Go to amazon.com and search for 'dividend' or 'passive income'.
We will find a good number of books carrying those keywords in their book title.
All of them show us the beauty of dividends notably in selecting a dividend stock, building up a passive income portfolio, and campaigning the management's interest in maximizing shareholders' value.
Most investors believe that dividends do not lie, and theorize that high dividend yields are cheap and could protect them from Armageddon.
Granted, dividends are a beauty.
While the beauty is known, the beast is relatively unknown and waiting to addressed. The latter subsequently becomes the central focus of this letter.
The principle - Buffett's $1 test
In capital allocation, all available options are relative in nature.
As laid down in Buffett's capital allocation framework, managers should conduct Buffet's $1 test to see whether return on invested capital is greater than every $1 reinvested.
Based on that result, the managers should make sequential consideration to:
- invest in the company
- acquire other companies
- repurchase shares
- pay dividends
The beast
It is not strictly 'yes' or 'no'.
Most companies in fact subscribe to multiple decisions and implement them at the same time.
In particular, dividends are a cash distribution. Cash is extracted from companies cash and cash equivalents.
Dividends effectively reduce the companies' capital (value).
Over-generosity in dividend payout weakens companies' financial position.
In that event, a good fundamental company could find itself in weaker or, worst, unsustainable financial position in future.
Random cases
Matrix
Matrix is known for her lucrative dividends. The management even announced a dividend reward to its potential shareholders prior to her listing.
In her first year of listing, Matrix was in a net cash position (+RM65.1m). The fortune reversed and the company recorded a net debt (-RM156.4m) at the end of FY17.
Recently, Matrix sweetened her cash call by issuing warrants, which are always mis-perceived as a reward by shareholders.
Scientx
In September 2013, Scientx paid out 10c of special dividend on top of 9c final dividend in celebration of her 45th anniversary. Her generosity continued and piled Scientx with more borrowings.
Takeaways
Dividend stocks are a beauty to most investors.
Because dividend cut will downgrade stock valuations (and prices), companies even set an unwritten policy in maintaining dividend payout regardless of their financial health.
Consequently, borrowings and/or external capital are sought.
A beast is shaped.
As intelligent investors, we must differentiate good (sustainable) and bad (unsustainable) dividends.
If it is our ultimate objective to construct a passive (sustainable) income (dividends) portfolio, it is necessary to examine the results of capital allocation of our shortlisted stocks.
Importantly, Charlier Munger told us that...
http://valueveins.blogspot.my/2017/05/dividends-we-know-beauty-do-we-know.html
