Deeper Dive into Dividends

By Gary Silverman, CFP®

“I don’t want to sell (fill-in-the-blank) because it pays good dividends.”

That statement, in various forms, is one I hear regularly. There’s just something about dividends that makes stock investors feel safe. Unlike capital gains which seemingly come and go at random, dividends are steady, sure income. And let’s face it, given how little fixed income investments pay these days (whether they are bonds, CDs, or money markets) stock dividends look as attractive as they’ve ever been.

Or at least it seems so.

“Oh, but company (fill-in-the-blank) has paid a dividend every quarter for over three decades.” I’ll hear. Or the variant, “…it has increased its dividend every year, regardless of what the rest of the market did.”

Now, there’s nothing wrong with a company paying dividends; nothing wrong with them paying dividends every year; nothing wrong with those dividends increasing consistently…IF it is truly excess earnings from the company. But there are a lot of other things a company can do with the money that might be better for it.

A company might use the extra cash they have to pay down debt. It might use it to build some reserves in case of an earnings shortfall. It could expand its plants, give raises to retain talent, or go into new lines of business.

But if a business looks at those and other uses of cash that might make them a more profitable or more stable company in the future and can honestly say that none of that a good use at this time, then yes, a dividend (essentially paying out some profits to its owners) is not at all a bad thing.

Notice that if a company pays dividends every year, and especially if they are increasing the dividends, then I rather doubt they have truly examined and made that decision on the realities of that year. Instead they have done so because they are afraid that if they cut back on that dividend in order to expand into a new market, new region, or upgrade what they already have, the dividend-loving public will sell off the stock and the financial pundits will announce that the sky is falling.

Instead of cutting dividends when there is a pressing need to use the cash elsewhere, a company might, for the sake of reputation, pay the dividend anyway and forgo the need. Even worse, some companies that have been having cash-flow problems and don’t have the money to expand let alone pay dividends—borrow the money to pay those dividends.

Before you get the idea that I dislike dividend-paying stocks, I’ve got nothing against them. I just want to make sure that the dividends that are paid are truly sustainable and are in the best interest of the company. Because, if you own a stock, you own the company and want it to succeed.

Which is why I ask, if you decide to invest in a stock mostly because it pays a dividend, take the extra time to regularly ensure that paying that dividend is good business for them. This way, you may have a better chance to share in their successes moving forward.

Gary Silverman, CFP® is the founder of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm and author of Real World Investing