Companies paying higher dividends do tend to be more mature. The mature companies investors want to own are still growing earnings, but that growth is probably more moderate than it is for a younger company whose total accessible market (TAM) isn’t yet defined. Apple is a fairly mature company, but they keep coming up with new and/or improved products that expand potential purchases for existing customers and attract new Apple customers. Microsoft’s fastest revenue growth is in Cloud computing, and it wasn’t too long ago that business line didn’t even exist. Coca-Cola grows earnings by expanding their product mix beyond the familiar soda and its variants. McDonald’s tweaks their menu offerings so mom and dad might have more options and thus be likely to surrender more often to the back seat calls for Happy Meals. Even at mature companies, management teams running the companies investors want to own improvise, adapt, and overcome to be increasingly relevant.
With opportunities available to improve the quality and breadth of offerings and expand their distribution, management isn’t paying a dividend because they can’t think of anything better to do with cash than return it to shareholders. If that is the case, investors are better off shifting their holdings elsewhere!
From an investor perspective, the promise to pay a dividend imposes discipline on management to generate sufficient cash flows to pay that dividend and have cash left over to invest in growth. Paying a dividend demonstrates management can execute on what they have told investors they will do. That ability to be disciplined and execute often additionally translates into the ability to grow the business and grow earnings. Investors are typically well-served to look for companies who are simultaneously growing revenues, earnings and dividends.
Dividends may mean different things to investors at different stages in their investing lives. Dividends give investors in the accumulation phase the opportunity to reinvest and buy more shares. The benefits of owning more shares are straightforward. The more shares an investor owns, the more quickly share price increases accrue to grow account balances. Even in a period where the overall market is stagnant, owning more shares means investors are collecting more dollars in dividends…which means accumulating investors have an opportunity yet again to invest in more shares and earn more dividend income. This “compounding” effect in investment returns got even Albert Einstein’s attention, and he called it “the eighth wonder of the world”.
For investors in the distribution phase of their investing lives, dividend income helps maintain the growth opportunity stock price appreciation provides in their portfolios while still helping generate the cash flows needed to cover distributions. The longer investors live, the more important it is to maintain an appreciation aspect in their portfolios so their portfolios continue to provide for them.
All investors can look at dividends as a reward for holding a company’s shares. Investors in the accumulation phase have the option to invest in more shares or utilize that money however they see fit. Investors in the distribution phase get cash flow from their investment without having to sell shares. Provided company management has struck an appropriate balance between dividend policy and growth investment, there is no stage in the investor life cycle where dividends are a bad thing!