
Why tech companies never pay out their earnings as dividends - aditya
http://fiveyearstoolate.wordpress.com/2010/01/31/my-friend-who-hates-tech/
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BobbyH
There is a huge reason why tech firms don’t pay dividends: their employees
have stock options. Unfortunately, although dividends paid to shareholders
lower the share price, the strike price on employee options is not adjusted
for the lower share price caused by dividend payments. Thus, paying dividends
hurts the value of employee stock options, so tech firms that use options
NEVER pay dividends.

Also, in terms of returning retained earnings to investors, there is no
difference between a company paying dividends and a company repurchasing
shares (assuming the shares are fairly valued). Happily, though, when a
company repurchases shares, it doesn’t affect the strike price of stock
options. Thus, tech firms don’t pay dividends and they repurchase shares
instead. So in addition to the "dividend yield", we also need to add in all
the capital that Microsoft spent on share repurchases, which was $47.7B in the
fiscal year ending in June 2009
(<http://www.microsoft.com/msft/reports/ar09/10k_fr_fin.html>). That ain’t
nothing.

As an aside, Microsoft started paying dividends only after switching from
using employee stock options to using restricted stock (the value of which
isn’t affected by dividend payments).

These points aside, the author has a good point, which is that more tech firms
should do more to return retained earnings to shareholders (whether via share
repurchases or dividends).

~~~
jagjit
I disagree with the notion that dividends paid lower the share price. Is there
a theoretical reason? Or is it observed in practice? I would very much like to
learn more about this if you could send pointers.

To me this looks more like a device used by managements to justify their
practice of share repurchase. The options should be repriced not when
dividends are paid but rather when stock repurchase is done. Like you mention,
stock repurchase never affects the strike price of options. There is a very
informative comment on stock repurchases by Warren Buffet in this 2005 annual
report - <http://www.berkshirehathaway.com/2005arn/2005ar.pdf>

~~~
dpifke
Paying out cash on hand should reduce the share price, because money in the
bank is proportionally owned by the shareholders.

For an extreme example, imagine a hypothetical company with 1 billion shares
outstanding and $1B in the bank and no other business than earning interest on
its cash. With $1B in the bank, it should be valued at $1/share plus some
share of expected future interest payments. Pay out a $1/share dividend, and
the company is now worth $0.

~~~
dschobel
Huh? share price is determined by one thing and one thing only, market demand.

As twitter has shown, valuation does not need to correlate to any traditional
financial metric whatsoever. Twitter is worth 1 Bn becomes someone decided to
pay for a stake at that valuation. No other reason.

~~~
Super_Jambo
Sure, but the fundamental value of the share obviously goes down at the
instant the company pays out a dividend, so the expectation is that the
companies price will drop.

Since everyone expects it to happen it generally does.

~~~
dschobel
Except that dividends are announced well in advance so if the price did drop
automatically on the day the cash is paid out, it would be trivial to short
the position.

The fact is, there is nothing predictable in the stock market.

edit: as BobbyH points out, my point about shorting is mistaken but that does
not change the key point about unpredictability of the markets vis a vis
declaring a dividend.

~~~
andrew1
A good example of dividend behaviour can be seen in the 16th December dividend
from Sycamore Networks (see <http://www.google.com/finance?q=scmr>). This
dividend was announced on the 18th November (roughly a month before the
effective date). The share price doesn't change at that point, but on the
effective date it falls by $9.70, almost exactly the dividend amount of $10. I
chose this example as Sycamore gave out a quite ludicrous amount of cash
(something like 35% of the company value) so the price drop is very obvious.
Another unusual feature of the dividend is that the pay date is actually
before the effective date. The dividend is paid on the 15th December, even
though its the people who own the shares at the market open on the 16th who
qualify for the dividend. This comes about due to a rule that NASDAQ have that
if a distribution is greater than 25% of a company value, then the effective
date is set to be the day after the pay date.

I think that while there is a lot that is unpredictable about the stock
market, you can be fairly sure that on a dividend's effective date, the share
price will fall by roughly the amount of the dividend. It won't be exact due
to all the other factors which would affect a stock's price on any day, but it
will be roughly correct.

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rphlx
I agree with the basic argument, but for most of the 1980-2000 period it was
more tax efficient to return money to investors through long term capital
gains, rather than dividends. This situation will return next year if the Bush
tax plan expires.

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russell
The answer is very simple. Invest in companies that pay dividends, like
telcos, electrical utilities, steel mills, railroads and other giants of the
the 20th century. Note that you wont get any stock appreciation to speak of.
Tech companies that dont invest in new markets die when competitors make the
move. Apple might very well be dead if it tried to live of the Mac franchise.

