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Long weekend reading: To yield or not to yield?

Long weekend reading: To yield or not to yield?

Instant income by way of dividend payouts, or nothing now in the interest of potential long-term wealth accumulation? In Part I of this exclusive subscriber-only White Paper, I have a look at the conversation surrounding yield.


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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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  1. The reason for investing is to get a return on the investment, agreed?
    So if companies reinvest their profits in total witout paying dividends, then an investor has one choice of getting a return and that is to sell shares. The long term result of this is that the company will loose all its share holders and the share capital it needs to continue to grow. The payment of dividends is a half way position which keeps share holders happy and able to survive whilst retaining share capital by the company for its long term survival. I guess very healthy comanies can ultimately buy back all the shares and become self sustaining, but why not use someone elses capital thats cheaper than borrowing from other financial sources.

    • Hi leo,

      Thanks for your comments. There seems to be a little bit of confusion about the way retained earnings and share capital work in the financing of a business. Most importantly, when shareholders ell there shares in the secondary market, the capital position of the company remains unaffected. What I mean to say is that the buying or selling of a company’s shares in the market does not change the capital of the company. When a company pays no dividends it retains more profits and has more capital to grow (or destroy possibly!). The trading of shares is independent of this. Keep an eye out for Part#2. It will explain all of this with some useful tables.

  2. Steve Leahy Excellent question. At the prices they payed it appears to be Empire Building and as a shareholder possibly concerning.
    I look forward to hearing Roger’s veiws

  3. I seem to have missed a point in your illustration tables. For example Table 1 indicates that the Dividends received totalled 21 cents over 2 years resulting in share price of $2.20 and if the share had been sold at that point the Funds in hand would total $2.41.
    In addition I assume Franking credits of 9 cents making total return $2.50 compared to $2.40 if there had been no dividends paid.

    Where have I gone wrong??

    • Hi John,

      There was on one Table (Table 1) in the entire article. Are there others in your copy? With respect to table 1, I have been too conservative on the PE of ten. Make it fifteen for a company earning a 20% ROE and retaining 50%. Keep an eye out for Part #2.

  4. Hi Montgomery team,
    Can a topic of a whitepaper be a more in-depth explanation of your 2nd best use of Capital allocation that being acquiring another business. For example MTU”s stake in DoDo, Carsales stake in iCar Asia or REA groups recent stake in Move Inc, how does one differentiate whether one is a superior add on ( a good use of retained earnings) or a case of Empire building ( a poor use of retained earnings)

  5. I completley agree with you Roger and wish more businesses in Australia retained their funds and used these in a more productive way than simply paying it out as dividends. I believe that the focus on superannuation and franking credits creates a dividend paying bias, i don’t know if there have been any studies etc that have looked at this, it is just my belief.

    If companies reinvested more into their businesses for value adding benefits such as capital expenditure, R&D etc then we may have a bigger pool of quality companies to invest in.

    Also, if the market was not so focused on receiving income, then perhaps we would have a raft of newer companies coming through the pipeline as investors would be happy placing capital into these upcoming businesses for growth. Instead, at least in the tech world, a lot still seem to have to go to the US.

  6. every ones situation is different , of coarse if possible growth stocks is what what you should be purchased & dividends reinvested if possible as Chris commented however yield is needed not only for lifestyle some may need it for living expenses such is more important to the retired .

  7. Dividends should be paid to shareholders as one of conditions/goals of the remunerate package of the CEO and Directors . The dividend should be minimum of 5%. if this not achieved then they should be taxed at a penalty rate of 20 points above the company tax rate.If the company the does not make a profit then a % of the turn over to be taxed. Bankruptcy should not ceased until all monies are paid back in full.

  8. I tend to think the focus on dividends has more to do with a tendency towards short term thinking and maintaining a share price perhaps more to do with incentives. TTN last year had a cashflow after investing of only $500,000 yet paid 3.3m in dividends, with uncertainty with it’s contracts it was’nt enough to save the share price. IFM which appears to looking promising growing overseas sales paid a dividend of 94% last year. Options were given at .21 cents so with a share price of 1.14 they look promising. There needs to be reward for effort, I am not sure what the balance is for shareholders and management.

  9. It seems to me that what’s also a vital ingredient in this mix is that the capital management needs to be excellent, not just for a couple if years, but as a long term trend else you forego dividends and let the company retain the wealth for a few years only to see some successive management make some poor decisions and cancel out prior years good work!
    *Long term* excellence in capital management would seem to be very important.

  10. Interesting article on the right balance between EPS and DPS.
    The logic of easrning more fropm a capital gain perspective than Dividend return is somewhat convincing but one can not guararntee the basis of a dividend gain based on a guaranteed PE ratio of less than or equal to 10 because the PE measures sentiment and influenced by sentiment.
    I would have thought that montgomery would have made the comparison of the return based on the Nets Nets value of a company.
    NTA – All debt divided by the shares on issue.

  11. Log-in is all too complicated for a simple-minded person like me. I would like to read your White Paper but your site keep on rejecting me. What a pity for both you and me

    • Seems to be working fine for everyone else Brian. If the issue is that you don’t want to obtain your own unique login, then it is indeed a shame – I think you would enjoy reading the paper.

  12. “However, if a company can generate high rates of return on equity, it is logical that earnings should be retained, irrespective of the demands and needs of shareholders. It is not the case that a particular class of shareholders are best qualified to influence the dividend payout policy of a company”

    And neither is it the preserve of management (who are most likely majority shareholders) either…a great example being Berkshire Hathaway !

    The company arrogantly does not pay a dividend, under the pretense that “we know what is best to do with it, you don’t – and if you need income, you can always sell some of the stock”.

    If people want to, they should be allowed to reinvest dividends; there is therefore no change to anything if they do. If not, perhaps to them, using that dividend for whatever they choose will give them a higher “return on equity” that is perhaps not tangible, e.g. taking a family holiday or having a celebration dinner.

    It is just as wrong for companies to dictate to “the peasants” how and if to receive what is essentially, their OWN money !

    • Hi Chris,

      The example in my whitepaper (Part #2), shows rather convincingly that it is not arrogance but logic & tax that compels Berkshire to retain the profits and still affords shareholders to do something tangible with the money. Keep an eye out for it Chris!

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