Why tech companies never pay out their earnings as dividends

http://fiveyearstoolate.wordpress.com/2010/01/31/my-friend-who-hates-tech/

by aditya • 16 years ago

67 50 16 years ago

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tocomment3• 16 years ago

How and why do sites like this one disable zooming on the iPhone? It really grinds my gears!

tocomment3• 16 years ago

It would be interesting to take a poll of ms shareholders to see if a majority want the dividend raised. It would be a great test to tell how broken corporate governemxe really is.

DenisM• 16 years ago

They do - it's called annual shareholder meeting where shareholders vote on issues. Getting something on the ballot isn't that hard, provided a lot of people care about the particular issue.

ashishk• 16 years ago

I think the issue is that often tech company founders / management have preferred shares and therefore greater voting rights than general common stock shareholders. So even if a large group of common shareholders wanted to see dividends, they wouldn't have much authority.

I may be wrong though, I'm just starting to learn more about corporate finance.

dschobel6• 16 years ago

This is true. Most companies are structured so that there exists a preferred share class with greater voting rights so to pass anything you'd have to get buy in from the board members who are the ones who typically own this share class.

macco• 16 years ago

Intel pays me dividends

dschobel6• 16 years ago

As does MSFT (as the article points out). The question is why do they retain a larger proportion of their earnings relative to non-tech companies.

timr• 16 years ago

You're ignoring the point. Intel pays crap dividends for a company of its size and profit margins.

breck• 16 years ago

> His view is that there is no way to be a truly long-term investor in tech companies because management never allows companies to transition from growth companies to mature, income-oriented ones.

I'm not sure if this is true if you looked at the tech industry as a whole. I think it is, but my view is biased from almost purely following GOOG, AAPL, MSFT, etc.

But if it is true, it would be a good explanation as to why Warren Buffett does not invest in tech companies.

rphlx• 16 years ago

I agree with the basic argument, but for most of the 1980-2000 period it was more tax efficient to return money to investors through long term capital gains, rather than dividends. This situation will return next year if the Bush tax plan expires.

ingenium2• 16 years ago

They probably do it because dividends are seen as somewhat obsolete, but firms have to continue paying them because they set a precedent. They are small because they have to be consistent or investors freak out, so the actual earnings aren't distributed anyway. I'd personally rather not have dividends for several reasons:

1. the stock price should accurately reflect the earnings of the firm. When a dividend is announced, the price of the stock decreases by the amount of the dividend. If you want some of those earnings, then sell a share. There's no need for the company to issue a dividend. This is a common misconception most people have.

2. You're taxed on the dividend payments (exceptions tax deferred retirement accounts). This is annoying, especially if you don't want them now and would rather have them just reinvested. Ignoring taxes, the value to the shareholder is the same regardless of whether dividends are paid or not.

My professors in finance all go on long rants against paying dividends, and it really does seem that they're antiquated. Most newer firms just don't pay dividends, and tech companies just happen to be newer firms usually. It's not necessary a property of just tech companies.

alanthonyc2• 16 years ago

"dividends are obsolete" sound to me like another form of "it's different this time."

I don't believe that. The purpose of a company is to make money for its owners. Dividends are payments to the owners of the money the company makes.

As far as capital gains goes, that is just a side-effect (albeit, a potentially lucrative one).

ingenium2• 16 years ago

I fail to see your argument. The owners make money without receiving dividends. It's reflected in the stock price. When a dividend is issued, the stock price goes down by exactly that amount. It's the exact same thing. If you want that money, sell the stock. My argument is that from a tax perspective, it's more beneficial for the owners for the company to NOT pay dividends. If you ignore taxes, they're identical.

