Dividends are good. When you make a loan, you expect interest payments in exchange for giving up the use of your money. When you rent out real estate, you expect rental payments in exchange for giving up use of your realty. Why should you expect to hand over your hard earned savings to corporate managers any differently? Just give us your money and we’ll make it grow? Promise?
Dividends represent a tangible payback for the use of your capital. As an owner of a share of a business, you have a right to expect a share of the profits.
Of course there are instances where it’s reasonable to defer payment until later … you don’t expect a new business to turn a profit right away. The value of the stock resides in the anticipation that it will someday return profits to shareholders. But this should be a temporary situation. And by the time a company issues shares to the public, there shouldn’t be too many that haven’t yet made a profit. Some corporations may try to convince you to just hand over your capital, rent free, indefinitely, but I won’t do it. Otherwise I’m counting on being able to sell it to someone else at a higher price, and that’s speculation, not investment.
Speaking of selling, that’s the only way to get a return on a stock that never pays a dividend. If you’re a buy and hold investor and don’t ever get a dividend, your return is zero. You must sell at some point or it’s a total loss … you’ve just handed over your money to Wall Street. So you have a choice; you can either be a buy and hold investor of dividend payers, a trader or speculator who may or may not earn a positive return, or a chump.
In recent years share buybacks have become a fashionable way to “return money to shareholders”. Buybacks are inferior to dividends. For one thing, as discussed above it requires the shareholder to sell to realize a return, and some may time sales well and others not. For another, it disproportionately enriches corporate insiders who have stock option compensation packages. Buybacks are more a scheme for insider self dealing than for compensating public shareholders for the use of their capital. Shareholders who watch their stock rise in price but do nothing while insiders exercise options are subsidizing executive compensation, not sharing in corporate profits.
Dividends are also a reflection of corporate profitability that can’t be manipulated with accounting gimmicks. They’re actual cash paid to shareholders. Because of this, they impose a degree of capital discipline on corporate managers; knowledge that investors expect dividend payments encourages them to think more carefully about how they deploy investor’s capital and they’re less likely to squander it on frivolous projects. Dividends say to corporate managers, don’t just tell me exciting stories, “Show me the money!”.