Why Dividends May Be Losing Their Value

Countless studies have shown that historically, dividend-paying stocks have outperformed their non-dividend-paying counterparts. But like any rule of thumb, now that everyone seems to be looking at the dividend indicator to judge future performance, you shouldn't blindly assume that any company that starts paying a dividend will suddenly rise from the ashes and outperform.

The rash of new dividends
In recent years, we've seen a host of companies decide to start paying dividends, especially in the tech arena:

  • Cisco Systems (Nasdaq: CSCO  ) began paying a dividend last year, with its stock now yielding almost 2%.
  • Apple (Nasdaq: AAPL  ) gave in to investor pressure to start paying a dividend following the death of former CEO Steve Jobs, with a payout of $2.60 per share due to start between July and September.
  • Most recently, Dell (Nasdaq: DELL  ) announced yesterday that it would initiate an $0.08 per share quarterly payout, which will result in a 2.7% yield.

In starting their payouts, companies are careful to say all the right things. Dell's CFO cited "sustainably strong cash flow from operations" as a key element allowing the company to "[add] another element to our disciplined capital allocation strategy" through a dividend. Apple's Tim Cook argued that "even with these investments [in the business], we can maintain a war chest for strategic opportunities and have plenty of cash to run our business. So we are going to initiate a dividend and share repurchase program." And Cisco's CFO noted that "Cisco's leadership position in the markets we serve is strong, and the time is right for Cisco to pay our first-ever cash dividend. ... This dividend complements our leading position, and is an important part of our commitment to bring value to shareholders."

Adding dividends for all the wrong reasons
But lately, companies have seemed to have other primary motivations for deciding to make payouts. In Dell's case, analysts argue that given its weak business results, paying a dividend invites income-hungry investors to buy shares, potentially boosting its stock price. When Apple and Cisco started paying their dividends, similar suggestions arose, as many pointed out that funds that focus specifically on dividend-paying stocks had been shut out of their shares.

More important, it's extremely hard to argue that any of these three companies has passed any relevant milestone that suddenly put them in a position to pay dividends. Apple and Cisco have notoriously huge cash positions on their balance sheets that have invited criticism from shareholders and investor advocates.

Contrast their behavior with that of other tech companies that have treated dividends more seriously. Intel (Nasdaq: INTC  ) , for instance, has been paying dividends consistently since 1992, and although its initial payouts were pretty puny, they've grown slowly but surely over the past decade to produce what's now a substantial yield of more than 3%. IBM (NYSE: IBM  ) isn't as generous with its dividend, which yields less than 2% after the stock's huge bull run. But with a 17-year history of raising its payouts annually, IBM is doing what every dividend investor wants to see.

Taking it out of their hands
From one perspective, paying a dividend may justify a boost in a stock's price: By taking money out of the hands of management, it makes it marginally harder for a company to make expensive acquisitions that all too often turn out to be strategic blunders. Yet with interest rates so low, the credit markets are more than happy to oblige takeover-hungry management teams by offering cheap financing.

Moreover, with many companies' questionable track record of timing stock buybacks, dividends may be a better use of capital. But when companies can't use cash profitably to reinvest in their own businesses, it marks a turning point for their growth. Investors can no longer expect the quick share-price appreciation that so many high-growth companies enjoy early on.

Don't bank on dividends
In the past, when companies were motivated to pay a dividend as soon as they possibly could, initiating a payout marked a rite of passage for a company as it emerged into sustainability. But for many companies, that motivation is gone -- and with the slew of companies paying long-deferred dividends now, you therefore shouldn't draw the same conclusions about their financial health. Only by looking at other factors can you really be sure whether a business is sound or whether a company is making a last-gasp effort to attract investors by making a dividend payout.

The best dividend stocks are great not only because of their payouts but because of the top-notch businesses that make them possible. Read all about nine of them in the Fool's latest special report on dividend stocks. With these stocks having long histories of lucrative payouts and steady growth, you won't want to miss out, so click here and get your free report today.

Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitter @DanCaplinger.

Fool contributor Dan Caplinger still cares about dividends but watches to make sure companies aren't gaming the system. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of International Business Machines, Intel, Cisco Systems, and Apple. Motley Fool newsletter services have recommended buying shares of Apple and Intel, as well as creating a bull call spread position in Apple. 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 never stops caring.


Read/Post Comments (7) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 13, 2012, at 6:18 PM, xrocom wrote:

    I believe you are thinking like the thief Jack Welsh looking only at rising stock prices where the board prints money with stock options. As the baby boomers pull out of stocks, if only to remove another headache, the only requirement is income. Dividends are the future. The ideal investment would be a 7% return every year with dividend and stock price (Vz and T). No need for 100% or 1000% in 5 or 10 years for a stock. I could live well if my apple shares provided a 6% to 7% return each year until I am 90.

  • Report this Comment On June 13, 2012, at 6:56 PM, MrFearful wrote:

    Good article, but I´d like to point out something else:

    I think Motley Fool authors use the word "may" far too often in their titles.

    No offense intended, but you can title almost anything with "may", like

    "Earth may be invaded by aliens next month".

  • Report this Comment On June 13, 2012, at 8:37 PM, 8bravo wrote:

    @MrFearful: I guess they do that on purpose so they can always say: see we were right ;-)

    Anyways, a real dividend income investor won't look at Apple shares until they've proven to pay and increase dividends for at least ten consecutive years. So what's the point about wondering about that now?

  • Report this Comment On June 14, 2012, at 1:22 AM, DonkeyJunk wrote:

    @MrFearful

    How confident are you in any stock or economic forecast that you can offer 100% certainty? The use of "may" is completely reasonable for scenarios that are fundamentally unpredictable. Imagine how many people would take MF authors to task for speaking in absolutes, regardless of the evidence.

  • Report this Comment On June 14, 2012, at 1:43 AM, rhoop wrote:

    For legal reasons every comment has to be worded to reflect an OPINION. That's why on CNBC an analyst will state how he FEELS a company MAY see signs of selling pressure.

    We live in a litigious society.

  • Report this Comment On June 14, 2012, at 3:31 AM, thisislabor wrote:

    You guys are stupid. :)

    If apple starts making a regular dividend payment I will be buying it tomorrow. ok, not tomorrow I am STILL unemployed.. but I will be buying in a few months when I start working...

    NOW, when they start missing payments over the next few years THAN i'll start 2nd guessing the validity and wherewithal of apple's claim to be a dividend based stock. speaking of which, what the heck does a software company have 40B for? seriously....

    there can't be THAT MANY skilled software engineers out there ... unless if ofcourse we buy off all of India... oh wait.. yea I forgot that is morally ethically and socially wrong to do but I give it 5 years before it is completely 100% common place.

    oh no wait! i do tax returns it is already common place and completely and socially unacceptable. good for profits? - yes! horrible for our society's two social class that is forming.

    hell, i'm finance major with a 140IQ and i can't get a job except for as teller... (nothing wrong with being a teller so no offense guys/gals...) just I am capable of applying higher level analysis/skills than just that.

  • Report this Comment On June 14, 2012, at 10:02 AM, MrFearful wrote:

    @ DonkeyJunk

    I agree with you. I was only referring to the excessively frequent use of the word "may" in titles. I also admit I am biased, as I used to work in news media (not in the US), where no editor would allow you to use "may" in the title. Sorry for the misunderstanding.

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