There are only a few things in life that are pure lily and in which nothing negative can rightly be said about them. I’m not foolish enough to believe that dividends are the ultimate panacea. Join me today as the Don in Black and explore the dark side of dividends.
Here are the top five reasons for that Not pay a dividend:
- In the US and some other countries, dividends are taxed twice. Companies pay taxes on their profits. When dividends are paid to shareholders, they must also pay tax on those distributed profits.
- When a person pays tax on a dividend distribution, the future income associated with the tax is forever lost. Some would argue that capital gains are better for this reason, as the investor chooses when the tax is due.
- Companies in new and growing industries need every penny for future growth and therefore cannot afford to pay dividends. In fact, they usually spend stocks and debt to raise additional capital.
- If a company has old debts with a very high interest rate, it may be better to reduce the debt before embarking on a dividend program.
- It is putting pressure on management to maintain the dividend going forward.
Black is just not my color; I prefer my white hat. Here are my five answers to the above questions:
- It is true that dividends are taxed twice in some countries. Many governments, including the US, have recognized this and granted tax breaks to minimize double taxation. In the US, qualifying dividends are taxed at a reduced rate of 15%.
- It is true that if a person pays tax on a dividend distribution, the future income associated with the tax is forever lost. Ultimately, we need to convert our investments into cash through either dividends or capital gains. The consistency of dividends depends on the quality of the company we invested in, while capital gains are often at the mercy of the market (good companies are often penalized in a downward-looking market).
- It is true that companies in new and growing industries need every penny for future growth and therefore cannot afford to pay dividends. New businesses rarely qualify as a good dividend company. Come back to me when you’re grown and mature.
- It is true that a company with old debt with a very high interest rate may be better off reducing the debt before embarking on a dividend program. Again, this is likely a new or middle-aged company that isn’t mature enough to be a good dividend company.
- It is true that paying an ever-increasing dividend puts pressure on management to maintain the dividend going forward. Isn’t that why we shareholders are paying them the mega-money to generate value for us by running a superior company?
Dividend payouts, while not perfect, meet a very specific need for investors looking for a reliable and growing source of income. Not all dividend-paying companies are good dividend investments. Investors must do their due diligence before making a purchase.
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