Don't Obsess About Dividends

With interest rates on bonds, bank CDs, and other low-risk investments at extremely low levels, investors have really taken to the income potential provided by dividend-paying stocks. But a stock that doesn't pay a dividend isn't automatically a loser. In fact, sometimes, a company that chooses to make other uses of its free cash than returning it to shareholders via dividends is making the smartest move it can with its capital.

Complaints aplenty
A recent MarketWatch article gives a good example of how important dividends have become to investor perception of a stock. The mining industry has enjoyed unprecedented success in recent years, as the prices of commodities have risen through the roof. Not only have precious metals like gold and silver reached all-time or multidecade highs, but base industrial metals such as copper have shot to record prices as well. The share prices of many miners have gone up dramatically as a result.

With that as background, though, the article points out that many miners haven't returned their newfound profits in the form of higher dividends. Take a quick look at a few successful miners and what they've done with their dividend payments in recent years:

Stock

2-Year Avg. Annual Stock Return

Current Dividend Yield

5-Year Annual Dividend Growth

Rio Tinto (NYSE: RIO  ) 92.6% 1.3% 1.5%
Freeport-McMoRan (NYSE: FCX  ) 134.8% 1.8% (9.7%)
Newmont Mining (NYSE: NEM  ) 28.9% 1.0% 2.4%

Source: Yahoo! Finance and Capital IQ, a division of Standard & Poor's.

As you can see, these major players in the mining industry haven't exactly seen their dividend payouts keep up with their stock price growth.

Moreover, plenty of high-flying stocks in the mining sector don't pay dividends at all. Silver Wheaton (NYSE: SLW  ) is up sixfold since late 2008 and has a silver-streaming business model that throws off cash at a furious pace, but it's still pondering when to start a dividend payout. Most small miners, such as Taseko Mines (NYSE: TGB  ) and NovaGold (NYSE: NG  ) , have never paid dividends.

What's wrong with that?
Many dividend investors never give these miners a second glance. But unless you're dead-set on having a steady income from all the stocks in your portfolio, judging every stock on its dividend policy can be a big mistake.

You always have to ask yourself this question: What's the best use for a company's cash? In the case of miners, spiking product prices mean that reinvesting capital into expanding mining operations often brings a huge payoff. As a shareholder, if your company can earn a double-digit return on investing your money, you shouldn't want a dividend -- especially since it's so hard right now to find good returns on the dividend cash you receive. In other cases, paying down debt is a smart move, especially for miners that racked up a lot of debt when metals were fetching far lower prices.

It's one thing for large companies, which often have spare cash even after putting a big part of their cash flow into new investments, to pay dividends. BHP Billiton (NYSE: BHP  ) , the world's largest miner, has a 2% dividend yield and has increased dividends at a 25% annualized pace since 2005. But that's only after spending more than $10 billion on capital expenditures in the past 12 months. Few companies have the wherewithal to do everything, so choosing to pay down debt and invest in promising profit-producing opportunities often wins out over returning capital in a dividend.

Keep an open mind
Dividend stocks have a place in nearly every investor's portfolio. But it's essential to remember that dividends aren't the end-all be-all of investing. In fact, you should be happier with a management team that can take all of its available cash and reinvest it profitably than with a company that simply pays out all of its excess profit in a dividend. Granted, it's better to get paid a dividend than not to enjoy profits at all. But when a company takes care of finding the next smart investment for you, it means less work for you.

Interested in what the best dividend-paying stocks are right now? Click here for our free, five-page report "13 High Yielding Stocks to Buy Today."

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.

Fool contributor Dan Caplinger obsesses about a lot of things. He doesn't own shares of the companies mentioned in this article. Motley Fool Alpha has opened a short position on NovaGold Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is obsessed with giving you what you need to know.


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  • Report this Comment On December 23, 2010, at 10:55 AM, shaileshnita wrote:

    It is a very good article and a reminder that dividend stocks are not always superior. For an average investor like me, it is easy to feel attracted to a stock with dividend because all the famous investments books provide historical evidence that on average the dividend paying stock provide better returns. First of all, the difference is only few percentage points and secondly, for those, who trade a few times a year, this statistic is irrelevant.

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