Cash Dividends

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Cash Dividends: The 1% Gain Lurking Beneath Microsoft’s Hype

By Dr. Steve Sjuggerud, President, Investment U
Monday, July 26, 2004: Issue #356

Microsoft announced $75 billion dollars’ worth of cash dividends and share buybacks last week, starting with a special $3-a-share dividend payable in December.

As if on cue, small investors clamored for shares of Microsoft after they heard the news.

Following suit, Intel has said it’s now mulling ways to return some of its cash to shareholders, too.

Two obvious questions:

1. Is this trend toward paying more cash dividends good?

2. Should you buy Microsoft and Intel because of this?

The answers:

First: The trend toward paying out dividends to shareholders is definitely good.
Second: Paying a small dividend alone doesn’t make a company worth buying.

Without Cash Dividends, Stocks Only Average 5.5% Gains

Most people have an idea that stocks have returned about 10% a year over the entire 20th century. But here’s what most people don’t know: That 10% return was made up of roughly 4.5% in cash dividends, and only 5.5% in capital gains.

Said another way, nearly half of your return on stocks has been from dividends.

Right now, the dividend yield on stocks is tiny The dividend yield on both the Dow and the S&P 500 is around 2%.

While 2% is awful by historical standards, 2% is still nearly twice the dividend that Microsoft will pay, once it doubles its dividend next year to 32 cents a year.

That means Microsoft will be paying a slim dividend of just over 1% next year.

One percent that’s it?

Why Money in Microsoft Isn’t Money in the Bank

If you’re going to buy Microsoft, buy it on its merits; don’t buy it for a 1% dividend.

While many small investors may disagree, money in Microsoft earning 1% is not the same as money in the bank earning 1%. In the last five years, the stock (currently around $30) has fluctuated between $60 and $20 a share.

There is risk You could buy at $30 and have it fall to $20. Sure you’d have made $0.32 in dividends but that hardly makes up for the $10 a share you’d have lost in market value!

You may not believe this but in the old days (before the late 1920s) investors actually demanded that stocks pay out more in interest (dividends) than bonds or money in the bank.

The logic was that stocks are riskier than cash or bonds, and therefore a stockowner deserves to get compensated. That logic disappeared somewhere along the way

Getting back on track, I think it’s great that more companies are deciding to pay dividends. Financial history shows that investors earn a higher total return investing in companies that pay dividends versus companies that don’t.

So for our sake as investors, I hope the trend toward increasing dividends continues both in quantity (the number of companies announcing dividend increases) and size (the amount those companies pay out).

But when it comes to a 1% dividend from Microsoft, Intel or Oracle, I just don’t get excited. Because as history shows, there’s no reason to.

Good investing,

Steve

Today’s Investment U Cribsheet

I like real, sustainable dividends, from real dividend-producing companies, like Rayonier (NYSE: RYN). Rayonier has 2 million acres of land, where it’s growing trees, and the company pays out 5% to shareholders in cash.