Why Big Dividends Are Not Bad News
The Motley Fool recently published an article titled Why Big Dividends Are Bad News. The article argued that while 2010 has been a great year for dividend investors, the larger dividend payments may in fact be bad news for the economy.
This year we have already seen 10 stocks initiating dividends, while 125 stocks have increased their dividends. Dividend investors have been excited about this shift in fortune after seeing so many firms like Alcoa, Pfizer and U.S. Steel cut their dividends last year.
The Motley Fool argues that the increased emphasis on dividends this year indicates that companies have no better use for their cash. Instead of plowing money back into the business to fuel future growth, these companies are taking the conservative route and just returning that cash to their shareholders in the form of a dividend.
However, I completely disagree with the notion that a growth company cannot pay a dividend.
Tech giants Cisco Systems and Apple are often cited as examples of high growth stocks that don’t pay dividends. They both are sitting on a pile of cash that just keeps accumulating. Cisco currently holds $39 billion in cash, while Apple holds over $23 billion in cash.
Are these growth stocks really finding a better use for that cash pile than returning it to shareholders in the form of a dividend?
Last quarter, Cisco managed to generate $158 million in interest income on their tremendous cash pile. That works out to a whopping 1.6% each year.
If Cisco wanted to maintain a “safety net” and keep their $39 billion in the bank, they could at least payout a dividend on their current operating cash flow. Over the last 12 months, the company generated $9 billion in operating cash flow. Paying out that amount in dividends each year would result in an annual dividend of $1.56 per share. That’s an amazing 6.9% dividend yield!
Of course it would not be very prudent for a company to return 100% of its cash flow to investors. However, a more modest payout ratio of 50% still results in a dividend yield of 3.5%. Even a conservative rate of only 30% would still give shareholders a 2.1% dividend yield.
That is considerably more than investors are currently earning off the excessive cash piles sitting on these company’s balance sheets. In this scenario, Cisco would still have their $39 billion in cash as well as 50-70% of future cash flows to continue to invest in “growth opportunities”.
Big dividends are not bad news for investors or the economy. Especially when companies don’t really have better ways to utilize those cash balances.
After all, the best dividend stocks have been able to outperform Apple and Cisco over the last few years. They are able to utilize their cash flow to fund growth opportunities and pay dividends.