The Dynamics of Shareholder Capital – Part IV

All this week, we have been discussing the various areas of shareholder capital.

In the wake of the recently announced 10-for-1 stock split at NVIDIA Corporation (NASDAQ: NVDA), we discussed the benefits of stock splits.

We concluded that no real economic benefit exists, but they can be a mild positive for other minor reasons.

We also discussed share buybacks. We gave an example that has been one of the best outcomes as well as one that has been one of the worst incomes.

We concluded that they can be a powerful tool, but they depend on management's acumen.

Today, we discuss a final large category of shareholder capital – dividends.

We are sure you know what a "dividend" is, but we always like to revisit the definitions.

"Dividends" are cash payments companies have decided to pay to shareholders.

For instance, a company might pay a $0.50 per share dividend. If the stock trades at $10, then the stock is said to have a 5% dividend yield. This is the $0.50 dividend divided by the $10 stock price.

Many companies have “regular” dividends, meaning they have committed to pay the dividend on a recurring basis. Most do it quarterly.

Many also look to increase that payout every year. The increases may not be significant, but they want to return more capital to shareholders each year.

A select group of companies is out there called the "Dividend Aristocrats."  These companies have increased their dividends for the past 25 consecutive years.

They make up some of the most well-established companies in the stock market and have posted impressive returns over time.

Some companies may also choose to pay “special” dividends.

A company might want to return cash to shareholders but not commit to returning that amount regularly.

We have seen a lot of this recently with the energy stocks. They have seen strong cash flow and want to be disciplined about not investing so much that they create too much supply.

Many have repurchased their stocks but have also decided to pay significant "special dividends.”

These companies understand that their results are subject to commodity prices, which can be unpredictable. A special dividend is a way for them to return capital to shareholders and show capital investment discipline while not letting down shareholders if the environment changes.

While they may not be as consistent as a regular dividend, they are still richly rewarded in their share price by paying out the cash. Sometimes, in particular situations, the payouts can be considerable.

Dividends are an exciting area of shareholder return.

They have some similarities to stock buybacks. If a company has opportunities to invest its capital back into its business and generate high returns, shareholders would prefer them to do so.

Dividends also are potentially not as tax efficient. They are treated as income, and many wealthy shareholders are in the highest tax bracket, so this can result in them paying a high tax rate.

In theory, buybacks are better, but this equation has many parts.

Remember that we often make the point that stocks are not companies. Our view is that owning the stock technically means owning the company's cash flows. However, shareholders very seldom see these cash flows.

Buybacks are a way of flowing them back through in a way, but it is not actual cash back to the shareholders.

Dividends are the exception. They are the one-way shareholders are actually paid for their ownership of the company via the stock.

We could write several issues of HX Daily about dividends and how different strategies (regular, special, high, low but consistent) have performed over time. Still, for today, we will stick with some high-level thoughts.

If a company is generating strong cash flow and has a relatively mature business, dividends make a lot of sense.

We don’t like that tax inefficiency, but we appreciate the capital discipline they may impose on the company.

We also ultimately look at stocks as "products."  The reality is that many buyers of this product like to see consistent and growing payouts.

Taking those payouts and re-investing them in the stock is also a great way to compound growth.

Overall – we think dividends and growing them make a lot of sense for the right businesses.

We will add one note of caution. If a dividend is too high or seems too good to be true, it may not be a good investment.

Some of the best shorts we have had in our career were in the highest dividend-yielding stocks. A very high dividend is often a sign of distress at a company, not strength.

Like share buybacks, it comes down to finding good management who can skillfully use this shareholder capital tool.

Do you think paying dividends is vital for a company? Please share your thoughts in the comments section online or at [email protected].

On this week's HX Podcast, Enrique is joined by Frank Cappelleri of CappThesis and CNBC contributer.

Frank's recently posted his technical analysis of three stocks he has been watching. Enrique was so intrigued by his insights and clarity, he invited Frank onto the Pod to discuss.

This is a rare opportunity to look at some current market setups, with all the data on-screen as they walk through it.

If that's not enough, stay to hear what Frank learned from a ballerina from the 1960's!