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  • Writer's pictureIshfaaq Peerally


The stock market $SPX500 hits all time high with a few of the companies in our portfolio such as $AAPL and $JPM reaching ATH as well. The best performers, however, today are $GME and $SWKS .


I'm sure you are all aware that Warren Buffett owns many companies which are considered dividend aristocrats such as Coca Cola $KO , American Express $AXP and Wells Fargo $WFC but he invested in those companies a long time ago and they only became dividend aristocrats recently. Warren Buffett's Berkshire Hathaway $BRK.B itself doesn't pay dividends.

When Warren Buffett buys a company he wants it to be reinvesting its earnings in the company itself instead of paying dividends. Only, when it has no better use of the money, then it can pay him dividends. The number one thing a company can do with its cash is to reinvest in the business, number 2 is to buy other companies. For example, Apple $AAPL has been buying many companies recently. Number 3 is to buyback shares. Again Apple and even Berkshire Hathaway has been buying back shares. Only when there's still cash left that they should be paying dividends.

One of the reasons he doesn't like dividends is that it is taxed as income. There's a theory in economics part of The Modigliani–Miller theorem, called The Dividends Irrelevance Theory. According to this theory, in a perfect world where markets are efficient and taxes don't exist, companies retaining earnings and paying dividends make no difference. But we don't live in a perfect world, therefore, companies should not be paying dividends as they are taxable as income and shareholders also should not be expecting dividends. We all know that in practice, this never happens. Shareholders like dividends and there's even a premium on dividend paying stocks.

When more and more investors invest in those dividend aristocrats, what happens is that the price goes higher and the yield goes lower. Some companies will react by increasing their dividend payout. When they run out of cash, they issue debt to pay dividends just to maintain the same yield. One of the largest $oil companies in the world, Chevron $CVX has been doing this. Crown Castle International $CCI which is a REIT is supposed to have a dividend payout ratio of 90% but they rose it to over 200% in recent years.

One example of a company which could have made better use of its cash instead of paying dividends is BMW $BMW.DE . They have a yield of 5% and they pay about a third of their free cash flow as dividends. They could have invested that money instead in developing electric vehicles and compete with Tesla $TSLA . German, Japanese and British companies tend to pay much in dividends. Maybe that's why you don't see innovative companies such as Facebook $FB or Google $GOOG coming from those countries.

My favorite dividend stock is Apple. Last year, they had a free cash flow of $64 billion. It is hard to spend that amount of money. The only things they can do is buyback shares and pay dividends. They spent $72 billions in share repurchases(they already had over $200 billion in cash) and paid $13 billion in dividends. Apple currently has a dividend yield of 1.8% which is great. They can spend over $50 billion in dividends but it won't make much sense. Even in a bad year, Apple will be able to pay dividends without hurting the business.

Just because a company is a dividend aristocrats doesn't make it a great investment. Look at what happened to GE $GE . Always see if the company should pay that dividends and whether they can afford it and it is sustainable in the long-term. It also depends on which type of investor you are. If you don't have the time for research, you should definitely invest in dividend aristocrats as they are safer but if you have the time, you can do better research and look for bigger gains.

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