Since we manage a dividend stock portfolio, I obviously strongly disagree with him on many of his points. Let’s start with his first point that can be proven to be patently untrue. He says that dividend paying stocks are a terrible investment. I have never come across a study showing that investing in a large basket of high dividend paying stocks was not a successful strategy. To wit:
- A study by David Dreman from 1/1/1970 to 12/31/1996 showed that the two highest quintiles of dividend paying stocks outperformed the market annually by 1.2% and 2.6%, respectively. The stocks with no yield underperformed by 2.7% annually.
- Tweedy Browne’s excellent paper “What Has Worked in Investing” includes a study that shows the highest decile of dividend paying stocks in the LSE outperformed the market 19.3% versus 13.0% from 1/1/1955 to 12/31/1988 in the UK.
- That same Tweedy Browne paper also includes a study that found from 1969 to 1989 investing in the stock market indexes of countries that had the highest yields was successful.
- A Credit Suisse study (again in the Tweedy Browne paper) showed that from 1980 to 2006 investing in the top deciles of S&P500 companies that paid the highest dividend handily beat the market.
Kessler does make one argument that is close to being correct. He astutely points out that some companies have very little in the way of growth prospects so they pay out a majority of their cash as dividends since the company has no further use for the money. His argument goes off the rails when he falsely proclaims that this paradigm applies to all dividend paying stocks. The Credit Suisse study I referenced above showed that while high dividend paying stocks outperformed the market, you could get even more outperformance by buying only those stocks that paid high dividends but had low payout ratios. The low payout ratio would mean that the company was keeping much of the cash it earned and presumably reinvesting in the business and growth initiatives.
On the issue of growth, there are also cases of companies that simply do not require large amounts of capital spending to grow. One such company is Philip Morris International (“PM”). Over the past three years, PM grew cigarette volumes by about 2% annually, revenue after excise taxes by almost 8% annually, and operating income by 10% annually. Over those same three years, the company generated in total $27.85B in cash and spent $2.325B on capital expenditures. What the heck is PM supposed to do with the leftover $25.5B in cash if not pay some of it out in dividends?
Finally, I am perplexed about Kessler’s statement: “The hardest job for investors is to pick stocks for their portfolio, seeking high returns. When I invest in a company, I like to stay invested. If they pay me a dividend, I have to go through the hassle of finding a home for this newfound cash.” First of all, most large companies have dividend reinvestment plans, which take the hassle out of reinvesting. Second, managing a business and allocating capital are two vastly different skill sets and humans rarely have both. Fund managers are presumably good at allocating capital, and they should prefer the split of an excellent CEO who is running a great business and giving fund managers the excess earnings to invest as they see fit. When the roles are blurred, you have a situation like Steve Ballmer and Microsoft where investors live in constant terror of what Ballmer’s next poorly thought out acquisition might be.
In summary, there are many varied investment strategies that are successful. Contrary to Kessler’s belief, investing in high dividend paying companies has historically been a phenomenally successful strategy and I see no reason why the future should be any different.
Disclosure: Long PM, MSFT