The Dividend Quality Feature

It's nice when there’s a jingle in your wallet. Best case, regularly and a little more each year. But why has the distribution of profits fallen out of favor in recent months?

The gap between dividend stocks and the overall market widened considerably in the coronavirus year of 2021. Dividend payers made a comeback in the difficult 2022 stock market year, only to fall behind again last year. 

Who actually pays dividends?

Successful business models generate positive cash flow. That means more money is left over from selling products and services than the company itself consumes. What can this surplus be used for?

1.    Investments in the company's own business model, for example purchasing new machines
2.    Company takeovers and other M&A activities (mergers & acquisitions)
3.    Debt reduction through loan repayments or redemption of outstanding bonds
4.    Share buybacks
5.    Dividend distributions

It is mainly established, large-capitalized companies that continually spoil their shareholders with dividends. Coca-Cola is a popular example. No wonder - the dividend has increased year after year without interruption since 1963. 

Not synonymous with success

During coronavirus times, there were major differences between individual business models and sectors. Major oil companies cut their dividends; Royal Dutch Shell even did so for the first time in over 70 years. The situation was completely different for the digitalization winners: most were not yet profitable and therefore did not pay dividends. Investors exclusively chasing dividends back then were foregoing investments in promising companies. 

The pros and cons of dividends

From Gutmann’s perspective, investing exclusively in dividend companies is not a good strategy. The argument of current income does not hold up. After all, what’s the real difference between receiving a dividend and selling shares if you need cash? In Austria, even the tax is the same. Capital gains such as dividends are subject to a 27.5 percent rate. Dividend payments can even be disadvantageous when foreign withholding tax comes into play. 

Moreover, the timing of dividend payments is not freely selectable. However, investors can decide on the timing and extent of share sales themselves. 

And yet there are good arguments for dividend stocks. Studies show that dividends are the most important part of stock market returns over time. 

Only cash is king?

It's an open secret: Different accounting standards result in different profit figures. Company management can turn various dials - just think of creating and releasing reserves. However, companies paying out dividends must have the cash to do so. That’s why dividend payers tend to have better balance sheet quality on average and also fewer cases of fraud. 

In the Gutmann Chief Investment Office, we focus on excellent business models, regardless of whether they pay dividends or not. What counts is quality. However, now that the market has neglected dividend payers over the past 12 months, our countercyclical interest in searching for quality in the dividend universe is increasing.