The humble dividend is a thing of wonder. It’s a tiny amount of cash paid out to investors regularly for their part-ownership of a public company. While the yield on the S&P 500 is barely above the yield on a 30-year US treasury Bond, it’s good to get paid for holding stocks that might eventually make you rich.
Stock dividends mean different things to different people. Investors seeking out regular income from their investments will focus on the high-yield dividend stocks that pay out a sizable chunk of earnings every year. While growth-oriented investors see it as money wasted on making investors happy instead of being reinvested in the business to fuel growth.
It’s fair to say most investors barely notice the tiny percentage dividend yield they get on their rather small stock holdings.
But the dividend is more than just a token of investor appeasement. Here are five things the dividend can tell you:
- The level of cash
Cash-rich Apple is the best example of what happens when a company has more cash than it knows how to spend. A lot of massive, multinational companies hoard cash relentlessly, but eventually they pay it back to the rightful owners in the form of dividends. Even innovative and high-growth tech companies are now admitting they have too much cash to use and dividend payouts have hit an all-time high.
- The potential for growth
A dividend payout doesn’t signal the end of growth. Instead it signifies a healthy company capable of paying out huge sums of money today because it’s optimistic about the future. At the end of last year there were ten stocks on the S&P 500 that had grown their dividend every year for more than 50 years. Dover Co. (DOV), for example, has paid a growing dividend for the past six decades without a pause. Earnings are still expected to grow 11.25% average every year for the next three years. Similarly, stocks on the Dividend Aristocrats Index have managed to grow dividends for 25 consecutive years.
- The management’s confidence
Dividends are linked to profits and cash levels, but the policy is ultimately decided by the company’s management. Management may choose to hold back all the profits and cash to fund major acquisitions or capital expenses later. Once a dividend is declared, it’s difficult for managers to cut or suspend it later. Cutting dividends scares investors and usually sinks the stock price. So, when management decides to declare a generous dividend policy, it’s an indication of confidence.
- The company’s value
Sophisticated investors use the dividend as a measure of the company’s value. Apply the Gordon growth or dividend discount model allows investors to calculate the intrinsic value of the company. If the stock price is lower than intrinsic value, it’s considered a good investment.
- The state of the economy
Dividend policies are usually sticky and stable. But the absolute volume of cash spent on dividends and buybacks shows the state of the economy. Aggregate data on dividend payouts, yields, and cuts can indicate the state of the American economy. For example, if the number of companies suddenly cutting their dividends spikes, it could indicate economic distress.
Dividends offer more than just an added return on your investments. They can actually give you vital information that guides your investment strategy and long term performance.