Dividends are everywhere these days. Numerous blogs cover dividend stocks and it is hard to open The Report on Business these days without running into one (if not more) columns on investing in dividend paying stocks. And judging by the number of new investors interested in dividends on the Canadian Money Forum, one would think that dividends are all there is to investing in stocks. Nothing could be further from the truth.
Investors should not lose sight of the fact that dividends are just one form of returning profits to owners. Businesses that generate profits can employ capital in other ways. Management can reinvest profits and grow the business — provided, of course, that reinvested profits generate a higher rate of return than owners can manage on their own. Management can also buy back the company’s shares, so that each remaining share can then earn a higher proportion of future profits. Though investors are not directly receiving their share when profits are reinvested or shares purchased for cancellation, they are indirectly receiving the same value through appreciation in the value of shares they hold.
Take Berkshire Hathaway (BRK-A) which has famously not paid a dime in dividends and until recently has never had a repurchase program. Long time BRK shareholders are unlikely to be crying that their holding is not paying a dividend. Neither do shareholders of Apple Inc. (AAPL) whose earnings have exploded due to the popularity of iPods, iPhones and iPads. Investing in stocks by just looking at current and past dividends is a mistake. What matters in investing is the profits that a business will generate in the future, not the dividends it paid shareholders in the past. If dividends were all there is to investing in stocks, AIG, Freddie Mac, Fannie Mae and Bear Stearns wouldn’t have gone bust and nobody would own shares of Berkshire Hathaway or Apple Inc.
