The Intelligent Investor_ The Definitive Book on Value Investing - Benjamin Graham [202]
In the late 1990s and into the early 2000s, the managements of leading technology companies took this “Daddy-Knows-Best” attitude to new extremes. The argument went like this: Why should you demand a dividend when we can invest that cash for you and turn it into a rising share price? Just look at the way our stock has been going up—doesn’t that prove that we can turn your pennies into dollars better than you can?
Incredibly, investors fell for it hook, line, and sinker. Daddy Knows Best became such gospel that, by 1999, only 3.7% of the companies that first sold their stock to the public that year paid a dividend—down from an average of 72.1% of all IPOs in the 1960s.9 Just look at how the percentage of companies paying dividends (shown in the dark area) has withered away:
FIGURE 19-1
Who Pays Dividends?
Source: Eugene Fama and Kenneth French, “Disappearing Dividends,” Journal of Financial Economics, April 2001.
But Daddy Knows Best was nothing but bunk. While some companies put their cash to good use, many more fell into two other categories: those that simply wasted it, and those that piled it up far faster than they could possibly spend it.
In the first group, Priceline.com wrote off $67 million in losses in 2000 after launching goofy ventures into groceries and gasoline, while Amazon.com destroyed at least $233 million of its shareholders’ wealth by “investing” in dot-bombs like Webvan and Ashford.com.10 And the two biggest losses so far on record—JDS Uniphase’s $56 billion in 2001 and AOL Time Warner’s $99 billion in 2002—occurred after companies chose not to pay dividends but to merge with other firms at a time when their shares were obscenely overvalued.11
In the second group, consider that by late 2001, Oracle Corp. had piled up $5 billion in cash. Cisco Systems had hoarded at least $7.5 billion. Microsoft had amassed a mountain of cash $38.2 billion high—and rising by an average of more than $2 million per hour. 12 Just how rainy a day was Bill Gates expecting, anyway?
So the anecdotal evidence clearly shows that many companies don’t know how to turn excess cash into extra returns. What does the statistical evidence tell us?
Research by money managers Robert Arnott and Clifford Asness found that when current dividends are low, future corporate earnings also turn out to be low. And when current dividends are high, so are future earnings. Over 10-year periods, the average rate of earnings growth was 3.9 points greater when dividends were high than when they were low.13
Columbia accounting professors Doron Nissim and Amir Ziv found that companies that raise their dividend not only have better stock returns but that “dividend increases are associated with [higher] future profitability for at least four years after the dividend change.”14
In short, most managers are wrong when they say that they can put your cash to better use than you can. Paying out a dividend does not guarantee great results, but it does improve the return of the typical stock by yanking at least some cash out of the managers’ hands before they can either squander it or squirrel it away.
Selling Low, Buying High
What about the argument that companies can put spare cash to better use by buying back their own shares? When a company repurchases some of its stock, that reduces the number of its shares outstanding. Even if its net income stays flat, the company’s earnings per share will rise, since its total earnings will be spread across fewer shares. That, in turn, should lift the stock price. Better yet, unlike a dividend, a buyback is tax-free to investors who don’t sell their shares.15 Thus it increases the value of their stock without raising their tax bill. And if the shares are cheap,