There’s a lousy idea floating out there, that it is a bad thing for a tech company to pay dividends (also here). Not true! Companies that pay dividends treat their capital more carefully, because now their equity has an explicit cost. Studies that I have read indicate that dividend-paying stocks do better then those that do not pay dividends, in the long run.
That said, it doesn’t mean that companies that pay high dividends do better than those with low dividends. It is well-known in REIT stocks that those that pay low but growing dividends have outperformed those with high dividends that grow slowly. The right combination is that a small dividend is paid, and the company uses the retained earnings wisely, in order to grow the business profitably, leading to increases in dividends.
When Microsoft started paying a dividend I was a skeptic, because Microsoft was overvalued at the time. No degree of financial engineering would change that. Dividends are at most a modest positive for any stock. Better you should look at the underlying ability to grow free cash flow and be able to reinvest it well.
That’s where investors should focus. Dividends are good, but growing dividends are better.
By David Merkel, CFA of Aleph Blog
