FOOL PLATE SPECIAL: An Investment Opinion
Grow Your Business, Skip the Dividends

Recent bad news at Eastman Kodak, Xerox, and Bausch & Lomb shows why we prefer companies that reinvest cash rather than pay dividends. If management cannot deploy cash profitably, they should go. Or you should find a better place for your money.

By Tom Jacobs (TMF Tom9)
October 2, 2000

Earnings disappointments led the market to carve 33% off Eastman Kodak (NYSE: EK) last week, slice off 33% of Bausch & Lomb (NYSE: BOL) on August 24, and water-torture Xerox (NYSE: XRX) down 44% since June. All three of these companies should find better ways to invest their cash, rather than flushing it away as dividends.

I grew up with all three once-venerable firms in Rochester, New York. People back then often bought nice, safe companies that paid dependable dividends. Kodak, sure, but most often the phone, gas, and electric companies. Like owning bonds.

Of course, that was before all heck broke loose and deregulation started the trek to the promised land. Today, what investor in her right mind would own a company that paid its profits in dividends?

There are, and have always been, two killer arguments against dividends:

  1. The company pays taxes on its earnings, and then you pay taxes on the same money again distributed as dividends. Double taxation.

  2. If management can't find a better way to deploy the money to make more, what does that say about management and the company's business?
Three examples: Kodak, Xerox, and Bausch & Lomb
Just look at this 30-year chart for these three once-Goliath consumer brands. Only one, Bausch & Lomb, came anywhere near the S&P 500, but then it could no longer huff and puff, and it expired. (I realize that reinvested dividends would have made some difference, but not much.) Hey, just look at the 1990s:
                       Market       Share Price 
               Yield    Cap.     9/30/91  9/29/00 
Bausch & Lomb  2.67%  $ 2.0 bil   47.50    38.94
Eastman Kodak  4.31    12.5       33.71    40.88
Xerox          5.33    10.0       10.17    15.00 
These companies controlled the universe in their businesses. What was more recognizable than the yellow Kodak film box? What verb did you use for making a photocopy? Sure, Bausch & Lomb led the way in contact lenses, but remember when Ray-Ban sunglasses were the must-have shades?

These managers took strong, dominant worldwide brands and squandered them. Sclerotic, ingrown, leather-chaired, backward-thinking leaders misled lots of decent, intelligent, trusting employees into thinking that they would be comfy forever.

My father was one of those employees. I'm no ingrate: For more than 30 years, the Big Yellow Mother -- through my Dad -- paid for roof, clothing, food, and college for me and three siblings. Ditto for many Rochester families with fathers (because it was fathers back then) at Kodak, Xerox, or Bausch & Lomb. The Kodak man thought a white belt was a fashion statement. Young and cool engineers went to Xerox. And the science brains went to Bausch & Lomb. These were friendly cultural differences. Everybody did great.

But the world changed, and management just kept paying out those dividends and putting off Judgment Day.

Dividends are for loser management

The protected post-World War II world where the U.S. had the only extant factories faded fast with the revival of Japanese and German manufacturing. It took longer for the news to get to Kodak, Xerox, and Bausch & Lomb.

Kodak fought court battles instead of innovating and moving on. It tried to compete with Xerox in copiers, to make a go of Sterling Drug, and bombed miserably -- all the time paying dividends. Investors should have yanked their money from loser management that couldn't find profitable business opportunities for cash they paid in dividends.

Repeat: If management can't find research and development to fund or good, complementary companies to buy, investors should find new places for their money.

Pain is inevitable, but suffering is optional
As the dividend grows and grows, it's harder and harder for management to change. It's like the little fib that's repeated for years until you can't turn back; the 10-cent price of telling the truth early becomes unaffordable later. It's the price of having to explain to investors that you subjected profits to double taxation in exchange for no growth. But it's better to do it now than suffer more later, as LouAnn Lofton (TMF Lou2) argued recently.

I'm not saying that retaining dividends guarantees a better future. You still need good management and opportunities. But it sure beats climbing a mountain on an empty stomach. It's too bad that investors in Kodak, Xerox, and Bausch & Lomb (people I know and love) have taken enormous hits lately, but their dividends are little consolation. Shareholders ought to be finding better places for their money than companies that insist on deploying profits inefficiently as dividends.

Your Turn:
Am I biting the hand that fed me? Share your opinion on the Eastman Kodak, Xerox, or Bausch & Lomb boards.

Related Links:
  • Kodak Crashes, Foolish Four Portfolio, 9/28/00
  • Half Off on Dividends at J.C. Penney, News & Commentary