No, the headline above is not goofy, and I presume it did get your attention.
In a concise and suitably critical piece, Floyd Norris of the New York Times tells us that the corporate dividends paid in the seemingly good years depended far more on bank largess than was widely realized. And as credit is being reined in, so to will dividends be, as a direct result of more stringent lending decisions.
From the New York Times:
“Dividends don’t lie.”Chalk up the death of another Wall Street cliché.
In the late bull market, dividend payments provided one of the seemingly strongest arguments for the bulls. Maybe earnings numbers could be manipulated, but dividend payments required cash. If the company had the cash to hand out, you could be confident the earnings were real.
It was a lie.
Yves here. Admittedly, Norris’ articles typically are more column than journalism, but I feel like applauding when someone at the Grey Lady decides not to mince words. Back to his piece:
It is now becoming clear that the great news on the dividend front from 2004 through 2006 was not an indication of solid corporate performance; it was just another sign of lax lending standards. Lenders who willingly handed out money to homeowners with bad credit were even more generous to corporate borrowers.Now the situation has reversed. The quarter just ended had the worst dividend news for American companies in half a century, and this quarter could be even worse. Many corporate boards review annual performance and decide what to do about the dividend during the first two months of each year, and it is not likely to be a happy time.
Until those meetings are completed, buying stocks for their high dividend yields may be risky….
Companies appeared to be flush with cash during those days [2004 through 2006], but some of that was a mirage stemming from optimistic accounting, particularly at banks. In other cases, the cash was real but it did not stay in corporate treasuries very long. Wall Street was preaching the doctrine of shareholder value, and corporate America bought shares back at an unprecedented rate.
From the fourth quarter of 2004 through the third quarter of 2008, the companies in the S.& P. 500 — generally the largest companies in the country — reported net earnings of $2.4 trillion. They paid $900 billion in dividends, but they also repurchased $1.7 trillion in shares.
As a group, shareholders were paid about $200 billion more than their companies earned over that four-year period. Suffering investors who held onto their shares during the 2008 plunge may want to reflect on the fact that investors who were dumping shares got roughly twice as much of the money as the loyal holders did.
As a seasoned investor said at the time, “Why should I invest in companies if they aren’t willing to invest in the business of their business?”
You can read the article in full here.
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Because leveraging was so cheap for so long, management was susceptible to charges of fiduciary breach if it actually chose to invest internally using retained earnings.
IOW, if the cost of capital was 4% but the external (for shareholders investing elsewhere) ROI was 8%, then the fiduciary duty to shareholders would have called for borrowing the capital and divesting the retained earnings.
Or so that’s what my corporate finance professor taught ;p