One of the first tasks for incoming Treasury Secretary John Snow is fixing the double taxation of dividends, once as corporate profits, and again by whoever receives them. Go right ahead. But as an investor, I avoid companies that pay dividends like the plague, and you should too.
Why? Because when they pay a dividend they are admitting they have nothing better to do with their money. If they won’t invest in themselves, why should I? In 1887, Theodore Vail quit as the president of AT&T when the directors of Bell Telephone declared a dividend rather than investing in his long-distance subsidiary. I’m with him. He rejoined 20 years later and built the modern phone company.
Sure, I understand the argument for reform. If companies pay all their cash profits out as dividends, then CEO’s can’t fudge numbers to drive up their stock, to make their options worth a ton, so they can buy $15,000 umbrella stands. Pay out all the cash, and then Wall Street will raise, for a modest fee, whatever “good” companies need to grow.
Scan the list of companies worth over $10 billion that pay a high dividend and you don’t exactly come away with the future of America, more like old home week. Duke Energy (5.6%), Eastman Kodak (5%), Ford (4.1%), GM (5.4%), JP Morgan Chase (5.6%), SBC Communications (3.9%), and Verizon (3.9%). Dividends entice investors into debt-laden, slow- or no-growth companies, more likely to cut their dividend, burning investors worse than conflicted research analysts. Run away. They are wearing a scarlet dollar sign. You want yield? Buy a bond.
Tax policy is loaded with unintended consequences. Higher taxes on dividends and a lower capital gains tax rate encouraged companies to buy back their stock instead of pay out cash.
That’s fine with me. My ownership stake goes up, including my “share” of their future cash. The hardest job for investors is to pick stocks for their portfolio, seeking high returns. When I invest in a company, I like to stay invested. If they pay me a dividend, I have to go through the hassle of finding a home for this newfound cash. More than likely, I would just invest in the same high return company that paid me the stupid dividend, so save me the paperwork and just keep the money. If I need cash or want to sell, I can do it for a penny a share.
Encouraging dividends clouds analysis. Who would we rather the stock market provide investment capital to, someone working on hydrogen fuel cells or dividend paying electric utilities milking 30-year-old soot-belching power plants? Should the market encourage a company delivering video over wireless broadband networks or a monopoly phone company that is over-charging for voice calls on their 50-year-old copper wires? Should the market help fund a new wonder drug at a “proteomic” company, or reward the sparse pipeline but 4.8%-yielding Bristol-Myers Squibb for knowing how to navigate the 95-year-old FDA? And should we really be throwing capital at Ford or GM, for any reason?
We’ve just gone through a period of over-funding entrepreneurs. We all understand that. But let’s not change policy to favor companies at the end of their lives, at the expense of those that are finding new ways of generating returns. I’d rather see dividends and capital gains have equal treatment, preferably with a 0% rate. But, dividends don’t create economic growth. Failing companies just bribe investors with dividends. Encourage companies with a future to invest in their operations, seeking high returns. If all that mattered were dividends, we (and maybe John Snow) would still be investing in railroad stocks.