Beginner’s Guide: What is the Dividend?
The dividend is the share of the earnings per share (EPS) that the company delivers to its shareholders. TheÂ percentage of the EPS that the company distributes as a dividend is what is called pay-out.
There is a current opinion that believes that companies shouldn’t pay dividends, since they would have more money to make new investments and that would more quickly increase the profits of companies and thus the value of the shares.Â Therefore, the shareholders would benefit more than if they collected dividends.
I do not agree with this theory for many reasons, among others:
- The fact of having to payÂ dividends, and having to increase it one year after another, is a very strong stimulus for the managers of the companies. The previous theory does not usually work in practice, and the directors of companies that don’t payÂ dividends usually “fall asleep on their laurels” when it comes to making new investments profitable. They invest more money, but normally what they do is increase the size of the company at the cost of reducing the profitability of the stock. The obligation to payÂ dividends makes the managers only keep the money they know how to monetize. Investing for investing’s sake is not good for the shareholder. The company must invest looking to increase the profitability for its shareholders; not the size of the company at the expense of the profitability of its shareholders.
Â The big accounting scandals (like Enron) have occurred in companies that didn’tÂ pay out dividends. If dividends are not paid out, it’s much easier to make up accounting. However, if a company says that it increased its profits by X% and there is a corresponding increase in the dividend it delivers to its shareholders, its bookkeeping is reliable.
HistoryÂ shows that the most profitable companies in the long run, as a group, are the ones who pay the most dividends. There are notable exceptions (tech stocks), but on the whole, companies that pay good dividends are more profitable than those that don’t pay them.
Business managers know how to invest money, but shareholders do as well. It’s important to have a stable cash flow of money to make new investments, to use for consumption, pay expenses etc..