Div­i­dend flow

Finweek English Edition - - INVESTMENT - Simon Brown is a Fin­week con­trib­u­tor and heads ju­s­tonelap.com, a free re­source of f inan­cial in­for­ma­tion and in­vest­ment ed­u­ca­tion. *The writer holds shares in MTN.

Iam a huge fan of div­i­dends, I love the f low of what I call “free money”, and the email no­ti­fi­ca­tions from my bro­ker about div­i­dends ar­riv­ing al­ways brighten up my day. With that in mind t wo re­cent events pro­voked this col­umn.

First, War­ren Buf­fett’s let­ter to Berk­shire Hath­away share­hold­ers (you’ll find it at berk­shire­hath­away.com and it is re­quired read­ing) and sec­ond the abrupt change in div­i­dend pol­icy at MTN*.

Buf­fett writes how he loves div­i­dends and al­ways wants as much div­i­dend f low from the com­pa­nies he has a stake in, yet Berk­shire Hath­away has never paid a div­i­dend and plans never to pay one. He goes into de­tail as to why he thinks this is the cor­rect de­ci­sion, in short he says it is in the share­hold­ers’ in­ter­ests.

His f irst point is that share­hold­ers have dif­fer­ent in­come re­quire­ments from their in­vest­ments and a div­i­dend pol­icy is a one size fits all. So, in short, a share­holder is bet­ter off sell­ing stock to fund his in­come re­quire­ments as he then has to­tal con­trol over how much in­come he gets. Buf­fett adds that, as­sum­ing good man­age­ment, the com­pany is bet t er of f keep­ing t he money it would oth­er­wise pay out as div­i­dends t o grow the busi­ness. If the com­pany gets it right and grows the busi­ness and prof­its, this will re­sult in a faster-in­creas­ing stock price that en­ables the sale of shares for in­come pur­poses. Fur­ther, those who don’t im­me­di­ately need the in­come are fur­ther re­warded as they watch their share val­ues in­crease. He does the sums and the ar­gu­ment is sound – but with some as­sump­tions. He runs the num­bers that show that share sales in­stead of div­i­dend pay­ments ac­tu­ally make you richer over time.

Tax is a lo­cal is­sue, we pay a 15% Div­i­dend With­hold­ing Tax, which is higher than the top rated Cap­i­tal Gains tax (13.3% with the first R30 000 ev­ery year tax free) so that cer­tainly works in in­vestors’ favour.

So the big­ger is­sue is; will man­age­ment use the re­tained prof its wisely? Let’s as­sume you have in­vested in a qual­ity man­age­ment team so that’s not a worry. Then the last point, a com­pany with a niche fo­cus may strug­gle to in­vest the money in its field of busi­ness – but in a global econ­omy that should also not be a prob­lem.

Bot­tom l i ne, Buf­fett has got me se­ri­ously think­ing about my love of div­i­dends, but how do we change the over­all mind­set lo­cally? Frankly we’re un­likely to.

The other is­sue was the re­cent MTN re­sults. The the­ory is that a fast-grow­ing com­pany will re­tain most of the profit paying a mod­est div­i­dend as it needs the money to fund ex­pan­sion, and this cer­tainly was the case with MTN. Then at some stage in a com­pany’s life cy­cle growth op­por­tu­ni­ties start to slow and it starts to pay higher div­i­dends as it doesn’t need the ex­tra cash as much. MTN was a growth stock with a low div­i­dend that would have ma­tured into a higher div­i­dend payer but much of the mar­ket ex­pected that change to be a num­ber of years off as it con­tin­ued to ex­pand glob­ally .

How­ever, in the re­sults for De­cem­ber 2010 it in­creased the div­i­dend pay­out ra­tio to 55% (per­cent­age of prof­its be­ing paid out as div­i­dends). This was ear­lier than ex­pected and the mar­ket loved it, now we had growth with div­i­dend. Then the De­cem­ber 2012 re­sults had an abrupt about turn as MTN an­nounced a change in div­i­dend pol­icy to div­i­dendto-ab­so­lute growth. In other words, no more 55% of profit, rather an in­crease of 5% to 15% for the next three years at the to­tal dis­cre­tion of the board. This is a huge change and one won­ders if it didn’t move to a higher 55% pay­out ra­tio too soon? Cer­tainly that seems to be the case.

As a share­holder in MTN and with Buf­fett’s words ring­ing in my ears, I’m happy enough with the de­ci­sion – but it does sug­gest a board that may have made the wrong call in 2010?

War­ren Buf­fett

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