Why We Should Hate Dividends

The purpose and goal of any business is to increase the wealth of its shareholders. It can be done by increasing the value of shareholder equity or giving dividends to the shareholders. Analysts and bankers HATE dividends. Should the average investor too?




The lure of companies paying high dividends is huge. For example Nordea Bank AB paid a week ago over 7 % dividend yield on its stock. Usually especially European value stocks have been paying generously high yields of dividends to the investors. Investors get the dividends (with a few tax exemptions in some countries) and can re-invest these dividends back to the stock market to gain the compound interest, which could boost the investors wealth considerable in the long run. It could be considered as investing "free money" to gain even more "free money" the year after.




Compound interest is the reason why I have been investing in value stocks which have a high dividend yield and great potential to increase it. But from what I have heard from analysts, professors and bankers, they all despise dividends and hate corporations that do that. That got me investigating the matter a bit more.




Let's consider a value firm which pays a good dividend for the stock. Now, the company is giving money outside to the company to the shareholders, which means that the cash isn't there for future investments. Shareholders are happy, but analysts and bankers are not.

Investing in assets is important when we consider the growth of the corporation. Capital expenditure and the increase in the long-term assets tell that something is going on in the company: They are investing in their operations. This means that something is coming and it will have a positive or a negative effect to the company.




For sure if the managers are wise, they pay the dividends so that there exists cash to do the planned investments. But still, less funds are available to invest in growth of shareholder equity.




In the worst case scenario, the free cash flow after paying the dividends can be negative! This isn't not so uncommon from what I've discovered. For example Finnish company Sampo generated free cash flow of 1,255bn€ and paid dividends worth of 1,286bn€ in 2017, creating a small deficit. In 2016 the situation was more severe: Sampo's free cash flow was 182m€ and paid dividends worth of 1,2bn€, creating a deficit of 1bn€




So who finances this deficit? Who pays these dividends? The banks of course!




Let's break it down a bit: After you've generated the cash, what do you have to pay with that? You have to pay your capital expenditure for compulsory investments and have the sufficient working capital for your business to operate. After that, whatever becomes negative, is financed from long-term liabilities. Paying dividends financed by debt sounds rather unorthodox and from this you get an evil eye from the bankers who are considering to grant a loan for the corporation.

What about the assets? What is the effect for the corporation that pays dividends but doesn't invest? Especially from bankers' and analysts' perspective we are interested on what the corporation does with its liabilities. If debt is used for gearing some investments and long-term acquisitions, woah that's good. And you get tax exemptions as well. But if the liabilities are used to finance dividends, firm isn't necessarily growing since it isn't investing in new businesses.


The money you get is away from the corporation and from the growth.


If we think in depth how a balance sheet works, it should be that long-term liabilities finance long-term assets and current liabilities finance current assets. If long-term finances short-term and short term finances long-term, it also sounds a bit wrong. This is why also cash should be financed from current liabilities and not from a bank loan.


What I've learned is to be more critical towards generous payout ratios of dividends and focus more on the free cash flow in a corporation when taking it into evaluation.


Berkshire Hathaway hasn't paid dividend in 50 years. When the question of whether the company should pay dividends or not was popped up in the annual shareholder meeting, the shareholders said: "Just don't. Keep investing the money as the same way you have done before, you are going to do it better than us".


In the 1990's dividend stocks weren't that much of a hot topic. Could it be that the modern society of "everything to me as soon as possible" has gotten us to praise dividends without that much consideration?


Text: SW
Pictures don't belong to me

My Global Economic Outlook

"En ole ekonomisti, mutta voin vilkaista" I would say about the current economical environment in Finnish. I'm not an economist, but I can take a look.


I decided to have a little fun and to make my own forecast what is going to happen in the world economy in the following years. So that I just could see how wrong can it go. I want to put my signature disclaimer already at this point that these forecasts don't have much sources, quantitative analysis or mathematics to back them. As our former minister of finance would say: "I just pulled the figures out from my head". You can choose to believe these or not. Critique is more than welcome.


Let's see what I can do with my 5-year studies from economics and finance.


