Companies pay dividends to create as much shareholder value as possible. Most profitable companies simply cannot successfully reinvest all of their income into building their business. They operate in certain niches, and can allocate capital to grow strategically. The first dollars tend to provide decent returns, but adding more and more money typically results in further dollars being less useful, so a lot of capital is wasted when it could have been sent to shareholders.
Here’s a link to a video about dividends on Morningstar. Josh peters, author of The Ultimate Dividend Playbook and editor of Morningstar’s DividendInvestor newsletter, discusses low-yield companies and what his expectations are for the future of dividends.
It’s a useful video where Peters discusses dividend payments of tech companies, tax implications of dividends, and his overall insights into where dividends fit into the investing picture.
Mentioned in the video is Berkshire and its blatant lack of a dividend. Buffett obviously loves dividend companies, since a large part of his company’s portfolio consists of dividend payers, and all of his fully-owned companies are essentially dividend paying companies, and yet his company does not pay dividends. Peters argues that Berkshire may be a sole exception to the dividend rule, since Berkshire is a conglomerate and Buffett can successfully allocate the capital in so many areas.
The name that suck out in my mind, however, was Apple (AAPL).
A company’s free cash flow is a good metric to look at. Free cash flow is equal to cash flow from operations minus capital expenditures. Successful companies tend to have high free cash flow because their businesses are profitable enough to keep pulling in cash without requiring much capital expenditure to maintain or grow.
Apple is an unmistakable example of this type of company. The year 2009 saw Apple pull in over $9 billion in free cash flow with no sign of that strength fading. And the company has over $24 billion in cash and cash-equivalents just sitting on its balance sheet. It’s barely making acquisitions and it’s capital expenditures are low, yet has a huge market capitalization and exceptional growth.
I think Apple is due for a dividend. But I guess shareholders don’t seem to think so.
Should they follow the path of Microsoft and pay a large special dividend to clear out their balance sheet a bit, and then institute a reasonable dividend policy? Or no? What about Berkshire Hathaway? Let me know what you think with a comment below.