I briefly discussed dividends when establishing my stock screening criteria (See "Selecting Stocks - Take Two" from January 2009). Based on the premise that the value of the unpaid amount is added to the company value (because a share is a portion of the company), I said I preferred companies that don’t pay dividends because individuals receive a 50% deduction on tax due on capital gains (ie the change in the share price) and it is paid only when you sell (if you are not classified as a day trader by the ATO and hold the shares for over a year) but pay full tax on income (ie the dividend) and pay it annually. (At least that is my understanding, tax law is always changing and I could simply have it wrong). Also, there are no brokerage charges associated with reinvesting your dividends if they are just retained by the company (although this is not an issue if the company offers a dividend reinvestment plan).
Graham and Dodd question the practice of retaining earnings (ie withholding dividends) on the basis that:
- if two companies are similar in all respects except the size of the dividend paid, the one with the higher dividend will have the higher share price.
- withholding profits lowers the return.
- it rarely succeeds in maintaining the dividend rate in terms of $ per share.
- any increase in share price generated by withholding dividends will not necessarily compensate the shareholders for the dividends withheld – particularly if you take into account the interest that would have otherwise been earned on the funds. I had a go at trying to test this using the data I’ve complied for the NAB, but given the volatility of the share market, seven years is too short a period.
- they believe a study would show that the earning power of a corporation does not expand in proportion with the dividends withheld, although they are assuming the company is retaining the majority of the earnings, say 70% to 90%.
- individuals in charge of companies have a vested interest in withholding dividends – they will want to retain the cash in the company where they have control over it and they will want to increase the size of the company for self aggrandizement and to generate a higher salary. They may also withhold dividends to depress the share price so they can purchase more shares or to minimise their tax bill.
Sum of earnings per share for the period: $14.455
Dividends paid to shareholders $10.380
Dividends withheld: $ 4.075
In 2009, after earnings fell to $1.975 per share from $2.373 per share the year before, NAB reduced its dividend to $1.46 per share from $1.94 per share the year before. With over $4 per share “saved up” in the previous six years (and more if I went back further), there seems little justification for reducing the dividend. I scanned through the annual report to find any discussion on how NAB determines the amount of the dividend and found nothing.
Graham and Dodd’s conclusions are:
- Any dividend not paid out loses value for the investor.
- The major proportion of earnings should be distributed and any earnings withheld should be justified by management.
- You should look for both an adequate return and an adequate dividend when investing.
