Another Good Article from Terry Smith on Dividends

As usual, there were some very perceptive comments from Terry Smith of Fundsmith on dividends and income funds in FT Money on Saturday (6/10/2018). Many investors want income – for example to finance spending in retirement – so they invest in high dividend paying stocks. Some simply think that reinvested dividends will enable them to grow their portfolio value but this is a poor result in reality. As Terry explains it would be better if the companies retained the earnings and reinvested them. The maths shows the negative impact of the tax you pay on the dividends.

Terry bemoans the fact that income funds outsell all other types by some margin, even though in reality many have only a yield that is slightly higher than the average. Needless to point out perhaps that the funds he runs are not income funds. But that does not destroy the wisdom of what he is saying.

All that matters is total return. If a company can reinvest the generated profits with a good return, there is no good reason to pay them out as dividends; as Warren Bufftet’s Berkshire Hathaway has never done with great results. Retained earnings compound even faster if no dividends are paid.

A personal investor can always sell a few shares to generate a cash income if necessary, and generally at a lower tax rate than they would pay on dividends.

Companies can usually find projects or acquisitions that can generate good returns. There are a few exceptions of course. Incompetent managements who pursue mirages or make disastrous acquisitions are examples, but those are the kinds of companies you should be selling not buying anyway.

Today the stock market is falling yet again, with growth stocks badly hit. There can be a tendency to hold on to those boring defensive and high-yielding stocks in a market rout. But that is a mistake. For the same reason you probably should not have bought them in the first place, don’t hold on to them. A yield of 4%, 5% or higher does not offset the risk of share price decline. Just consider when you are cleaning out your portfolio today to get rid of the duds that won’t be generating high and growing profits in the future. That’s all that matters.

Incidentally I had a letter published in the Financial Times today on the subject of Brexit, which was very kind of them as I effectively criticised their editorial policies. It was headlined “Please – no more letters from moaning Remainers” and was in response to two previous letters from clearly biased correspondents. You can find it on the FT web site.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Pay-outs from Labour’s Dividend Plans

I said in my last blog post that the Labour Party’s plans to take 10% of a company’s shares and pay the dividends into an employee trust did not make much sense. I have actually worked out what the implications of such a scheme would be on a few large UK public companies. These are the figures (after 10 years and assuming 10% of the total dividend is therefore paid to employees):

  • BP pays £6.15bn in dividends and has 74,000 employees: £8,310 per employee.
  • Shell pays $10.87bn in dividends and has 92,000 employees: £9,846 per employee.
  • M&S pays £304m in dividends and has 84,000 employees: £360 per employee.
  • Tesco pays £82m in dividends and has 448,000 employees: £18 per employee.

The latter two do of course have many part-time employees. How they might be treated is unknown so I have assumed they get an equal share. Tesco has also been paying a low dividend of late because of past financial difficulties but even if it returned to previous levels, the pay-out to each employee would be low – hardly sufficient to motivate them.

In the case of the oil companies where they have relatively few employees in a capital- intensive business, the pay-out would exceed the £500 cap in year one, so it would be mainly the Government that benefited.

This seems a perverse result to say the least. Are M&S and Tesco employees so much less worthy than BP and Shell employees? Whether an employee got any worthwhile share of the dividends would much depend on the kind of company they worked for.

Another odd result is that the Government would collect a lot more in tax (the amount above the £500 cap) from capital intensive companies than from those with lots of employees.

The more one looks at this, the more perverse this scheme turns out to be.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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