Dividends and Investors (Part 1)

Why do companies pay dividends?

It’s a good question. After all, dividends reduce management’s flexibility. The company can’t use the money it pays out to invest in research and development or other important internal items. Indeed, a Presidential Commission identified dividends paid as a major way US companies differ from firms elsewhere in the world.

Also, dividends are taxed twice. Companies pay corporate taxes on their earnings, then pay dividends out of earnings. Investors then have to pay income taxes on those same dividends when they receive them. So dividends aren’t very tax-efficient.

But dividends are an admission by the company that the ultimate owners aren’t the managers, they’re the shareholders. Paying dividends gives the owners the option to put the money back into the firm or to do something else with the money. It gives investors more choices. It also eliminates the opportunity for management to do something stupid with that money.

Dividends are totally transparent. Of the many items in a corporation’s financial statements, dividends are the one number that can’t be fudged. Since management is usually highly reluctant to cut them except in extreme situations, they often indicate financial strength as well.

Dividends are a good indicator of a company’s commitment to its current shareholders, in spite of the tax code. It’s no wonder that companies with big, safe dividends often perform quite well.

Douglas R. Tengdin, CFA
Chief Investment Officer
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By | 2014-09-05T19:36:30+00:00 June 29th, 2010|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. –
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