Put another way: Company X's stock is $100/share. They issue a 50 cent dividend. The stock price will go down to $99.50/share upon announcement. The investors/owners still have $100 whether the dividend is issued or not, except the investors have to pay taxes on that 50 cent dividend now instead of having it re-invested.

rms• 16 years ago

pragmatism vs. idealism, etc. etc.

tocomment3• 16 years ago

If a stock doesn't pay dividends it's just a glorified baseball card.

russell• 16 years ago

The answer is very simple. Invest in companies that pay dividends, like telcos, electrical utilities, steel mills, railroads and other giants of the the 20th century. Note that you wont get any stock appreciation to speak of. Tech companies that dont invest in new markets die when competitors make the move. Apple might very well be dead if it tried to live of the Mac franchise.

Companies are allowed to keep their income so long as it is necessary for their business. You might think that a mom and pop store would be allowed to keep millions in cash, but since that kind of money isnt necessary for the operation of the business the excess gets taxed at 80%. (My info is old so the exact percentage may be out of date.) Large tech companies like Microsoft and Intel pay nominal dividends to keep the Federales at by, not out of generosity to their stockholders.

acgourley• 16 years ago

"Tech companies that dont invest in new markets die when competitors make the move."

He moves on to say that these tech giants usually end up dying anyway, so he is suggesting they "die with dignity" or at least realize when they should stop growing into new markets tangential to their core competency.

BobbyH2• 16 years ago

There is a huge reason why tech firms don’t pay dividends: their employees have stock options. Unfortunately, although dividends paid to shareholders lower the share price, the strike price on employee options is not adjusted for the lower share price caused by dividend payments. Thus, paying dividends hurts the value of employee stock options, so tech firms that use options NEVER pay dividends.

Also, in terms of returning retained earnings to investors, there is no difference between a company paying dividends and a company repurchasing shares (assuming the shares are fairly valued). Happily, though, when a company repurchases shares, it doesn’t affect the strike price of stock options. Thus, tech firms don’t pay dividends and they repurchase shares instead. So in addition to the "dividend yield", we also need to add in all the capital that Microsoft spent on share repurchases, which was $47.7B in the fiscal year ending in June 2009 (http://www.microsoft.com/msft/reports/ar09/10k_fr_fin.html). That ain’t nothing.

As an aside, Microsoft started paying dividends only after switching from using employee stock options to using restricted stock (the value of which isn’t affected by dividend payments).

These points aside, the author has a good point, which is that more tech firms should do more to return retained earnings to shareholders (whether via share repurchases or dividends).

jagjit3• 16 years ago

I disagree with the notion that dividends paid lower the share price. Is there a theoretical reason? Or is it observed in practice? I would very much like to learn more about this if you could send pointers.

To me this looks more like a device used by managements to justify their practice of share repurchase. The options should be repriced not when dividends are paid but rather when stock repurchase is done. Like you mention, stock repurchase never affects the strike price of options. There is a very informative comment on stock repurchases by Warren Buffet in this 2005 annual report - http://www.berkshirehathaway.com/2005arn/2005ar.pdf

dpifke• 16 years ago

Paying out cash on hand should reduce the share price, because money in the bank is proportionally owned by the shareholders.

For an extreme example, imagine a hypothetical company with 1 billion shares outstanding and $1B in the bank and no other business than earning interest on its cash. With $1B in the bank, it should be valued at $1/share plus some share of expected future interest payments. Pay out a $1/share dividend, and the company is now worth $0.

joe_bleau• 16 years ago

Sure, dividends lower the stock price in practice. Lots of mutual funds even warn about timing purchases right before dividends. The phrase you'll want to google for is "buying the dividend".

http://www.investopedia.com/ask/answers/137.asp

richardburton• 16 years ago

I don't feel this an explanation of why they hold on to the cash. More an explanation of why even large tech companies are perhaps not the best long-term investments.

kelnos2• 16 years ago

Yeah, that was my first thought as well. Better article title might be "Why Tech Companies Suck for Not Paying Out Dividends."

jakarta3• 16 years ago

In theory yes, repurchasing shares should do just as well as paying out dividends.

In practice, no.

Most companies are run by people who are utterly bad at allocating capital. They will buy stock back when it is overvalued, when it is trading towards its high because they feel on top of the world and unstoppable. They are almost always making a grave mistake.

