What’s Wrong with Dell Paying a Dividend?
Larry is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Bravo to Dell (NASDAQ: DELL) for starting to pay a dividend. Last month, the company announced it will begin paying 8 cents per quarter to investors, resulting in a current yield of 2.6%. Dell’s a bit late to the party, but good for it. Some, though, think this is a bad idea. They are wrong.
Critics prefer Dell to funnel its money mainly toward growth initiatives, more acquisitions and more research and development. Their argument: Dell needs to focus resources on shifting out of its strong dependence on the low-margin personal computing business. In the first quarter, Dell’s net income dropped by a third.
But Dell can afford to both reward shareholders and expand into promising new business areas. Over the past four quarters, in a difficult operating environment, Dell generated $4.9 billion in cash flow from operations. Combined with share repurchases, Dell now plans to return between 20% and 35% of free cash flow to shareholders. It joins other tech firms like Microsoft (NASDAQ: MSFT) and Cisco (NASDAQ: CSCO) that, after long resisting the idea, instituted payouts. Microsoft began offering dividends in 2003; its payout now yields 2.7%. Cisco joined the dividend party in May 2011 and yields 2%.
In short, with current cash generating abilities and over $17 billion in cash and investments on its balance sheet, the company is not lacking for R&D and acquisition dollars. Recently, the company struck a $2.4 billion deal to buy Quest Software (NASDAQ: QSFT), which gets Dell more into the high-margin enterprise development market.
Indeed, to suggest that a payout is inappropriate is irrational. When Dell chief Michael Dell announced the dividend, CNBC worried about a dividend bubble. I have difficulty conceiving how a dividend bubble is even possible. It’s akin to saying that there’s too much charitable giving going on, or too many happy people in the world.
Investors don’t purchase common stocks to paper our walls with ornate certificates. Or to gloat about our ownership of a company. Or for what the company has done in the past. We purchase common stocks because we expect to be rewarded by the company now and in the future. Market appreciation can be part of our investment return, but that is a reflection of the anticipated rewards down the road – not a way in which companies reward shareholders.
There are only two ways companies can reward shareholders: 1) pay a divided, and 2) buy back shares. While both these methods are legitimate, dividends convey a confidence in rewards-to-come that share buybacks don’t. Once instituted, a dividend is very difficult to pull back, and companies realize this.
Moreover, as I’ve noted numerous times, large-cap stocks are different. It’s dangerous to own a large-capitalization stock with a very large implied forward growth rate. Similarly, it’s perplexing when one owns a mature large-cap, with a strong balance sheet and strong free cash flow… yet is reluctant to reward shareholders. So kudos to Dell’s adding a reward for shareholders. My only question is: What took them so long?
Thomas Villalta, CFA, is president and chief investment officer at Jones Villalta Asset Management LLC in Austin, Texas. His blog is http://www.largecapguy.com/. Their firm holds long positions in Dell.
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