The most common argument from investors who aren’t interested in dividends is that the company should be able to find something better to do with its cash than give it back to shareholders. They believe that the funds should be used to grow the business either by investing in the business itself or by acquiring new ones.
But in reality this does not always work. Of course, a management team should grow the company’s business or acquire other companies, as long as it will add to long-term profitability and cash flow. But often, executives spend shareholders’ capital on ill-fated acquisitions because the money is there. Hoarding capital to potentially reinvest via an acquisition or some other use can lead to less-than-desirable habits. But if a company has a strict dividend policy and then management wants to make an acquisition, it usually must go to the capital markets for financing, which forces it to closely examine whether the transaction really makes sense.
Studies have also shown that companies that pay dividends have more reliable earnings than those that don’t. Douglas J. Skinner and Eugene F. Soltes, professors at the University of Chicago and Harvard University, respectively, concluded that earnings of dividend-paying firms are more persistent than those of other firms and that this relationship is remarkably stable over time. They also researched that dividend payers are less likely to report losses and those losses that they do report tend to be transitory losses driven by special items.
So non-dividend-paying companies may use their cash to acquire growth, but dividend-paying companies have stronger and more consistent earnings. And a vital rule of investing is that stock prices follow earnings. If earnings are better and more reliable for dividend-paying companies, that should mean dividend-paying companies’ stocks perform better.
Companies that have grown or initiated dividends have outperformed the general market by 170.6% over the past 45 years. Dividend stocks beat those that don’t pay dividends, and shareholders enjoy steady income payments additionally.