James Mackintosh’s Streetwise column in Today’s WSJ (behind a paywall for non-subscribers) tells the tale of a American industrial giant that had to cut its dividend twice this year, most recently down to a penny a share. As Mackintosh wrote, “The business has been eating its seed corn recently, partly to maintain the dividend.”
Mackintosh seems to blame “irrational” investors for placing too much emphasis on dividend payments, and managers for being cajoled into making dividend payments when the company really needed to push less, not more, cash out the door. He ends by repeating the flawed Miller & Modigliani dividend irrelevancy axiom–discussed at length in Getting Back to Business–that investors shouldn’t really care whether a company pays a dividend or not.
I read the incident differently. Sensible businesspeople investing through the stock market are seeking a rising (or at least a stable) income stream from their equity investments. They do not want to bleed a company dry until it essentially fails, which is largely what happened in this case. In an ideal world (in which shareholders, the board, and executives are all aligned), investors should encourage companies to make all necessary investments in their businesses (even, alas, small acquisitions) and then make a claim on the residual free cashflow. For a dividend investor to “jump the queue” and get ahead of necessary long-term investments is, in contrast, a riskier strategy.
Getting that balance is hard, and plays out in real time. There are no double-blind experiments to see which internal business investments will work out and which won’t. That’s where individual judgment comes in, in the form of active management. It’s your capital; you (or your asset manager) get to make the choices. The company in question stands out as a negative example that can highlight better capital allocation decisions in other businesses. On the same day this article was printed, a different large US corporation hiked its dividend by 11% due to its abundant cashflows, even after reinvestment is considered. That company has raised its distribution by 50% in the past twelve months due to those rising cashflows. The devotees of Miller & Modigliani would also have this company not make any payments to “irrational” shareholders. In contrast, I’m looking forward to the 50% higher check.