Are Dividends making a Comeback?

What do Facebook (Meta), Google (Alphabet) and Salesforce have in common?

Apart from being tech companies and a few other things, they announced their first ever dividend this year.

Dividends are back! Investors rejoice

Or at least dividends are growing in popularity in Silicon Valley.

Why is this newsworthy?

Well, here's a brief history.

There are 3 key benefits of being a shareholder of any (public) company

1. Voting rights: You get to vote each year at the Annual General Meeting to directly or indirectly influence how the company will operate
2. Dividends: As a reward for contributing your capital to the company to pursue its business, you get to share in the profits of the company in the form of dividends
3. Capital appreciation: If the share price of the company gets to a price higher than what you bought, you can sell it at a gain

Dividends used to be a key reason to own shares (and they still are in Europe and Australia). A century ago, it was normal for US companies to pay 6% dividend yields each year. In fact, in the 1st quarter of 1938, the S&P 500's dividend yield was as high as 9.2%! Even IPOs paid dividends back then!

But over the years, dividend paying stocks grew fewer each year in the US and became synonymous with low growth, old economy stocks for old people.

However, this wasn't too bad a deal because some companies who didn't pay dividends rewarded shareholders handsomely in the form of capital appreciation.

E.g. Amazon has never paid a dividend. Since its IPO, the share price has risen over 200,000%. This works out to over 7,000% each year over 27 years in capital appreciation. The highest dividend yield in the world today doesn't come close!

In summary, dividends went out of fashion and shareholders didn't whinge about it because they got their fix elsewhere.

Why did companies stop paying dividends?

Taxes

One reason could be companies had to think about the most tax efficient way to return money to shareholders.

Dividend income tax can be higher than long term capital gains tax.

Also, you only have to pay capital gains tax when you sell shares. If you don't sell any shares, you don't have to pay taxes on any profits you make on them. This gives shareholders flexibility to sell shares when its most tax beneficial.

As more founders continued to stay with their companies for longer e.g. Jeff Bezos (Amazon), Mark Zuckerberg (Facebook) etc., perhaps they realized it was better to keep reinvesting for tax purposes.

Australia, for example, is a big dividend market because of something called "franking credits". These credits can be used to reduce the taxes you'd have paid on your dividend income. International shareholders don't benefit from franking credits though, so this is an incentive for locals.

On the ASX, it is unusual for any profitable company to refrain from paying dividends. The unique system of franking encourages companies to pay dividends far more than in other countries.

It could also be growth.

Growth

In pursuit of high growth, tech companies convinced shareholders that they must continue to invest every dollar of profit back into the business or spend every dollar of revenue (make no profit) to maximize shareholder value.

The management team (CEO) usually determines when to pay a dividend. To make this decision, there's 1 key question they have to answer

Who has the best chance of maximizing shareholder value?

The company or the shareholder?

Would company profits be better spent with the company? Which means, can the company invest the profits to make greater returns in the future?

Or would it be better spent by the shareholder? Is the CEO unable to find better ways to invest the profits? If not, they can pass on the responsibility for figuring out better ways to deploy that capital to the shareholders by paying it back to them as dividends.

Also, even if the CEO decides to return the cash to shareholders, they also have to decide what's the best way to do so.

Should they buy shares (share buyback) or pay dividends?

Tech companies often choose buybacks for tax reasons, and possibly to juice share prices so the CEO can get monster bonuses. But a share buyback really rewards share sellers not shareholders (leave a comment if you'd like me to expand on this point).

Sometimes, the answer can be do both; pay a dividend AND buyback some shares. That's what Google did. I guess that way you reward both shareholders and share sellers.

Anyways, the bigger question that beginner investors should be thinking about is:

Is the era of high growth tech over?

Does this shift to dividends signal that these CEOs of some of the most valuable technology companies in the world signal that perhaps, they can no longer find high growth opportunities to invest shareholder money in? Has the music stopped? Is the fun over?

When Microsoft paid its first dividend in 2003 people asked a similar question. Well, back then, the stock was trading at $24. Last I checked, Microsoft is trading at close to $413.

So, dividends and growth can go together.

But if dividends and growth could go together, why don't more tech companies pay dividends?

Well, some tech companies pay dividends: e.g. Apple, Nvidia (in the past).

Also, Microsoft is in a class of its own. Maybe they don't need as much cash to achieve the growth they have done so far.

Put differently, perhaps if Microsoft kept all the dividends they paid to shareholders all these years, maybe the share price wouldn't be that much higher. In that case, the money was better spent paying dividends.

We're living in interesting times. Investors can get income from high growth tech. Investors can walk and chew gum.

Final Thoughts

A bigger question, I think, is what could this be saying about their outlook for the next decade?

Could we be entering a period of economic "stagflation" as has been thrown around by economists? Stagflation caused by artificially created inefficiencies such as deglobalization, reduction of global peace, etc. Do these companies think growth will be harder in the next decade?

Has the new economy (tech) become the old economy (banks, mining)? If yes, what is the new NEW economy? AI? Web 4.0? Blockchain? Maybe something else cos these "previously high growth" tech companies are still investing in those spaces.

Or could this be something else? What are your theories?

With Alphabet announcing its first dividend, this leaves Amazon as the only trillion-dollar company that's yet to pay a dividend. Maybe Amazon will pay a dividend this year (or next or never) and then we'd know that dividends are truly making a comeback.

More dividend comebacks:

Gatwick airport plans to pay its owners a dividend for the first time in five years, making the UK’s second-largest airport one of the first in Europe to reinstate shareholder payouts since the pandemic. London’s Heathrow airport and Manchester Airports Group, which owns 3 UK airports, have not yet said when dividends will restart.