Companies are allowed to keep their income so long as it is necessary for
their business. You might think that a mom and pop store would be allowed to
keep millions in cash, but since that kind of money isnt necessary for the
operation of the business the excess gets taxed at 80%. (My info is old so the
exact percentage may be out of date.) Large tech companies like Microsoft and
Intel pay nominal dividends to keep the Federales at by, not out of generosity
to their stockholders.

~~~
acgourley
"Tech companies that dont invest in new markets die when competitors make the
move."

He moves on to say that these tech giants usually end up dying anyway, so he
is suggesting they "die with dignity" or at least realize when they should
stop growing into new markets tangential to their core competency.

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jakarta
In theory yes, repurchasing shares should do just as well as paying out
dividends.

In practice, no.

Most companies are run by people who are utterly bad at allocating capital.
They will buy stock back when it is overvalued, when it is trading towards its
high because they feel on top of the world and unstoppable. They are almost
always making a grave mistake.

Share buybacks need to be used like Henry Singleton at Teledyne:

You buy back stock when it is trading towards its lows and likely undervalued.

You issue stock and use it as currency for acquisitions when it is trading
near highs so that you take advantage of its overvalued status in the market
place.

<http://en.wikipedia.org/wiki/Henry_Earl_Singleton>

Singleton showed how to properly allocate capital in tech and do it in a way
that enriches everyone. That's why most people today look to what he did at
Teledyne as models for best practices in capital allocation.

~~~
netcan
I'm always confused when I hear of any strategy that involves doing x when
share price is low and y when share price is high.

If you can know when shares are low or high, there are lots of ways of using
that information. The problem is knowing.

~~~
jakarta
If you are running a company, you should know when the price of your stock
disconnects from the actual fundamentals of your business.

~~~
sokoloff
Agreed, and I think it happens much more often than most people realize...

It's the disagreement on what something's worth that makes the market.

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elblanco
Really? I get my dividends just fine...

<http://www.google.com/finance?q=ibm>

<http://www.google.com/finance?q=microsoft>

<http://www.google.com/finance?q=sun>

<http://www.google.com/finance?q=oracle>

etc. etc. etc.

And their dividend payouts are about on par with my non-tech holdings also.

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breck
> His view is that there is no way to be a truly long-term investor in tech
> companies because management never allows companies to transition from
> growth companies to mature, income-oriented ones.

I'm not sure if this is true if you looked at the tech industry as a whole. I
think it is, but my view is biased from almost purely following GOOG, AAPL,
MSFT, etc.

But if it is true, it would be a good explanation as to why Warren Buffett
does not invest in tech companies.

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ghshephard
The argument seems sound to me, except that a company like Apple is such a
great counter example. In 1997, Michael Dell was famously quoted when asked
about what should be Done with Apple (a company that Steve Jobs had _just_
returned to)

"What would I do?" Mr. Dell said to an audience of several thousand
information technology managers. "I'd shut it down and give the money back to
the shareholders."

The rest, is as well all know, history - Apple became worth more than Dell in
2006, and today, is worth almost six times as much as Dell.

I'm pretty certain Apple investors are happy that Apple didn't start issuing
dividends and run the company on its (by then dying) Mac OS 8.x, but decided
to completely reinvent itself on NeXT OS (aka OS X).

An anecdote, but a useful one.

~~~
Xixi
I don't think the comparison is applicable here. In 1997 Apple was clearly not
in a position to transition from a growth-oriented company keeping it all for
investment, to a profit-oriented company paying back a large chunk of its
profit to shareholders. In 1997 Apple profits were minus 1 billion dollars.
Even if you factor out Next buyout (400 millions), that's still deep down in
the red. Not profits to distribute.

But that would definitely apply to 2010 Apple & Microsoft : should they
continue to look for growth at all cost, or start paying big (bigger)
dividends to shareholders? I lean toward investing... continue to try to
change the world, please. Even if lately Microsoft seems to be bad at it (but
are they really?), trying to follow the leaders instead of implementing a
vision, it doesn't mean it's too late...

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jagjit
The tech companies, by not paying out dividends, are in effect telling
shareholders that they can invest the profits better than them.

This belief I guess comes out in part due to the meteoric profit growth that
successful tech companies witness which leads to hubris in the management. The
other reason for this belief is the shareholders themselves who let management
invest profits in any project they want in the hope of ever increasing profits
and stock price.

About microsoft's dividends, one thing the article misses is that msft's
payout is very high but most of it is via stock repurchases. The reality is
that managements of all companies - tech or otherwise - concentrate on their
own interests. That is why you see companies spending so much on stock
repurchases rather than pure dividends. In theory it reduces the number of
shares - but in practice it is a device to prop up the stock price so stock
options or stock price linked benefits for employees and management are
profitable. Microsoft spends disproportionately higher on stock repurchases
compared to dividends. If they paid all that money as dividends, it would be a
very decent dividend paying company.

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tocomment
It would be interesting to take a poll of ms shareholders to see if a majority
want the dividend raised. It would be a great test to tell how broken
corporate governemxe really is.

