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Amid the generally gloomy mood in the financial markets, many dividend investors have never been happier. With many companies boosting their dividend payouts in recent months, shareholders have reason to celebrate. But higher dividend payments could actually be a bad sign for the overall economy.
New dividend payers
Most investors see dividend stocks as conservative, slow-growth stalwarts, and with good reason. Southern Company (NYSE: SO ) , for instance, pays investors handsomely, but its future profit potential is largely limited by regulators. Regulation can also cover major capital investments, so utilities don't necessarily have the freedom to plow profits back into its business, even if they thought doing so would improve profits.
With other stocks in non-regulated industries, investors aren't surprised to see dividends rise, because the companies in question are mature businesses with few opportunities for additional investment internally. Philip Morris International (NYSE: PM ) , for instance, has a worldwide tobacco empire, but there's only so much additional expenditures on marketing and publicity can do to boost profits. Eli Lilly (NYSE: LLY ) can take some of its profits for use in research and development, but there's a point of diminishing returns for those expenses as well. At some point, investors recognize that these companies aren't supposed to do anything with the cash they generate, other than return it to them in the form of dividends.
Is growth going soft?
What does have the potential to disturb the market, though, is the fact that companies once seen as major growth drivers see no better alternative for their spare cash than to pay dividends.
Take Starbucks (Nasdaq: SBUX ) , for example. Earlier this year, the coffee giant instituted a $0.10 quarterly dividend, giving the stock a current dividend yield of about 1.6%. With the stock projected to earn $1.23 this year, that's not a dangerous level to start. But it means the company is admitting that it no longer believes it can generate a better internal return by keeping the $300 million it will pay in dividends annually.
Viacom (NYSE: VIA-B ) also recently started paying a dividend in the 2% range. Its $0.60 payout will divert $360 million from company coffers to shareholders each year. Again, one might think it would be able to spend the money better -- perhaps by improving its online content distribution strategy, for starters.
Nowhere to spend
You can see another sign of this reluctance to reinvest in businesses by looking at those companies that have accumulated large amounts of cash without paying huge dividends. While Cisco (Nasdaq: CSCO ) and Apple (Nasdaq: AAPL ) sit on huge stockpiles of available money, some have clamored for them to start paying a dividend.
But the implications of paying a dividend in this environment would be staggering. Essentially, by paying a dividend, growth companies are admitting that they no longer believe reinvesting profits in their own businesses is a worthwhile endeavor. They see no alternative but to return that money to shareholders.
And once you receive a dividend payment, you face the same dilemma. What should you do with the money? With savings accounts paying next to nothing, and even long-term bond rates heading lower, you don't have a lot of good options yourself.
Meanwhile, consider the things that companies aren't doing with the money they're paying out in dividends:
- They're not hiring new employees.
- They're not taking on new projects in an effort to expand their business reach.
- They're not investing in new opportunities that would lead to the job creation the economy so badly needs right now.
In short, while getting a dividend check is nice for shareholders, it could be a symbol that companies are giving up on creating new hires or developing new projects. And while dividends most likely increase household wealth, which in turn could increase domestic consumption, it still may not be a great sign for the overall economy.
Be careful what you wish for
Clearly, it's better for a company to be able to pay a dividend than not. Dividends prove that a company has the financial resources to commit to an ongoing obligation to shareholders.
But with asset prices at relatively low levels, it's troublesome that companies aren't focusing on making profitable investments with their spare cash. As nice as it is to get a dividend check, corporate managers's inability to find better uses for their profits could bode ill for the health of the economy.
High-yield dividend stocks look great, but will they deliver? Selena Maranjian takes a second look at those attractive dividend yields.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.