Don't be fooled by quick money
If there's one thing company directors should do more often, apart from taking a pay cut, is to cut the pay of shareholders. Yes, I'm calling for lower and fewer dividend cheques.
With interest rates falling as the economy slows, companies are yet again responding to shareholder demands to increase dividends. In my view, it's insanity.
In the US, companies are chastised for diluting shareholders with capital raisings, but down under, management will do almost anything to preserve dividends, including raising capital at the drop of a hat.
Short-term decisions to appease shareholders that aren't in the long-term interests of the business are 10-a-penny, and go almost unremarked. That could place the companies in which you invest at greater risk.
Pokie manufacturer Aristocrat Leisure was producing so much cash before 2007 that share buybacks and dividends became excessive. But when the boom turned to bust, the company's wasted research and development expenditure was exposed and earnings crumbled. You can guess what happened next.
The company was forced to raise $200 million, then, just over a year later, it paid damages of US$212 million in regard to a past bond issue. Right now the share price rests more than 75 per cent below its record high in 2007. Still, what about those juicy dividends, eh?
You can see the problem. Shareholders would have been far better off had the company avoided the buybacks and huge dividends, and kept something in the tank for a rainy day. Just ask investors in the listed property trusts that lost far more than they banked in dividends when the sector collapsed during the global financial crisis.
While most ASX-listed company directors get the arguments for not paying out too much cash, many seem too weak to do it.
Metcash went through a similar experience, paying out virtually all its profits as fully franked dividends. But under pressure from the Coles/Woolies price war last year, management announced a highly discounted capital raising.
What's the point of raising capital at a discount, diluting the value of the business, and then paying part of the proceeds straight back out as dividends? The only beneficiaries are the investment bankers and, really, does anybody want to give that lot more money?
QBE falls into the same category and even the banks are getting in on the act. Right now, they're considering distributing more of their profits as special dividends despite bad debt provisions being at or near record lows.
And yet the economy is slowing and the cracks in China's economy and (shadow) financial system are more obvious than ever. This is the time to accumulate cash, not pay it into the pockets of management and shareholders who can't see past the next dividend cheque.
Paying too much in dividends to shareholders and then waiting until the share price is in the toilet to raise capital, as many companies did during the global financial crisis, is dreadful capital management.
While companies such as ResMed should be considering shareholder-friendly moves because it has more than US$600 million of net cash, there are scores of companies boosting dividend payments at a time when their businesses are potentially about to face their biggest test for a long, long time.
Surely it's better to do that from a position of strength, when ready access to cash could allow them to take advantage of incredible opportunities to set the business up for decades. But no, munificent board members have to satiate the thirst of the yield hunter.
This appears to be the attitude of too many companies: avoid the tough decisions and only consider the short term because, when trouble hits, we can reach for the hat.
Shareholders deserve better and companies must be prepared to explain why it's not in their interests to pay out too much in capital. It's not as if there's a lack of evidence of the damage that too little capital can do to a business.
So, corporate Australia, find your backbone: make the case for hanging on to capital and if shareholders desert you, you'll find people like me will come flocking to replace them. Businesses should be run for the long-term interests of shareholders, not those who are only hanging around for the next dividend cheque.
This article contains general investment advice only (under AFSL 282288).
Nathan Bell is the research director at Intelligent Investor Share Advisor.