“What is a dividend? Do all companies pay them?” We hear this question a lot from people who are in the early stages of learning about investing. It’s a perfectly valid question, so we put it to members of our investing team to discuss.
RYAN: Scott, what are dividends? And why don’t all shares pay them?
SCOTT: Really good question mate. So a dividend is… most people should think about it the same as they think about interest from a bank, or rent from a property. It’s the cash flow that the owner gets from what the asset is doing.
Now if it’s cash in the bank, someone’s paying you that interest to lend your money. And you’re getting a return on that. If it’s renting, someone’s living in the house or the unit, they’re paying you for the privilege.
In the case of dividends, you own a share or multiple shares of a company, they’re making a profit, and they’re returning some of that profit to shareholders in the form of cash because at the end of the day, there’s only so much money that say, a CBA needs to run its business. All that spare cash, no point keeping it on the books, the owners, the shareowners, they want some of that money because they want a return from their investments.
So a dividend is the cash portion of profits. The company says it no longer needs or can’t use successfully and therefore is happy to pay out to its shareholders.
RYAN: So why don’t all companies pay them?
SCOTT: That’s an even better question. So the company that makes a profit, they make $100 profit in a year. They’ve got a couple of questions. But fundamentally they come down to, do I use that money to grow my business? Or do I give that money back to shareholders? They’re the two questions. Now, the answer to the question is people, the companies don’t give money back to shareholders, if they think they can use that money themselves to make their business even more worthwhile.
Most famously, Warren Buffett last paid a dividend in 1965. And never since because he said guys, look, if I keep this money, I can compound it at a market beating rate, if you’re investing in my company, I assume you want that? We all say yes, we do please and so Buffett keeps that cash and reinvests it on behalf of the shareholders. If they can find good uses for the money, better use the money that I can, they should keep it and reinvest it in growing the business.
Amazon famously has not made much money but reinvested all of its profits in top line growth, trying to become more dominant over time, shareholders have forgone those dividends. I’ve got no cash flow from that business I own some shares. No cash flow at all. But I know that by reinvesting that money that profit Jeff Bezos is making the company even more successful even more, larger and over time more profitable, because he’s reinvesting that cash.
So if the company doesn’t need the money or can’t use the money successfully at a high rate of return, it should give it to its shareholders; if it can use the money, particularly if it’s running at a loss, and it needs that money simply to keep the business afloat, it’s not going to pay a dividend because it’s investing now for future returns down the track.
RYAN: So in terms of investing strategy, it sounds like going for dividends or just going for growth, investing in companies that don’t pay a dividend. Sounds like it’s completely different strategy and there’s no right or wrong answer, or approach.
SCOTT: I think that’s fair… it depends on what you want.
So if you need to live off the income directly, you need those dividends, that that’s the one extreme… if you absolutely want to invest in the hyper growth as much growth as you can get, and you don’t want any dividends because you don’t want to invest in companies that don’t want the cash you want to invest in companies that need that money to grow.
There’s a group in the middle though, where you might invest in a company that pays a dividend, but you might even reinvest that dividend back in the company to buy more shares. So there is a there is a midpoint.
Often we see numbers that up to half of the return from the major industries over time have come from reinvested dividends, for example, so they can be a great source of compound wealth.
But depending as you said on your individual strategy, there’s a very big spectrum of where you might want to invest your cash. The types of companies depend on the return you want, and the way you want to compound your growth or take money out of that investment to fund your living expenses.
RYAN: Excellent. Thanks, Scott.
SCOTT: Thanks, Ryan.