Dividends - A Proper Perspective - Salvador Dali

FOCUS Malaysia did a credible write up on dividends in Malaysia. There are still a few major issues which were not highlighted in the article. We need to fully appreciate the paradigm of investing, of listed shares, the expectations of investors and the real nature for dividends.

1) All things being equal, dividends are positive. Let's first examine WHY there are listed stocks. If we cannot grasp that, no point debating further. A stock gets listed for TWO MAIN REASONS, the other reasons are secondary. One, is to raise capital to power growth plans for the company. Two, to allow for investors to participate in the prospects and potential growth of the company.

2) There are investors who invest because of the stability of the business and the predictable profit streams. These are usually termed as blue chips, the ability to sustain profits growth and maintain stable dividends. A lot of long funds will want to invest in them. A lot of retiree funds will want to be in them as they are deemed to be of lower risk to the volatility of the markets and can provide stable returns.

3) The first two points already alienate a umber of stocks accordingly, hence it is pointless to just segregate based on frugality or generosity owing to free cash flow. These free cash flow also should not be a 1, 2, 3 year snap shot as that paints a diminished view of free cash flow, or rather, the quality of FCF. A proper view should at least include a 10 or 15 year average FCF, and average FCF growth rates. To based a "need" to declare good dividends based on short term FCF would be unpersuasive at best.

4) I personally do not believe in dividends. If you like dividends so much, you can just as well sell some shares in it every year and take that as dividends??!!  Or did you believe that the share price does NOT adjust down when it goes ex-dividend???!!! Why bother investing in the company if its not to participate in the growth and prospects??? If FCF is so great that it overwhelms their ability to reinvest that said capital, then the company may consider dividends. Even then, the management has to exhaust other plausible options - e.g. buying out competition; going upstream/downstream if it made economic sense; investing in growth in other untapped markets/regions; maintain edge by investing in research & development, investing in potentially synergistic companies for the future, etc...

5) The revealing reasons for companies paying solid dividends. I am not talking about those institutional stocks only. I am especially talking about those that have not yet become blue chips, and/or smaller growth companies. When these companies keep paying good/high dividends (relative to FCF and profits) - it is a good sign generally. It shows a high degree of reliance on owning and HOLDING their shares. It also shows that they are keen to maintain and reward themselves via dividends without NEEDING or WANTING to dispose their shares.

6) Look at the goreng shares, I can bet you they have no dividends to pay, and even if they did it will be minuscule as their main route to riches is via goreng ops. Plus they are unlikely to hold much shares since bulk of shares could be circulating around syndicate groups.

7) What I am more interested in are those companies that have a high FCF but declare little or no dividends - what gives? Look at the companies, their FCF were so high compared to the dividends. Management should AT LEAST indicate what they are planning to do with funds (as mentioned - e.g. buying out competition; going upstream/downstream if it made economic sense; investing in growth in other untapped markets/regions; maintain edge by investing in research & development; investing in potentially synergistic companies for the future; anticipating a downturn; needing a cushion for untoward incidents; stock buybacks; etc...). Investors should not be kept in the dark on corporate strategy going ahead.

Thats because good management and bad management can/will use FCF differently. I need not tell what a good management team will do with the funds, its good and boring. But let me look at things "bad management" can do with huge surplus cash:
a) take the cash largely for themselves via a purchase of assets - e.g. inflating the assets value and getting a kickback
b) using the funds to buy "own assets" (probably at inflated prices)
... and I am sure you all can think of a few more

Posted by Salvador Dali at 8:09 PM