Michael Formuziewich

Leon Frazer is a single style dividend growth manager. We have followed this investment discipline for over 70 years. Below are some reasons why we invest in dividend paying companies: (Part 1)

1.  Paying a regular quarterly or monthly dividend is a choice made by the board of directors of a company, with input from the management of that company. There is no law which states that once a company starts paying a dividend that it must continue to pay a dividend forever. A dividend can be cut or eliminated at any time, for any reason by any company which currently pays a dividend. A dividend then, is a signal from management that the company has a competitive advantage which allows them to earn a profit. Not just a profit in one year, but this signal is telling investors that management believes they can earn a profit on a long-term basis.

2.  A dividend increase is an even stronger signal than just paying a dividend. If a regular dividend payment is a signal that the management of a company has an ongoing competitive advantage then a dividend increase is a signal that management expects their current advantage (and therefore profit) to increase or get larger in the future. Note that a company could increase their dividend by paying out more of their profits; this is known as an increase in the dividend payout ratio. Although we like dividend increases, we much prefer increases that are backed by increasing earnings and cash flow because a healthy company should be able to increase earnings and cash flow for a long time whereas increases in the dividend payout ratio can’t continue forever.

3.  In a growing industry, companies will have a suite of potential projects they can spend money on. Some will be necessary to maintain their existing assets and to ensure they can continue to operate in a profitable manner (often called maintenance capital expenditures). Others could be labeled as growth projects – those ones that should help the company become more profitable in the future (often called growth capital expenditures). Obviously, a company that pays dividends will have less money to spend on growth than a company that doesn’t pay dividends, all other things being equal. The management of a dividend paying company will then have to spend more time deciding which growth projects to invest in. Projects that may be marginal will be more likely to cancelled or delayed in favour of the existing dividend. The end result? It has been our experience that management teams of dividend paying companies are very good at allocating capital to higher return projects and avoiding many of the more marginal and riskier projects.

For Part 2 Click Here

 

 

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