What do chocolate, pizza, and high dividends have in common? Simply put, nearly everyone loves them.
There is nothing that investors love as universally as dividends. Everyone, from David Einhorn to retail investors, favors higher pay-outs in nearly every scenario.
While I enjoy a good dividend too, I feel the general lack of skepticism about high pay-outs is problematic. Contrary to popular belief, some companies should not be paying dividends.
This is especially true in the cases of Coach (NYSE:COH), Abercrombie & Fitch (NYSE:ANF), and American Eagle Outfitters (NYSE:AEO), where a reasonable investor could argue that their dividends are a money poorly spent.
When dividends attack
Don't get me wrong, I like receiving dividends under two scenarios.
1). If a company is doing so well, with such little competition, that it simply has extra cash. Google, for instance, could probably make a one time pay-out to shareholders and not even notice it. That is something that makes sense to me.
2). If a company earns steady, growing, cash-flows but is in a slow growth business. The caveat to this is that the company must be in a strong competitive position, so its cash-flow is not easily threatened. Some good examples would be General Mills, utility companies, and railroads; these businesses should pay dividends.
For everyone else, a dividend payment can be a bit of an unnecessary albatross that erodes competitiveness. Let's take a look at our aforementioned examples.
Abercrombie & Fitch and American Eagle
One of the most competitive industries right now is apparel, especially teen apparel. For the past few quarters, Abercrombie and American Eagle have admitted that a tough consumer environment, coupled with increased competition and discounting, has hurt results.
The numbers back this sentiment up. Abercrombie pays a 2.5% yield even though recent third-quarter earnings tanked nearly half, year-over-year, and comparable sales plunged 14%. CEO Mike Jeffries, which has had a few recent PR gaffes, has watched EPS drop 12% annually over the past five years. Still, even with horrible results, they haven't cut the dividend once; in fact, it was actually increased this year.
Meanwhile, American Eagle hasn't done much better, as the companies third-quarter same-store sales dropped an alarming 5%. So, not only are American Eagle's margins under pressure, do to competitive "discounting," less people are going to the stores.
American Eagle CEO Robert Hanson was willing to take responsibility on the earnings call, when he stated that "Our financial performance is clearly unsatisfactory and not consistent with our objectives." I only wish some analyst on the call would have asked this glaring follow up question: "Mr. Hanson, given the tough macro-environment, should you really be paying out a whopping 3.5% dividend yield right now?"
In an ultra competitive environment, with sales tanking, the fiscally shrewd move would be for these businesses to slash their dividend.
Handbag and accessory giant Coach is in much better condition than both teen retailers. Coach's business is doing quite well on the surface, but competitors are closing in fast.
Michael Kors (NYSE:KORS) has growth earnings at 50%, and revenue at 40% over the past five years; both numbers are nearly five and four times as fast as Coach. Coach's most recent quarter showed flat growth, while Kors grew earnings 45% as it pushed its way toward more market share in Coach's accessory business.
There is one category that Coach is clobbering Kors in however.
Coach's dividend has been increased four times in the past two years, to a rate more than double its 2011 figure, even as its businesses has slowed dramatically. That might be fine if Coach was a safe, slow-growing, consumer staple, but it's not. In fact, Coach is hoping to offset its North American losses by growing emerging markets and its men's business.
That growth will take heavy investment and, to me, the hefty dividend increases are sending a mixed message. Coach is doing some things well, but I wonder if the dividend increases are simply a move to keep investors from fleeing to Kors (which doesn't pay a dividend).
The dividends won't kill this brand, I'm relatively bullish on Coach, but they could be a sign that management is being short-sighted. That would be worrisome, in my opinion, this luxury brand shouldn't worry about attracting "bargain hunting" investors.
Foolish Conclusion: We're the problem
Decades ago, Ben Graham told us that the "prime purpose" of a corporation was to pay us dividends. The corporations listened--too well.
Too often dividend increases are used as a tool to pacify investors when a business underperforms. This is the exact opposite of what they should be, they should be a reward when a business is doing well. Yet, as long as investors feel "better" when a struggling business ups a pay-out, it will keep happening, even at the expense of the underlying business.
I love dividends, but just like chocolate and pizza, they only make sense in moderation, and when a corporation is relatively "fit."
Before any stock you own pays a dividend you should ask yourself: "could this money be better spent elsewhere?" In the case of Abercrombie, Coach, and American Eagle, the answer is yes.
Adem Tahiri owns shares of Coach. The Motley Fool recommends Coach and Michael Kors Holdings. The Motley Fool owns shares of Coach. 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 Motley Fool has a disclosure policy.