Dividends Are Not Always Good

Some consider dividends to be an important beneficial element of a company. This comfort, however, comes at a price. Instead of paying a dividend, a company may be better served by reinvesting in its business, paying down debt, or buying back company stock.

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By George L. Smyth
July 18, 2000

Drip. Dividend reinvestment plan. It makes sense that the word "dividend" would be important. The second word tells us what is being done with the dividends, and the third word rounds out what we're talking about.

It appears that everything revolves around dividends. This means that dividends are pretty important, right?

Although thinking this makes all the sense in the world, I suggest that dividends are one of the least-important elements of the mix. Just as in "American Football," the "Foot" part of the word pales in importance to other aspects of the game, so are dividends less important, than other aspects of the investment strategy.

What I am talking about is the question of whether one should select a company based on the dividend being offered. There occasionally seems to be a feeling of comfort that certain money will come your way through the power of the dividend. I suggest that this comfort comes at a price.

The companies we generally tend to favor as Drip selections are large growth companies. These companies dominate a sector and we expect this domination to continue at least over the ensuing decade.

Of course, growth requires money, and its availability is one element we examine when considering a company as a Drip solution. If a company does not expect to grow and has excess money, it makes sense to give some of it to the shareholders in the form of a dividend. However, a company that is expanding its empire will want to use its money to continue its dominance, too. Every dollar not sent to the shareholders can be poured back into the company, and may be worth considerably more down the road.

Another worthwhile place the money can go is toward reducing the company's debt. As has been stated in a previous column, not all debt is bad debt. However, whether the debt a company has incurred is considered "good" or "bad," the company is still paying interest on that debt. Every dollar of interest that is not paid to creditors becomes available to expand the company.

What if the company doesn't have any debt? One thing a company could do is repurchase some shares. If the company buys more shares than it issues, the repurchase plan can reduce the number of outstanding shares, which in turn adds value to the remaining stock. The earnings per share may advance without the company doing any better. This can be a worthwhile way to increase shareholder value, especially if the shares later rise in price.

When cash is offered to shareholders in the form of dividends, this money is not available to the company to do the above-mentioned items, which are essentially long-term in nature. Receiving cash is, of course, a short-term event — and it is taxed.

Worst of all, the security that one feels when receiving sure cash through dividends may be fleeting. It is not uncommon for a company to reduce the dividend for a plethora of reasons. The dividend certainly should not be considered as safe as interest from CDs or a savings account.

Now that we understand the negative impact dividends can have on a company, the question that has not been answered is exactly how this translates to shareholder value in the long term. This question will be examined in next week's article.

Finally, we have relevant news to share today: Johnson & Johnson (NYSE: JNJ) reported second quarter results and Jeff shared thoughts on it in Fool News. Secondly, Drip Port may not use Temper to buy its first five shares of PepsiCo (NYSE: PEP). Drip Port is still considering its options. Finally, Intel (Nasdaq: INTC) reports earnings tonight and Fool News will have a number summary, with full coverage (from Rule Maker, too) tomorrow.

Drip Portfolio

7/18/2000 Closing Numbers
Ticker Company Day Chg % Chg Price
INTCINTEL CORPUnch.Unch.$146.31

  Day Week Month Year
To Date
Drip .00% -.05% 3.23% 35.26% 75.72% 20.86%
S&P 500 .00% .03% 3.84% 2.81% 60.90% 17.33%
S&P 500(DA) .00% .03% 3.84% 2.81% 63.52% 17.97%
S&P 500(DCA) n/a n/a n/a n/a 31.21% 9.56%
NASDAQ .00% .67% 7.78% 5.05% 172.34% 40.03%

Trade Date # Shares Ticker Cost/Share Price LT % Val Chg

Trade Date # Shares Ticker Cost Value LT $ Val Ch
  Cash: $0.08  
  Total: $6,317.22  

• S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.

Drip Port launched with $500 on July 28, 1997, adds $100 to invest every month, and the goal is to own $150,000 in stock by August of the year 2017. Due to the slow nature of dollar-cost-averaging and our relatively significant starting costs, we do not expect to seriously challenge the S&P 500 for the first three to five years as we build an investment base. The long-term advantages of dollar-cost-averaging still overcome the short-term disadvantages, however. Final note: our investment in Campbell Soup is frozen due to fees instituted in its investment plan. Click here for a history of all Drip Port transactions.