Share buybacks need to be used like Henry Singleton at Teledyne:

You buy back stock when it is trading towards its lows and likely undervalued.

You issue stock and use it as currency for acquisitions when it is trading near highs so that you take advantage of its overvalued status in the market place.

http://en.wikipedia.org/wiki/Henry_Earl_Singleton

Singleton showed how to properly allocate capital in tech and do it in a way that enriches everyone. That's why most people today look to what he did at Teledyne as models for best practices in capital allocation.

netcan• 16 years ago

I'm always confused when I hear of any strategy that involves doing x when share price is low and y when share price is high.

If you can know when shares are low or high, there are lots of ways of using that information. The problem is knowing.

jakarta3• 16 years ago

If you are running a company, you should know when the price of your stock disconnects from the actual fundamentals of your business.

kelnos2• 16 years ago

It's not really about high and low, it's more about valuation. If you can peg your valuation at $20 per share based on a variety of factors related to your revenue, free cash flow, discounted growth, etc., but your stock is trading at $12/share, your company is undervalued and a share repurchase may be a good idea. But if your stock is trading at or above $20/share, yet you can't make the case that your company is actually worth more than $20/share, it's foolish.

jagjit3• 16 years ago

The tech companies, by not paying out dividends, are in effect telling shareholders that they can invest the profits better than them.

This belief I guess comes out in part due to the meteoric profit growth that successful tech companies witness which leads to hubris in the management. The other reason for this belief is the shareholders themselves who let management invest profits in any project they want in the hope of ever increasing profits and stock price.

About microsoft's dividends, one thing the article misses is that msft's payout is very high but most of it is via stock repurchases. The reality is that managements of all companies - tech or otherwise - concentrate on their own interests. That is why you see companies spending so much on stock repurchases rather than pure dividends. In theory it reduces the number of shares - but in practice it is a device to prop up the stock price so stock options or stock price linked benefits for employees and management are profitable. Microsoft spends disproportionately higher on stock repurchases compared to dividends. If they paid all that money as dividends, it would be a very decent dividend paying company.

ghshephard• 16 years ago

The argument seems sound to me, except that a company like Apple is such a great counter example. In 1997, Michael Dell was famously quoted when asked about what should be Done with Apple (a company that Steve Jobs had _just_ returned to)

"What would I do?" Mr. Dell said to an audience of several thousand information technology managers. "I'd shut it down and give the money back to the shareholders."

The rest, is as well all know, history - Apple became worth more than Dell in 2006, and today, is worth almost six times as much as Dell.

I'm pretty certain Apple investors are happy that Apple didn't start issuing dividends and run the company on its (by then dying) Mac OS 8.x, but decided to completely reinvent itself on NeXT OS (aka OS X).

An anecdote, but a useful one.

jakarta3• 16 years ago

The thing is, most business turnarounds keep turning.

Apple is a case of one success versus a universe of failures

Xixi• 16 years ago

I don't think the comparison is applicable here. In 1997 Apple was clearly not in a position to transition from a growth-oriented company keeping it all for investment, to a profit-oriented company paying back a large chunk of its profit to shareholders. In 1997 Apple profits were minus 1 billion dollars. Even if you factor out Next buyout (400 millions), that's still deep down in the red. Not profits to distribute.

But that would definitely apply to 2010 Apple & Microsoft : should they continue to look for growth at all cost, or start paying big (bigger) dividends to shareholders? I lean toward investing... continue to try to change the world, please. Even if lately Microsoft seems to be bad at it (but are they really?), trying to follow the leaders instead of implementing a vision, it doesn't mean it's too late...

elblanco2• 16 years ago

Really? I get my dividends just fine...

http://www.google.com/finance?q=ibm

http://www.google.com/finance?q=microsoft

http://www.google.com/finance?q=sun

http://www.google.com/finance?q=oracle

etc. etc. etc.

And their dividend payouts are about on par with my non-tech holdings also.

Why tech companies never pay out their earnings as dividends

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