Old World vs. New World Dividend Model

[Dividend Watcher]

I wondered aloud over in DividendDream's thread:

(04-28-2015, 10:01 AM)Kerim Wrote:

(04-27-2015, 11:24 PM)Dividend Watcher Wrote: I often wonder how/why the European companies evolved to only paying once or twice a year and often base it on a percentage of earnings whatever they may be. Maybe the better question is how did the North American companies end up paying quarterly for the most part and more seemed to be focussed on a consistently increasing dividend and let the payout ratio fluctuate. Alas, that's a philosophical question for another day.

Why not today?!

I sometimes think that the European model, if that's what we can call it, makes a lot more sense from a corporate perspective. I imagine it would free the company to focus more on the long term health and growth of the company. Paying a fixed amount, as opposed to a percentage, can put a lot of pressure on a company as earnings inevitably fluctuate. Of course this "American" approach has distinct advantages for us dividend growth investors -- it makes our ride much more smooth and predictable.

On the other hand, does it really make more sense? Some businesses look at expenses as fixed (meaning they have to pay them whether they sell 1 item or a million) versus variable (the costs vary by the quantity they expect to sell). So wouldn't a manager want to know that he has to pay the dividend regardless if the business is going up or down and factor that into their pricing calculations? Afterall, that's one of the bases for calculating prices in a lot of business models. Would certainly please the "owners" of the business to be consistent.

[Kerim]

(04-28-2015, 01:10 PM)Dividend Watcher Wrote: On the other hand, does it really make more sense? Some businesses look at expenses as fixed (meaning they have to pay them whether they sell 1 item or a million) versus variable (the costs vary by the quantity they expect to sell). So wouldn't a manager want to know that he has to pay the dividend regardless if the business is going up or down and factor that into their pricing calculations? Afterall, that's one of the bases for calculating prices in a lot of business models. Would certainly please the "owners" of the business to be consistent.

Thanks for taking the initiative to get this open as a new thread -- it is an interesting topic.

I think you make a good point about fixed vs. variable costs. But dividends are discretionary at the end of the day, only really subject to shareholder expectations and pressure. But if management looks at them as fixed, perhaps it provides stronger incentives to ensure sufficient profits to cover.

I guess I can see it either way. If dividends are a percentage of profits, perhaps there is more flexibility and weaker incentives; and if they are a fixed amount, there may be less flexibility and stronger incentives.

In any case, as a DG investor, I prefer knowing (for the most part) what I can expect every quarter.

[crimsonghost747]

(04-28-2015, 01:10 PM)Dividend Watcher Wrote: So wouldn't a manager want to know that he has to pay the dividend regardless if the business is going up or down and factor that into their pricing calculations?

The managers job is to make as much profit as possible. Whether that cash is going to dividends, share buybacks, future investments or is getting flushed down the toilet, this doesn't change the pricing model. The point of making the pricing calculations is to achieve a good balance of sales and margin, where that money goes afterwards doesn't matter.

But on to the real subject:
I do think the European way is much more logical, they make the profit that they can and out of that they throw X amount to shareholders based on the state the company is in. If they have more debt they might pay some of that instead of distributing the money etc. Or they might pay more dividends than usual because they simply can't find new investment opportunities right now. The American way is ofcourse lovely for us DGI investors but is it really healthy for the company? There are a lot of companies out there who are paying more than their EPS or more than their FCF in dividends, simply because they are expected to keep or raise the dividend year after year.

Take a look at PG for example. They had a bad year due to the strong dollar among other things. They are in the process of selling brands and restructuring their operations, I'm guessing a lot of that incoming cash will be used to pay down debt. Their payout ratio is starting to be high. Looking at this logically, was there ANY other reason to raise the dividend *right now* apart from keeping up with their dividend aristocrat status?

The only problem I have with the European model is the fact that many companies choose to wait until the end of the year before paying a dividend. I'm not sure how problematic it would be to use a similar model where dividends are within, say 40% and 60% of EPS but still pay out quarterly?

And yes it's a bit unstable which does make it slightly harder for us planning on one day living more or less only on dividend income. But as long as the company is making a stable profit the dividend will not change dramatically so the only thing needed (together with proper diversification ofcourse!) is a bit of caution.

[Dividend Watcher]

(04-28-2015, 01:45 PM)crimsonghost747 Wrote: The managers job is to make as much profit as possible. Whether that cash is going to dividends, share buybacks, future investments or is getting flushed down the toilet, this doesn't change the pricing model. The point of making the pricing calculations is to achieve a good balance of sales and margin, where that money goes afterwards doesn't matter.

crimsonhost, I think it's a matter of how we're looking at it.

Yes, a manager's job is to make as much money as possible and to do that many decisions are made; is it a 5.5oz chocolate bar vs. 6oz? Do we put 12oz of cereal in the box or 14oz? Do we run our high load machinery in the daytime or do we defer running those pumps/dryers/annealing furnaces/etc. until the off-peak hours in the middle of the night? Do we move the plant to China or keep it in a country/state that has a much higher cost of doing business.

Likewise, do we want the managers to be committed to paying the owners of the business (who put up at least part of the capital to help build the business) a fair share or do we say "screw them" when times get tough? It's a matter of priorities.

The fixed/variable expense model concept is really much more nuanced than a simple go/no go decision. There are many things included in each that can be put in either category or split between them depending on management's view.

(04-28-2015, 01:30 PM)Kerim Wrote: I think you make a good point about fixed vs. variable costs. But dividends are discretionary at the end of the day, only really subject to shareholder expectations and pressure. But if management looks at them as fixed, perhaps it provides stronger incentives to ensure sufficient profits to cover.

Yes, dividends are discretionary just like a lot of things they spend their money on. But I'm guessing that the executives in the DG50, the Dividend Champions & Challengers and the Dividend Aristocrats lean a lot more to the "dividends are part of our fixed expenses" mindset than something that's an afterthought. Kerim, you pointed to that and its result in your last sentence above.

I agree, the European model is much more logical looking at it from the company's perspective but I'm not looking at it from the company's perspective. Luckily, there are some European companies that seem to think higher of their shareholders than as an afterthought.

But I digress and don't want to argue about it.

I'm much more interested in how the practices came to be the way they are. Why, since the U.S. was much more of European descent when the industrial powerhouse was being initially built, is it that it's become common to pay a fixed or increasing dividend quarterly versus the European model? Or was it that way in Europe and something changed because of the Industrial Revolution, the War to End All Wars or WWII? So far, in my scant search, I haven't found an answer.

[Dividend Watcher]

I did some more Googling this morning trying to answer the question. Of course, still bombarded with recent history but I did find one unrelated nugget.

Quote:From the market bottom in 1982 to the peak in 2000, the S&P 500 increased by an astonishing annualized rate of 15% in nominal terms.

Yes, truly astonishing. That's an 18 year period at 15% growth and it included the 1987 crash. When things came crashing down in 2000-2001 I said to myself I'll never see that again in my lifetime. I think I may be right.

[rayray]

It doesn't matter to me as long as a company remains stable, can change with the times, and pays a dividend that grows as time marches forward.

Of course, market dips are a beautiful thing if utilized properly : )