United States


Let's start with the United States and meet the US 10-year treasury bond with its yield. As you can see below, since last year the yield has started to go up in fears of rising inflation in the United States. In February 2018 the markets were shocked when the inflation in January was greater than expected. President Trump has offered kindly tax cuts for the corporations and people which has boosted consumption perhaps a bit more than expected. Seems that people are afraid to save and invest their extra income at these times of uncertainty.


Because of this FED with its new chairman Jerome Powell would be more probable to introduce several hikes in the interest rates during 2018. Powell has answered these expectations with hawkish tone of voice in his speeches to the US congress.

Analysts have estimated that it would be highly probable that the FED would raise the rates in 2018 "3 times or more". Now if the inflation has started to rise faster than expected, FED might do quick actions in order to tackle the inflation. So what does this cause?


First of all, raising the interest rates would boost the rise in the bond yields even more. This would give the investors the incentive to take their money of the stock market and invest it into bonds and debt instruments since they are considered less risky instruments than stocks (we can argue from this). This would create a bear market and the stock market would start to decline.


Goldman Sachs has estimated that if the US 10-YR bond hits 4 % during 2018, the "shit hits the fan" so to speak in the stock market. Goldman is expecting the yield to hit 3,5 % already in the following 6 months. A 4 % yearly yield would really lure the value investors from the stock market, since how many US firms pay a dividend that big anyway?


The rise in the interest rates will be problematic and send the economy into recession. The cost of borrowing will increase and businesses are not that willing to invest and financial expenses are expected to increase. Consumption decreases since people (especially the ones with a mortgage) have less disposable income when their financial expenses increase. These will cause the inflation to decrease but also low the economic growth.

And what's more, the loose cannon Donald Trump already introduced tariffs in imports of steel and aluminum. This has raised concerns that the higher costs can make US steel companies less competitive against their international competitors and would thus harm their business. China and EU are preparing themselves for a trade war.


I would see that the US 10-YR yield could hit 4 % by the end of the year. This would cause a slight meltdown in the stock market and would send the US eventually into recession. I would say that this would happen in 2019.


Europe


The rising interest rates in the US would cause the USD to appreciate against the Euro. The ECB would be very grateful from this since it would make the European export products more competitive in the international markets. This would boost the European economy even further for the next years before the economy starts to heat as much that the ECB has to intervene in a same way that the FED does in the United States, However, I wouldn't be so much worried about the situation in Europe, since the German 10-YR yields are still relatively modest. However, it has started to rise as well this year which can cause troubles for the stock markets in Europe in 2020 I would presume.

In terms of economic growth and recession there's no clear sign of danger yet and the inflation is in control, but we must brace ourselves in a couple of years to see if the recession comes to Europe with a 2-year delay from the one of the United States. I would see that the economic growth stimulated by the euro depreciation would rise the inflation in Europe to the ECB's goal of 2 % in 2020 and cause the ECB with its new head to intervene and to raise interest rates. The recession in Europe would come somewhere around 2021.


Engagement into a trade war with steel would also hinder international trade on which the European Union is quite dependent on. Although the EU has extremely strong inner markets, the US tariffs are going to have an effect for the European steel industry and can hinder the economic growth in Europe.


Asia

Xi Jingping pretty much announced that he is now the new dictator of China. The Chinese central government decided to remove the maximum of 2-year term for a president, which would mean that Xi could rule China tens of years. This throws the hopes of China becoming closer being a market economy to the trash. It is interesting to see how the other world will react to this in the future, but I don't have a hunch of what is going to happen in China in the next 5 years.

The Japanese economy posted great figures for economic growth in 2017, but experts forecast that the growth will be not that great this year. The Bank of Japan has stimulated its fragile consumer spending successfully, but the room for growth seems to be running out. The government is aiming to raise sales tax in 2019 which could break already the fragile consumption in Japan and send the third biggest economy in the world to recession in 2019.


Conclusion


We have enjoyed the long roller coaster of rising valuations in the stock market and good figures in the economic growth in the US, Europe and Asia. Now however the rising interest rates and bond yields are introducing friends the dynamic duo of recession and the bear market.


This will all start in 2019 from US and Japan. Europe joins the blues a few years after.


*mic drop*


Text: SW
Pictures don't belong to me.