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Should I invest in companies that do not pay dividends?

By Angelique Ruzicka

13:19, 10 January 2022

Glass jar holding coins with the word Dividend
Dividends offer a way to build a regular passive income stream – Photo: Shutterstock

If you’re looking for an investment that offers stable income, then putting your money in companies that pay a regular dividend could be a good option.

Dividends are payments made by companies to shareholders in stock, cash or property. Some payments are made regularly. Others are special one-time events. Dividends come from profit and their form must be approved by the company’s shareholders.

The advantage of dividends is that they offer a great way of building a regular passive income stream.

Why do companies pay dividends?

There are two ways companies pay out dividends. They can give out cash from their earnings on a per-share basis, or they give out additional shares. This is what’s commonly referred to as a ‘scrip dividend’.

Dividend payments are generally aligned with company profit announcements. This means they could be paid quarterly, semi-annually, or annually. But generally, they can be made at any time.

Dividends come from a company’s free cash flow. There are various things that the board of directors can do with left over money including paying down debt, reinvesting into the business, buying another business, or letting the money accumulate.

However, many companies consider their shareholders. Generally, paying dividends to shareholders is a company’s way of thanking investors for their ongoing support.

Dividends can also be used as an incentive to encourage continued investment. “Some slow growth companies, like tobacco firms, are better off paying out dividends. Some high growth companies are betting off putting money back into the company or acquiring competitors,” explains Holmes Osborne, principal at Osborne Global Investors.

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Attractive for pensioners

Companies that offer regular dividend payments can be particularly enticing for retirees. “Investors often choose to invest in companies that have dividend policies consistent with their own goals and objectives. For instance, because retired individuals often need to supplement their income, they often have portfolios comprised of companies that pay out a large portion of their earnings as dividends,” says Robert Johnson, professor at Creighton University and CEO at Economic Index Associates.

Johnson adds: “Individuals who aren't looking to supplement current income, and are looking to minimise taxation, tend to invest in companies that don't pay dividends or pay minimal dividends. Firms generally adopt a certain dividend strategy – either a high-pay-out or low-pay-out strategy – and stick to it. They don't want to alienate their dividend clientele.”

To pay or not to pay

Not all companies pay dividends, but it would be foolish to ignore companies that don’t pay dividends. Here’s why.

Looking solely at whether a company pays a dividend tells you little about a company’s prospects. There are plenty of prominent companies that don’t pay dividends but are still very worthwhile investments, including Google parent Alphabet (Goog), billionaire Warren Buffett’s Berkshire Hathaway, and Amazon, the world's largest retailer outside China, to name but a few.

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“Google proves excellently how investing in expansion into new ventures provides shareholders excellent returns even without dividends. In the past five years, the price per share of Alphabet Inc rallied from $800 (£589.47) to its all-time highs of $3,037 in late 2021,” points out Alexander Voigt, founder and CEO at daytradingz.com.

Johnson adds: “Warren Buffett's Berkshire Hathaway has never paid a dividend since he took the helm of the company in 1965. And, over that period, investors in Berkshire Hathaway have earned a compound annual return in excess of 20%.

“As a long-time Berkshire Hathaway stockholder, I would rather Mr Buffett and his team take the Berkshire earnings and reinvest them instead of paying me a dividend that requires me to pay income taxes and also tasks me with reinvesting my after tax take.”

Why some companies don't pay dividends

There are many good reasons why a company won’t pay any dividends. Johnson says: “If a firm has attractive growth prospects and can reinvest earnings at high rates of return, it would be in the investors' best interests to not pay a dividend, retain those earnings and reinvest them.”

Alternatively, companies can choose to buy back (repurchase) stock. A firm will buy back stock when it has excess cash, and management believes the market undervalues the shares.

“Stock buybacks tend to bolster the stock price of the firm, because the percentage of the company that any individual stockholder owns effectively increases after a buyback. Buybacks are often preferred to cash dividends, because only the shareholders who want to sell the stock back will incur a tax liability,” says Johnson.

However, there are also many negative reasons why a company doesn’t pay a dividend, and this could alert investors that there’s something wrong with the business itself.

“The best way to establish if the company is not paying a dividend for the ‘right reasons’ is to look at its past growth history. If the company has managed to grow rapidly, then the cash it chose to reinvest in the business rather than pay out as dividends has likely been put to good use.

“If, on the other hand, the company has struggled to grow quickly, then the company’s management has not been putting its cash to good use. In that case, shareholders would likely be better off with a dividend,” points out Ben Reynolds, founder and CEO at Sure Dividend.

Of course, bad management coupled with a lack of any dividends could be a good indicator that it’s time to sell.

Read more: Stocks vs trusts: Which is best for dividend income?

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Berkshire Hathaway
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The difference between trading assets and CFDs
The main difference between CFD trading and trading assets, such as commodities and stocks, is that you don’t own the underlying asset when you trade on a CFD.
You can still benefit if the market moves in your favour, or make a loss if it moves against you. However, with traditional trading you enter a contract to exchange the legal ownership of the individual shares or the commodities for money, and you own this until you sell it again.
CFDs are leveraged products, which means that you only need to deposit a percentage of the full value of the CFD trade in order to open a position. But with traditional trading, you buy the assets for the full amount. In the UK, there is no stamp duty on CFD trading, but there is when you buy stocks, for example.
CFDs attract overnight costs to hold the trades (unless you use 1-1 leverage), which makes them more suited to short-term trading opportunities. Stocks and commodities are more normally bought and held for longer. You might also pay a broker commission or fees when buying and selling assets direct and you’d need somewhere to store them safely.
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