Dividends are particularly important to private shareholders, many of whom are retired and rely on their dividend income. The maintenance of a healthy and growing dividend is therefore important. Unfortunately, in recent years companies have tended to reduce the level of dividends, either preferring to retain profits within the company, issuing scrip dividends (ie. shares in lieu), or buying back shares instead (see here).
It has been argued that UK companies historically paid out too much in dividends, leaving insufficient to reinvest in the business, but there are several reasons why dividends are important. These are:
- The payment of a cash dividend ultimately demonstrates that the company is generating real cash profits. The lack of confidence in modern accounting is endemic, and profits can apparently be displayed, when the company clearly is not generating cash. If a company board has the confidence to pay a good, rising dividend, then it is a stronger indication of the real health of the business than any accounting profits.
- Historically a large proportion of the returns from equity investment have come from dividends. In real terms, the FTSE indices (which ignores the failed companies anyway), shows little growth over long periods of time, if reinvested dividends are ignored.
- Retaining dividends within the company is fine if the company can gain a better return on that investment than the individual shareholder could. But the directors do not know what return the shareholder can obtain, and the shareholder may prefer to make his own decision on whether to reinvest in the company or not. Often, retained profits are simply invested at a lower rate of return by injudicious expansion of the business, or worse, on a major acquisition to the aggrandisement of the directors but negative return to shareholders. An even worse situation is where a company retains cash but simply puts it on deposit when it has no foreseeable use for it, instead of returning it to shareholders - not an uncommon circumstance.
Dividend policy, or the lack of it, is therefore a major concern to UKSA members. UKSA would like to see more consistency and better guidelines on dividend policy for all companies.
