Matt Yglesias trolls business readers with a piece headlined, “Dividends Are Evil: They’re a triumph of short-term thinking and do nothing for the economy.”
I’m all for companies investing more of their profits back into their firms, but dividends aren’t “evil,” particularly when compared to share buybacks.
Under the circumstances, it’s worth being very clear: When firms pay dividends, nobody is returning anyone’s money. It is true that at some point in the distant past these firms raised money in an initial public offering, and that some companies even actually do use IPO money to finance growth and investment—although recent high-profile IPOs, such as Facebook’s and Twitter’s, are really more about letting early employees cash out and get rich. But General Electric was a founding member of the Dow Jones industrial average back in 1896. Anyone whose equity investment in GE helped build the firm died a long time ago. Shareholders in large, publicly traded firms got their stock by buying it from other shareholders. That’s the whole point of becoming a publicly listed firm—so your shares can trade in a deep and liquid market.
In other words, if you buy a GE stove, then GE gets your money. If you buy shares in GE, then GE doesn’t get anything. If your stove is defective and you get a refund, that is returning money to customers. If GE has cash lying around and hands it out to shareholders, that’s not returning money to customers—that’s a windfall.
This is all kinds of wrong. Yglesias would have you believe that companies get a one-time capital boost when they go public and then the company gets no benefit from its stock thereafter.
But companies raise capital all the time by selling new shares. General Electric didn’t go public more than a century ago with 10.1 billion shares. It has issued new stock many times over the decades. In 2008, for instance, it issued some $15 billion in new common and preferred shares to make it through the crisis. If you bought those shares in GE, then GE got everything, and I’m guessing that most of the folks who bought them are still alive.
So-called follow-on stock issues are a big source of capital—far bigger than IPOs, though they get almost none of the press. In the last five years, already-public companies have raised about five times more capital than IPOs have.
Companies can also use their shares as currency, by using them to purchase other companies or to pay employees.
If you buy GE shares from, say, your neighbor, it’s true that your neighbor gets the cash, not GE. But GE does get something very valuable, particularly if you make a profit: Support for the price of its shares, which makes its “currency” worth more and which allows it to sell new shares at a higher price.
The dividends and buybacks question is at least somewhat debatable, though I’d say Yglesias has got it backwards. Certainly dividends aren’t “evil” compared to buybacks. Dividends are one of the fundamental reasons why investors buy stocks at all—even if they themselves don’t know it. After all, if companies didn’t pay dividends, the only way to unlock its value for investors would be to sell itself. Nobody wants one-ten-billionth of a lightbulb plant just for the sake of owning it. Shareholders want asset appreciation and income from it—or at least the prospect of income.
Think of a private company. A widget-company owner isn’t going to reinvest all his profits in perpetuity. New businesses tend to re-invest more of their profits at first, because they tend to have more growth opportunities. With size, though, growth slows, and owners take more of the cash. Much of the point of owning a company is to produce income.
Share buybacks, on the other hand, are good if the company has a lot of extra cash and buys its shares when they’re cheap. All too often, that doesn’t happen. Management uses this financial-engineering tool to enrich themselves and to artificially goose share prices.
Dividends are harder to manipulate, and shareholders get income, which has accounted for more than a third of the real return of the S&P 500 over the last 85 years.
Yglesias calls dividends “a barbarous relic of a less financially sophisticated era.” If we’ve learned anything over the last six years, it’s that we could use a few more barbarous relics and a little less financial sophistication.