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?