount profits to shareholders or invest back into the business for further growth? To me, it depends upon the company, its business plans and objectives. Whether I prefer it or not depends upon what are my investment objectives.

In general, in developing industry sectors, the companies earn their profits by innovation, product uniqueness, time of market, etc. For examples, companies in technology, alternative energy, biotechnology, traditional pharmaceuticals, etc., sectors need heavy dollar investments to continue their growth and maintain competitiveness. The argument that all profit needs to be ploughed back into the business holds ground. Therefore, it is rare (if not impossible) that a growth-oriented company will provide dividends. Google, Intel, Microsoft, Apple, RIM, et. al., fall under such groups. Although it can be argued that some companies in technology sectors, such as Intel and Microsoft, are becoming more of a value (and perhaps dividend) play. There is nothing wrong in this argument and intentions of management of such companies. From my viewpoint, when such companies are at nascent stage, it is very difficult to understand them and their proposed business model for generating earnings. By the time they start demonstrating their potential with revenue and growth in market share, Mr. Market already prices them at higher multiples.

On the other hand, in mature industry sectors, the companies earn their profits by efficient execution and economies of scale. For example, companies in consumer staples, retails, real estate, banking, and technology services are the ones that depend heavily on these two factors. These sectors do not need large dollar investments for continued innovation. So if I am investing in these sectors, I expect management to share the profits with shareholders in the form of dividends. They do not have any strong argument that all profits need to be invested back into business for growth. When such companies are consistently paying and growing dividends, they are (1) ensuring that shareholders are an important part of their business; (2) shows management’s ability to be financially responsible; and (3) confidence that their business strategies will continue to generate earnings. Since most of the companies pay dividends from free cash flow, the likelihood of engineering the balance sheet is very low.

I believe both sides of the arguments are correct, similar to a glass being half empty or half full. An individual investor needs to view this from their investment goals and what they want to achieve.

3 Responses to “Should Companies Pay Dividends?”

  1. Dividend Tree says:

    Mark: Couldn’t agree more with you. Thanks for stopping by.


  2. Mark says:

    Only cash cows should pay dividends. Mature companies with excellent free cash flow

  3. Mberenis says:

    Your blog loads really slow for me and maybe other readers. I can’t see anything! You should check it with a speed test and make sure it’s okay. I’m 7mb down / 499k up.

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