You may have noticed that, as we’ve been updating our dividend reports, we have been adding an additional page to the report (page 2) that focuses on pointed dividend analysis from the perspective of the income investor. There are several new sections on page 2 of the dividend report, but in this article we wanted to highlight the ‘Assessment of Company Dividend Strategy’ section. What we set out to accomplish in the two incremental paragraphs of this particular section is somewhat unique, and we wanted to offer a couple themes that will help explain the following unique perspective: what is good for the company over the long haul isn’t always good for the income investor in the near term.
Let’s provide a couple examples. Acquisitions, if value-creating, can be very good for the long-term investor, but they aren’t always great for the income or dividend growth investor, at least in the near term. Several companies, perhaps none other with a higher profile than Pfizer (PFE) in 2009, have cut their dividends to pursue acquisition-related growth. In the event of M&A activity, cash often goes out the door, and this cash could otherwise have gone to the income investor. Of course, it could be a great transaction with tremendous opportunity, but when cash goes out the door, the strength of the dividend is often reduced.
Another example occurs with share buybacks. Warren Buffett is a fan of gaining a larger piece of the companies he owns when those companies buy back stock, but when it comes to the income investor, a capital allocation policy that is heavily weighted toward share repurchases can actually be detrimental to the long-term potential dividend growth prospects of the company. Just like a creditor doesn’t like it so much when a company engages in a large buyback program as it reduces credit quality, income investors often don’t like that buybacks are absorbing capital that otherwise could have gone to supporting the dividend. The company could even be getting a great deal on its own stock.
The analysis behind the dividend is sometimes different than the analysis backing the valuation of the company itself. As in the two examples above, both acquisitions and share buybacks can certainly be value-creating moves by the executive team and applauded by long-term investors, but because they draw down capital that could otherwise be used as either a safety net to the existing payout or to facilitate ongoing growth in the dividend, from the income investor’s perspective, such activity isn’t always welcome. There are a plethora of other examples just like these, and our dividend analysis would not be complete without an in-depth discussion of them for each company.
We hope you enjoy the new page 2, and our team continues to add this unique perspective with each industry update. Please stay in tune with our dividend work! Thank you for reading. Here are some examples from the Machinery & Tools industry.
