Retailer J.C. Penney is reducing its dividend. Wall Street institutions probably don't support the company on this move, but using Warren Buffett's thinking on dividends leads us to a different conclusion. A lower dividend pay-out will be a good thing for the company and allow it to reinvest more cash into righting its business. In fact, the company'd be smart to cut its dividend even further.
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J.C. Penney's troubles
It's hardly a secret that J.C. Penney has had a rough go at it for several years now. Same-store sales have decreased each year since 1995, with the exception of 1996. Earnings per share growth over the last five years has been -22%.
The J.C. Penney brand isn't resonating with customers, as they move over to more fashionable stores like Target (NYSE: TGT) and Kohl's (NYSE: KSS). Wal-Mart's (NYSE: WMT) dominance has also diminished J.C. Penney's marketshare. So the announcement that a cut in dividends is coming isn't surprising.
Reasons for the dividend decrease
J.C. Penney's board cited a couple of reasons for the decrease. They first attributed it to current industry conditions. They also pointed out that the move is consistent with restructuring measures announced back in February. The company should get back about $42.5 million a quarter from this move that they can now apply to increased capital spending. J.C. Penney also said its trying to bring its dividend in line with the dividends offered by its competitors.
J.C. Penney vs. competitors
With that in mind, let's look at what some of its competitors are paying out:
Wal-Mart's Yearly Dividend = $0.24
Target's Yearly Dividend = $0.20
Neither Kohl's nor Kmart (NYSE: KM) pays out a dividend.
J.C. Penney had been paying out over four times as much as Wal-Mart and Target, before this announced decrease. Four times! When you think about the fact that the retailer's market share has been declining and its problems have been mounting for several years now, it's pretty amazing that it waited this long to decrease dividends. And even with this decrease, it'll still be paying out more than double what Wal-Mart and Target do to their shareholders.
Street thinking on dividends
Sentiments on dividends differ. J.C. Penney has heavy institutional ownership, with 70% of its shares outstanding sitting in the accounts of places like Merrill Lynch (NYSE: MER) and J.P. Morgan (NYSE: JPM). These places like getting a fat dividend from a company like J.C. Penney, because at least they're getting something even while the stock's price is dropping. They're getting that income no matter what. Many mature companies pay out dividends and the conventional Wisdom on the Street seems to be that this is a good thing. Perhaps J.C. Penney felt beholden to that ownership, and while it was satisfying that group of investors, it wasn't taking care of the rest of its shop. The fact that the company was mature didn't mean it was indestructible.
Buffett's thinking on dividends
The other thinking on dividends, though, (and the position that seems to make the most sense to your humble writer) has become best popularized by investment guru Warren Buffett. Buffett hates dividends. He's said that his company Berkshire Hathaway (NYSE: BRK.A) will never pay out dividends, and he prefers that the companies he invests in do not either.
Why? Well, a couple of reasons. For one thing, Buffett would prefer that the company keeps the money and reinvests it in growing the business. This is something J.C. Penney certainly could have benefited from. A second reason is more ancillary -- taxes. Simply, the money's taxed twice. The company pays taxes on its income before getting a dividend to you. Then you have to pay taxes on that dividend again.
The decrease is a good move
Shareholders of J.C. Penney, in my opinion, should welcome this decrease in dividends from the company. It's a good thing. The company could certainly use the extra cash flow to further work out its problems. I'll even go further and say J.C. Penney's new head, Allen Questrom -- he starts tomorrow -- should lower them again, if not do away with them altogether (at least for now). Reinvest that money into strengthening the company's capital base and brand. Income-driven investors and Street institutions wouldn't like that from J.C. Penney, to be sure. But it would be a smart move for a long-struggling company that hopes it can return to better days.
Your Turn:
Do you like dividends or despise them, Fool? Should J.C. Penney keep that money coming to shareholders, or is it smart to use it to rebuild the business? Talk about it on the J.C. Penney discussion board. Also, check out some great thinking on dividends by reading this thread on the Ahlgren Economics discussion board.
Related Links:
J.C. Penney's Shiny New Chief, Fool News, 8/2/00
J.C. Penney: A Two-sided Coin, Fool News, 5/16/00
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