Heard in the Village: February 2010

Dividends came up this month in February 1, 2010 issue of BARRON’S. Their point was large U.S. companies like Cisco Systems, Google and Apple were doing their shareholders a disservice. They were holding large cash amounts for possible acquisitions which can often be a sign that the core business is slowing. There are often acquisitions that are done for management’s egos and end up losing money. The article pointed out that managements don’t want to be locked into dividends because they don’t want to be held accountable when they are cut. They would rather buy back shares. The villagers thought a sign of a good company was having the ability to grow while paying increasing dividends. This shows management’s faith in the company’s future. Villagers generally don’t like buying back shares because it is a manipulation of earnings to get temporary higher stock prices without generating more sales. Too many buybacks are done to appease institutions and help management’s stock option plans. The other problem with buybacks is the stock price can go down losing the money that could have been paid out in dividends.

When they talked of dividends to some outsiders, there was an argument. The outsiders didn’t care about income; all they wanted was capital gains. All they cared about was earnings and momentum. They had no use for income until the professor told them that the value (price) of a stock is derived from all the income, present and future, you can get out of a stock-not earnings. Capital gains were made up of earnings and a price-earnings ratio which is frequently based on human emotions.

Earnings can go up but the price goes down because the p-e went down. Dividends stocks are more stable because their owners get paid to wait. Good yields attract buyers while the markets fall while capital gain stocks keep falling. The eventual low prices will come from high dividend yields investors will be willing to receive. Capital gains speculators will eventually sell to income investors. When the outsiders thought about what the professor said, they weren’t as cocky and against dividends.

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