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Meta commemorated its 20th anniversary this week as all commendable and well-established enterprises should: by compensating shareholders a dividend. As an alternative to a birthday celebration, the Silicon Valley stalwart marked its maturation with a stock buy-back and, for the first time, by presenting a dividend. Shareholders will obtain 50 cents per share. Markets celebrated, with Meta’s share price ascending by 20%, adding over $200bn to the company’s market capitalisation on the day of the declaration.
The dividend, a 17th-century creation, was a staple of markets for much of the 20th century. Investors employed the money they earned from dividends to appraise shares. The Bloomberg terminal of its time, Moody’s Analyses of Investments, evaluated the giants of American rail on dividends per mile of railroad laid. However, the years have not been kind to the once-dominant dividend. Since the early 1990s, regular cash payments to shareholders have been in decline, conceding to stock buy-backs, wherein management uses earnings to repurchase their stock, augmenting the share price.
Managers have an inclination towards buy-backs because they reduce the number of shares on the market, heightening earnings per share—and consequently often executive compensation as well. A higher stock price is all the more enticing if management is compensated with the option to acquire company shares. In the past, investors have also favored buy-backs. Capital gains are taxed at a lower rates than dividend income in some countries, and investors like possessing an appreciating asset due to the flexibility to choose when to sell and pay the taxman.
Meta’s decision to allocate earnings to its minority owners received an exuberant reception, nonetheless. It is just the latest indication that markets are beginning to acknowledge dividends. Those from s&p 500 firms escalated to $588bn last year, up 22% compared to three years ago. Investors have injected $316bn in dividend-focused exchange-traded funds globally, nearly doubling their size over the same period. An analyst at Bank of America speculates that 2024 could be “a banner year for dividends”.
Why the shift? Daniel Peris of Federated Hermes, an investment house, and author of a new book, “The Ownership Dividend”, attributes the decrease in cash payments to decades of declining interest rates and Reagan-era adjustments to buy-back rules. As the risk-free rate declined, returns on bonds and savings diminished, and so did the advantages of holding cash. Inexpensive money enabled investors to channel capital into non-dividend-paying growth stocks.
During that era, writes Mr Peris, high-profile financiers began to perceive the dividend as the domain of “widows and orphans”. Only conservative companies, like banks and utilities, tended to prioritize them. Yet today’s economic environment appears different. Interest rates have risen. Startups without a path to profitability are struggling to win over investors. Additionally, the Biden administration has imposed a tax on buy-backs. It is currently modest, but officials hope it will increase.
Perhaps cash is once again paramount. Elevated interest rates imply that investors can allocate income. Many are enjoying respectable, risk-free returns in money-market funds. Higher risk-free rates also devalue the future earnings in today’s currency, indicating that some investors will prefer immediate cash over higher stock prices in the future.
A parallel assessment applies to management, whose options for utilizing cash have become more restricted. Heightened rates necessitate higher anticipated returns from long-term investments and discourage assuming debt to finance share repurchases. The Biden administration’s mistrust of corporate takeovers means that acquisitions are less feasible. Many firms are therefore deliberating the most effective means of returning funds to their shareholders.
Investors have reason to exercise caution, however. As economists contend, receiving a dividend is akin to withdrawing cash from an ATM—it does not make you wealthier. If a company were to reinvest its earnings rather than distribute a dividend, it should generate more income in the future and consequently deliver a higher share price. Consequently, investors should be equally content with either alternative.
A company that issues a dividend is indicating confidence in its future cash flows, since shareholders often assume dividends will be enduring and managers are unwilling to reduce them. Nonetheless, such a move also indicates that executives have no superior avenues for investing company funds, which augurs unfavorably for a firm’s expansion. Although high-yielding dividend stocks offer a dependable income stream, they are unlikely to remunerate owners with a noteworthy capital appreciation.■
Access more from Buttonwood, our columnist on financial markets:
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Investors may be getting the Federal Reserve wrong, again (Jan 24th)
Wall Street is praying firms will start going public again (Jan 18th)
Also: How the Buttonwood column got its name