~~~
ashishk
I think the issue is that often tech company founders / management have
preferred shares and therefore greater voting rights than general common stock
shareholders. So even if a large group of common shareholders wanted to see
dividends, they wouldn't have much authority.

I may be wrong though, I'm just starting to learn more about corporate
finance.

~~~
dschobel
This is true. Most companies are structured so that there exists a preferred
share class with greater voting rights so to pass anything you'd have to get
buy in from the board members who are the ones who typically own this share
class.

~~~
anamax
> Most companies are structured so that there exists a preferred share class
> with greater voting rights

"Most"? The press accounts around Google's IPO said that voting preferences
were somewhat rare. They mentioned some newspaper companies and Ford.

Do MS, Apple, or Cisco have voting preferences?

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ingenium
They probably do it because dividends are seen as somewhat obsolete, but firms
have to continue paying them because they set a precedent. They are small
because they have to be consistent or investors freak out, so the actual
earnings aren't distributed anyway. I'd personally rather not have dividends
for several reasons:

1\. the stock price should accurately reflect the earnings of the firm. When a
dividend is announced, the price of the stock decreases by the amount of the
dividend. If you want some of those earnings, then sell a share. There's no
need for the company to issue a dividend. This is a common misconception most
people have.

2\. You're taxed on the dividend payments (exceptions tax deferred retirement
accounts). This is annoying, especially if you don't want them now and would
rather have them just reinvested. Ignoring taxes, the value to the shareholder
is the same regardless of whether dividends are paid or not.

My professors in finance all go on long rants against paying dividends, and it
really does seem that they're antiquated. Most newer firms just don't pay
dividends, and tech companies just happen to be newer firms usually. It's not
necessary a property of just tech companies.

~~~
alanthonyc
"dividends are obsolete" sound to me like another form of "it's different this
time."

I don't believe that. The purpose of a company is to make money for its
owners. Dividends are payments to the owners of the money the company makes.

As far as capital gains goes, that is just a side-effect (albeit, a
potentially lucrative one).

~~~
ingenium
I fail to see your argument. The owners make money without receiving
dividends. It's reflected in the stock price. When a dividend is issued, the
stock price goes down by exactly that amount. It's the exact same thing. If
you want that money, sell the stock. My argument is that from a tax
perspective, it's more beneficial for the owners for the company to NOT pay
dividends. If you ignore taxes, they're identical.

Put another way: Company X's stock is $100/share. They issue a 50 cent
dividend. The stock price will go down to $99.50/share upon announcement. The
investors/owners still have $100 whether the dividend is issued or not, except
the investors have to pay taxes on that 50 cent dividend now instead of having
it re-invested.

~~~
dschobel
That's a very one-dimensional view of investing though. The Bogle (the founder
of Vanguard) school of investing says that investing in the hopes the price
will go up or down is nothing but speculation on the same level as investing
in commodities (a barrel of oil does not do anything, it just sits there and
is worth what the market says it is worth).

This traditional view holds that companies are fundamentally different than
barrels of oil, in that they can produce wealth and provide reasonable returns
to their share-holders year after year and that you can take your 7%
appreciation at the rate the economy grows (or at least used to).

Timing the market is certainly a valid (if highly risky) strategy, but it's
only one view of investing. It's only in this strategy which dividends don't
make sense.

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richardburton
I don't feel this an explanation of why they hold on to the cash. More an
explanation of why even large tech companies are perhaps not the best long-
term investments.

~~~
kelnos
Yeah, that was my first thought as well. Better article title might be "Why
Tech Companies Suck for Not Paying Out Dividends."

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macco
Intel pays me dividends

~~~
timr
You're ignoring the point. Intel pays crap dividends for a company of its size
and profit margins.

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tocomment
How and why do sites like this one disable zooming on the iPhone? It really
grinds my gears!

