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- In the US, “dividend irrelevancy” reigns
- Is this view about to change?
What do Berkshire Hathaway (US:BRK.B), Meta (US:META), Amazon.com (US:AMZN), Alphabet (US:GOOGL) and Tesla (US:TSLA) have in common?
Half a point if you placed them in the list of top 10 US stocks by value. But score yourself five out of five if you spotted the common thread to this mega-cap grouping: despite their size, none pays a dividend.
If you’ve bought into large US stocks before, this isn’t likely to be news. Indeed, if you’ve invested in these stocks, the lack of cash distributions is half the attraction, given the withholding tax overseas investors must pay on US dividends.
Nevertheless, shareholders more familiar with the UK market might still find this situation odd. According to FactSet, just six stocks in the FTSE 100 lack a dividend yield. Exclude the four expected to resume payouts in the coming months, and we’re left with the loss-making Ocado (OCDO) and the Mike Ashley-controlled Frasers (FRAS).
Stateside, ambivalence towards dividends is far more entrenched. Many are de minimis. Almost a fifth of stocks in the US blue-chip index neither pay a dividend nor are expected to. It is a feature of US stocks regardless of size, industry and growth profile, ranging from the high-growth software developer Fair Isaac (US:FICO) to the now-mature palpitation-in-a-can purveyor Monster Beverage (US:MNST).
Still, this phenomenon is relatively new. Half a century ago, US companies’ relationships with investors were governed by cash, rather than market-determined reference prices. So what changed?
Tax played a role. From 1954, Uncle Sam started treating dividends as ordinary income. As well as giving the state a second bite of corporate profits, this meant investors couldn’t ‘time’ the tax like capital gains.
But according to Daniel Peris, an income-focused fund manager at Pittsburgh-based Federated Hermes, this is only part of the story. In an excellent new book, The Ownership Dividend, he documents how from the early 1960s, first academics and then the finance industry began to see dividends as irrelevant, a fallacy, a puzzle, or a nothingburger of a capital decision.
Because capital structures don’t matter (or so the argument goes), cash should instead be put towards new investments or innovation, where the returns might be higher. This may explain why dividend ambivalence has only grown in recent decades, despite a lower dividend tax rate.
In fairness, the post-payout world can claim some success. If Google can become a $2tn company without paying dividends, many will rightly ask why would payouts improve its investment case?
Peris’s answer lies in his view of dividends as a maxim of business ownership. To his mind, the equivalence of capital gains with dividend payments – a tenet of modern finance – denies the centrality of cash. Peris also thinks today’s “more normal” interest rates will end both equities’ anchoring to bond yields and the appeal of Wall Street and Silicon Valley’s preferred method of “capital returns”, the share buyback.
He has few illusions that the consensus will suddenly shift. “Two full generations into this paradigm, it will be an uphill struggle to convince investors, practitioners, and corporate executives that a change is about to occur,” Peris writes. Shaking the idea that dividends are a quaint anachronism will be tough.
Nonetheless, he believes change is possible. For a start – and unlike the era in which payouts started to lose popularity – the reduced capital intensity and higher margins of today’s services-led US economy mean there is much more cash available for dividends. Peris also argues that a growing dividend encourages buy-and-hold strategies that can reduce market volatility and help to neuter the effect of inflation.
Barring a “crude return to the past”, a key test of his thesis will be the ability of those (often cheaper) dividend stalwarts to keep up with tech stocks’ capital gains, on a total return basis. Failing that, a rethink of cash returns might help to repatriate the image of another equity market, often decried for its apparently short-sighted “dividend obsession”.
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