Outlook: Time to look at dividends


Microsoft msft (nasdaq: msft) blew away Wall Street's earnings forecasts Monday, but didn't offer to share a penny of its rich skimmings with the shareholders who fund the company.

Microsoft's shareholders, of course, wouldn't have it any other way.

It's a conventional wisdom in the stock market these days that dividend pay-outs are a waste of money. After all, growth companies are much better off plowing their profit back into the company coffers to keep up the pace in earnings. If a company can afford to give away its money, why would you want to invest in it?

Microsoft leads a host of tech companies that keep all their profits to themselves, with their shareholders' blessing. Bill Gates' software titan reported net earnings of 40 cents per share for the quarter ended June 30, beating First Call's consensus forecast of 36 cents per share. The company continued to grow its balance sheet from top to bottom: Revenues rose 39% from the corresponding quarter last year, while earnings grew by an explosive 60%. But the company that leads America's technology revolution said it still wouldn't pay a dividend to its shareholders.

Microsoft has never paid dividends. Nor have most of the market's hottest tech companies, including America Online aol (nyse: aol), Dell Computer dell (nasdaq: dell) and Cisco Systems q (nasdaq: q). A few of the exceptions: 88-year old International Business Machines e (nyse: e), chipmaker Intel intc (nasdaq: intc) and Hewlett-Packard hwp (nyse: hwp).

Marshall Acuff, market strategist at Salomon Smith Barney, says Microsoft should be able to hold on to its profits for as long as the company can churn out strong bottom-line growth.

"Among the many factors that determine a company's dividend policy, its maturity is the most important. In a company's life cycle, growth is usually the greatest early on.

When growth slows, companies begin to pay dividends," Acuff explains.

As a company's earnings growth slows, its stock price will also appreciate at a slower pace. That's a warning sign to investors. In the end, it's typically the stock market that forces a company to pay dividends. Shareholders who see slower stock appreciation will demand to get something back for their money in the form of dividend payments.

In Microsoft's case, investors have already voted with their pocket books. If you had invested $1,000 in the Redmond, Wash.-based company a decade ago, you would be sitting on stock worth more than $130,000 today. If you sold your investment at such a mind-numbing profit, you probably wouldn't worry too much about Microsoft's unwillingness to pay dividends.

With the sharp gains in the stock market over the past few years, it may not be surprising that dividend payments are falling out of fashion on Wall Street. Most fund managers still focus narrowly on growth stocks, leaving value-style investors in the dust.

Moreover, dividend payments are taxable, and there are few things fund managers detest more than taxes.

As a result, fewer companies are raising their dividend payments, and the dividend ratio--the measure of dividends as a percent of earnings--is at the lowest level in history.

But with markets at a historic high, it may be time for investors to take a closer look at dividend payments. Remember: As soon as the market peaks, investors will see a lower return on their equity. And if the market drops before dividends are raised--a likely scenario, given Wall Street's prescience--the total return on investments will inevitably fall.

The good news is that some tech companies do pay dividends, albeit often at meager rates to earnings. Take Big Blue, for example. IBM also beat the market's expectations yesterday with earnings per share of 91 for the preceding quarter, compared with the consensus forecast of 88 cents per share.

Sure, IBM's growth pales against Microsoft's. But over the past year, IBM's stock has actually outpaced Microsoft's. Since last July, IBM's stock is up some 130%, compared with 76% for Microsoft. And Big Blue pays dividends.

Sometimes you can have it both ways, after all.