Are Dividends Overrated?

Following a question about why an individual should want to own shares in a company that doesn’t pay dividends, Emptyend produced a thought provoking response .

His reasons were as follows:

a) expectation [well-founded to date] of growth, leading to capital gains
b) potential for a company selling itself, creating a capital gain
c) not as much need for a company to pay underwriters to sell new shares because it has retained it earnings to fund its investment programme
d) my investment is completely tax-free and charge-free inside an ISA, so there is no leakage of my entitlement to a share of the company’s earnings

He then went on to say:

I take the view that if a company is worth investing in then I should be happy to have the earnings rolled up and save on admin and underwriting costs, rather than paid out in dividends. And if/when the company is sold on to new owners, it will be up to them whether they continue to reinvest in the business by retaining all their earnings, or whether they pay it out to shareholders in dividends, share buybacks etc…….

And continued:

……but I can’t see why it should be automatically considered attractive to invest in a company that is continually weakening its financial position by paying dividends out to shareholders. It is, IMO, a tacit admission that growth opportunities are limited. And it is also dangerous for shareholders to come to rely on a dividend stream that can potentially be withdrawn or slashed at the whim of the board!

Note: emphasis added by me.

This is interesting to me as, following my reading of books by Dremen, Siegel and the boards at UK Fool, I’ve long been of the opinion that a high yield, value approach was the one to take.

Emptyend has consistantly proved correct in calling how the current crisis will play out and he does not paint a rosy picture for shares in general, instead favouring asset backed Oil EPs valued at or below their NAVs. It’s worth noting that there are values on their assets not on their income which often gives them high PE ratios.

What has interested me here is that I have been considering a move abroad, where dividends are not taxed as generously as in the UK and as such it may be more tax efficient for me to consider such companies instead of concentrating on a HYP type approach. I’m not saying I’m going to invest in High PE growth stocks, but rather not make yield my main indicator of value.

I am still in the process of evaluating how I am going to proceed, but as Emptyend points out companies such as Oil EPs could do well in during the current turbulent times via step changes to the NAVs (ie finding Oil) which would result in re-rating of their prices.