Investors Who Have Flocked To Dividend Paying Stocks May Want To Look At Other Ways Companies Are Using Cash Flow

Wednesday, August 22, 2012 07:07
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Investors Who Have Flocked To Dividend Paying Stocks May Want To Look At Other Ways Companies Are Using Cash Flow

Tags: dividends | investment strategies | investor behavior

Investors get attached to their dividends, especially when Treasuries are yielding practically zero. In fact, some are calling the current attachment to dividends a dividend bubble, similar to the tech bubble and the housing bubble.

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The iShares Dow Jones Select Dividend Index ETF has benefited greatly from this attachment. It’s now trading at $57.82 per share. This makes its yield only 3.56%--less than the stock market’s historical long-term average.
 
This means investors are paying a very high price for that paltry dividend yield. They also seem to be ignoring other ways companies use their cash flows to reward investors. One of those is through stock buybacks, paying down debt, or purchasing other companies.
 
It wasn’t that long ago that dividend payouts meant companies couldn’t find any better way to use their cash. And stock buybacks actually beat out dividend payouts on return. When buybacks happen, the companies increase in earnings and book value are a tax-free event until investors sell.
 
Solid businesses that are more sensitive to economic cycles benefit more from buybacks. Investors may also reap better investment rewards by putting their money into companies who are using their free cash flow to pay off debt.
 
Good investing involves finding companies that are doing a good job of allocating their capital. Back in the 1990s when IBM was paying a 7% dividend, an investor once said he’d never sell his IBM stock because of the dividend. About a month later, that dividend was slashed. Not long after, IBM stock took a huge hit in the market.

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