Met celebrated This week marks its twentieth anniversary, as all good and mature companies should do: by paying a dividend to shareholders. Instead of a birthday party, the Silicon Valley stalwart marked its coming of age with a stock buyback and, for the first time, offering a dividend. Investors get 50 cents per share. The markets celebrated and Meta’s stock price rose 20%, adding more than $200 billion to the company’s market cap on the day of the announcement.
The dividend, an innovation of the 17th century, was a mainstay of markets for much of the 20th century. Stock pickers used the money they made from dividends to price up stocks. The Bloomberg terminal of the day, Moody’s Analyzes of Investments, evaluated the giants of American rail based on dividends per mile constructed. But the years have not been kind to the once dominant dividend. Since the early 1990s, regular cash payments to shareholders have been declining, losing out to share buybacks, where management uses the profits to buy back their shares, driving up the share price.
Managers like buybacks because they reduce the number of shares on the market, which increases earnings per share – and often so does executive compensation. A higher share price is all the more attractive if management is compensated with the option to purchase company shares. In the past, investors also preferred buybacks. In some countries, capital gains are taxed at a lower rate than dividend income, and investors like to own assets that appreciate in value because they can choose when to sell and pay the tax.
However, Meta’s decision to hand over the revenue to the minority owners was met with a harsh reception. It’s just the latest sign that markets are starting to appreciate dividends. That of S&P 500 companies rose to $588 billion last year, a 22% increase from three years ago. Investors worldwide have poured $316 billion into dividend-focused exchange-traded funds, nearly doubling their size over the same period. An analyst at Bank of America speculates that 2024 could be “a banner year for dividends.”
Why the shift? Daniel Peris of Federated Hermes, an investment house, and author of a new book, “The Ownership Dividend,” attributes the decline in cash payments to decades of falling interest rates and Reagan-era changes in buyback rules. As the risk-free rate fell, returns on bonds and savings declined, as did the benefits of holding cash. Cheap money allowed investors to put capital into growth stocks that don’t pay dividends.
At that time, Mr. Peris writes, haughty financiers came to regard dividends as the domain of “widows and orphans.” Only sedate companies, such as banks and utilities, tended to deal with them. Yet the current economic climate looks different. Interest rates have risen. Startups without a path to profitability fail to win over investors. And the Biden administration has imposed a tax on buybacks. It’s meager at the moment, but officials hope it will rise.
Maybe cash is king again. Higher interest rates allow investors to put their income to work. Many enjoy respectable, risk-free returns in money market funds. Higher risk-free interest rates also lower the value of future profits in today’s dollars, meaning some investors will prefer cash today to higher stock prices tomorrow.
A similar calculation applies to management, whose options for deploying cash have become more limited. Higher interest rates require higher expected returns from long-term investments and discourage taking on debt to finance stock repurchases. The Biden administration’s distrust of corporate takeovers means takeovers are less feasible. Many companies are therefore considering how best to return dollars to their shareholders.
However, investors have reason to be cautious. As economists argue, earning a dividend is like taking cash out of one ATM– it doesn’t make you richer. If a company were to reinvest its profits instead of paying a dividend, it should earn more money in the future and therefore have a higher share price. As a result, investors should be equally happy with either option.
A company that pays a dividend indicates that it is confident in its future cash flows, as shareholders often assume that dividends will be permanent and managers are reluctant to cut them. Yet such a move also suggests that bosses have nowhere better to invest company money, which bodes ill for a company’s growth. While high-yielding dividend stocks provide a reliable income stream, they are unlikely to reward owners with a capital gain worth celebrating.■
Read more from Buttonwood, our financial markets columnist:
Bitcoin ETFs are off to a bad start. Will things improve? (February 1)
Investors May Be Getting the Federal Reserve Wrong Again (Jan. 24)
Wall Street prays for companies to go public again (January 18)
Also: how the Buttonwood column got its name