Do dividends create shareholder value?
The famous Miller-Modigliani theory argues that, in a perfect world, they don’t. Quite the opposite, it says, since every dollar so spent is a dollar the company should have invested into itself.
As such, this line of reasoning goes, dividend-paying companies aren’t just cheating themselves. They’re cheating their investors as well in the end.
Here at Wide Moat Daily, we know better than that. Though sometimes, I’ll admit, we take it for granted that everyone understands why we’re right and Miller-Modigliani is wrong.
So let me introduce you to one of the most thought-provoking essays I’ve ever read about dividend value: financial economist Fisher Black’s “The Dividend Puzzle.” Decades old though it is, it remains as relevant as ever.
Black began his evaluation with the observation that “the harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together.”
That’s because, while critics are right in theory that shareholder payouts detract from companies’ coffers, they’re often very wrong in practice. As Black explained, the reality is much more complicated than a mere 1 – 1 = 0 equation.
Those complications can create significant profits for everyone involved, especially in the three specific situations I reveal below.
The dividend-paying reality
As with any other business structure, dividend setups are built on, around, and by a whole host of factors. There are cash flow needs to consider, capital allocation, emotions, inflation, and taxes that influence the outcome, just to name a few aspects.
And these influences can all come together to work out very well.
On the corporate side of the equation, paying shareholders directly can keep management in check from reckless spending. That’s something Michael Jensen, one of the most influential economists and finance professors of the past 50 years, argued in his landmark 1986 paper, “Agency costs of free cash flow, corporate finance, and takeovers.”
“Companies with excess cash are prone to empire building,” he noted. “Managers may pursue acquisitions, unnecessary expansion, or low-return projects simply because they control the capital.”
Dividends and share buybacks, on the other hand, force management to justify future capital needs to investors.
Jensen and Black weren’t alone in this thinking. In 1984, Frank Easterbrook also made the case that dividend-paying companies have to rely on capital markets more often. And that makes investors more likely to demand leadership accountability.
This setup also signals more reliable levels of strength to shareholders of all shapes and sizes, from individual retirees to institutions. A business that can give away chunks of money and still grow its earnings year after year is automatically attractive.
As such, more money flows into the company that is re-investable. That influx then goes toward growing the business, which often means greater payouts for shareholders, which attracts even more shareholder activity.
It’s a big, beautiful cycle that benefits everyone involved when done right.
The monthly-paying dividend boost
That dividend-induced cycle can benefit everyone even more when dividends are paid monthly instead of the normal quarterly model.
From shareholders’ perspective, they’re paying their mortgages, utility bills, insurance, and credit cards on a monthly basis. So receiving extra income on a monthly basis as well can make budgeting much easier.
It also makes reinvestment plans more productive for pre-retirees who choose that route. They might be getting the same exact amount annually, but buying up more shares more times per year can add up meaningfully over a decade or more.
Once again, that appeal can attract more investor attention, not less.
So, no, dividends don’t leave well-positioned, well-managed companies worse off. And their shareholders aren’t ultimately suffering for the cash they receive.
Just keep in mind those two hyphenated terms: “well-positioned” and “well-managed.” Because, again, we live in the real world, not a theoretical model where everything is ultimately predictable.
We should never buy into a company just because it pays dividends, even if they’re monthly. Those dividends have to make balance-sheet sense.
That’s why investors should always consider a business’ level of quality first. Shareholder payouts mean nothing if they’re not supported by competitive advantages and attractive long-term growth prospects.
And even if that all adds up, there’s one more consideration still: valuation. If a company isn’t attractively priced, you could lose money on it – or at least not make as much money on it – just the same as if it were poorly run.
But when we do find quality discounted dividend-paying companies, it can make quite the difference to our portfolios over the long term…
Especially when those dividend-paying companies operate on monthly models.
1. Realty Income: The Monthly Dividend Company
When it comes to monthly dividends, Realty Income (O) stands out – and not just because it copyrighted the name “The monthly dividend company.”
This real estate investment trust (REIT) has built one of the world’s premier net-lease businesses, with more than 15,000 properties in its portfolio. Those buildings are then leased to a diversified list of investment-grade and service-oriented tenants across all 50 American states…
And a widening swath of Europe as well.
Realty Income’s conservative balance sheet and disciplined acquisition strategy are impressive. They’re the reason why management has been able to raise its dividend every year for more than three decades now.
This REIT really is the gold standard for dependable monthly income. And, as my regular readers know, it remains one of the highest-conviction SWAN (Sleep Well At Night) investments I’ve ever found.
2. Agree Realty: A blue-chip net-lease compounder
Agree Realty (ADC) is another excellent monthly-paying net-lease REIT choice. Over the years, it’s quietly but purposefully become a high-quality landlord worth paying attention to.
Led by CEO Joey Agree, the company owns freestanding properties leased to industry-leading retailers. Its tenants include powerhouse names like Walmart, Tractor Supply, TJX, Best Buy, and Home Depot.
Those businesses tend to be excellent tenants that never miss a beat when it comes to their rental obligations. But Agree Realty doesn’t take their consistent payments for granted; it also works hard toward establishing conservative underwriting and internally generated growth.
This combination naturally translates into consistent adjusted funds from operations (AFFO) expansion – which has helped it both raise its dividend consistently and establish an investment-grade balance sheet that gives it access to excellent outside financial support.
Investors looking for income and long-term capital appreciation would do well to consider Agree Realty for their portfolios.
3. Healthpeak Properties: monthly healthcare-helping income
Healthpeak Properties (DOC) taps into healthcare, one of the most durable kinds of real estate rentals available today. America’s aging population is in increasing need of medical care, from regular doctor’s visits to hip replacements to more serious interventions.
Following its merger with Physicians Realty Trust two years ago, this REIT has become a leading landlord for outpatient medical facilities, life-science campuses, and continuing-care retirement communities. Moreover, the tenants it signs on are all located in some of America’s strongest healthcare markets.
The result is a resilient portfolio that allows Healthpeak Properties to maintain its attractive monthly dividend. So this REIT is yet another compelling choice for those income-oriented investors in search of both stability and consistent growth.
The monthly dividend mindset
Fisher Black was spot on when he pointed out that the world is a lot more complicated than dividend critics want to believe. There are so many other factors to take into consideration, including (but not limited to) how:
- Inflation steadily erodes purchasing power.
- Easy access to too much money can go to business leaders’ heads.
- Retirees depend on reliable income.
- Most investors are drawn to the concept of safety.
All of that makes the dividend system realistically attractive – under the right conditions.
When dividends are distributed by exceptional businesses that work hard to generate abundant free cash flow, that’s when I take notice. And when those businesses go above and beyond by paying monthly dividends…
It’s delicious icing on top of an already attractive cake.
Happy SWAN investing!
Brad Thomas
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Source: Wide Moat Research
