Why do UK companies pay high dividends?

Notepad_Phil

Eco_Miser said:

Malthusian said:

Eco_Miser said:

UK investors like a steady income. Certainly those who are (partially) living off that income do.

The alternatives of selling shares as needed, or taking part in share buybacks result in having less shares, and therefore less future income.

The first part is potentially true as part of the cultural explanation of why UK dividends are higher than in other stockmarkets.

The second part isn't. Selling shares does result in less future income but only to the exact same extent as a company paying dividends. If you own £1,000 worth of a company and it pays you a £40 dividend instead of reinvesting it in the business, it has exactly the same effect on your future income as if it had reinvested the dividend but you'd then sold £40 worth of shares (either to the company in a share buyback or a third party). If the dividend next year is 4% you forfeited £1.60 of future income either way.

A dividend is just a company moving some money you already own from a bank account you already own into a different bank account you already own.

Consider two very similar companies, both make an annual profit of 4%, every year for a long enough time with zero inflation (to keep the maths simple).

Company A pays a 4% dividend, company B reinvests its profits, to continue making a 4% profit on its increased valuation.

Every year you get £40 from company A, and still have £1000 of shares.

Every year you sell £40 worth of company B, because of that £1.60 that you didn't earn, but take anyway, you now have less than £1000 worth of shares, and each year that deficit compounds, meaning you run out of shares after 78 years. Alternatively, you can leave the £1.60 invested, and take less income.

The 78 years is for a 4% growth, it drops to 33 years for 8% and 24 years for 10%.

The two situations are not equivalent in the long term.

But all things being equal wouldn't the share price of company B be more likely to rise more than company A to reflect the additional reinvested profit. i.e. you'd have £1040 worth of stock at the end of the year in company B so selling £40 means you'd still have £1000 as with just taking the dividend.

masonic

Eco_Miser said:

Every year you get £40 from company A, and still have £1000 of shares.

On the ex-dividend date, company A's shares will fall in value to £960. All other things being equal, the number of shares you hold in company A vs company B will differ at the end of the year, but their value will not.

You can think of Acc vs Inc unit classes in collective investments to be a special case of this, where all other things really are equal, and in one case the fund's income is distributed, and in the other it is reinvested.

Where there is a difference is that you will probably incur costs to sell shares in a company, but not to receive a dividend. Conversely, it may cost you to reinvest a dividend, but not to hold a non-dividend paying share.

Eco_Miser

masonic said:

Eco_Miser said:

Every year you get £40 from company A, and still have £1000 of shares.

On the ex-dividend date, company A's shares will fall in value to £960. All other things being equal, the number of shares you hold in company A vs company B will differ at the end of the year, but their value will not.

Except the value will have risen over the year to £1040, so on ex-div day, it falls back to £1000.

Selling shares in company B also reduces your holding back to £1000, give or take the error introduced by only being able to sell whole shares. As the shares grow in value over the years, this error also grows, and gets ridiculous when the price of a share is greater than the amount you want to take out. At some point you will have to sell your final share, just to get your income.

masonic said:

You can think of Acc vs Inc unit classes in collective investments to be a special case of this, where all other things really are equal, and in one case the fund's income is distributed, and in the other it is reinvested.

Where there is a difference is that you will probably incur costs to sell shares in a company, but not to receive a dividend. Conversely, it may cost you to reinvest a dividend, but not to hold a non-dividend paying share.

This is also an important point, as is the ease with which dividends arrive in one's bank account.
A further point, though not really relevant to (relatively) small shareholders is that your shareholding and therefore voting power decreases as you sell shares.

masonic

Eco_Miser said:

masonic said:

Eco_Miser said:

Every year you get £40 from company A, and still have £1000 of shares.

On the ex-dividend date, company A's shares will fall in value to £960. All other things being equal, the number of shares you hold in company A vs company B will differ at the end of the year, but their value will not.

Except the value will have risen over the year to £1040, so on ex-div day, it falls back to £1000.

Selling shares in company B also reduces your holding back to £1000, give or take the error introduced by only being able to sell whole shares. As the shares grow in value over the years, this error also grows, and gets ridiculous when the price of a share is greater than the amount you want to take out. At some point you will have to sell your final share, just to get your income.

Well yes, both holdings will be worth £1000, or £960, or some other equal value after the capital/income is taken. Your point about being unable to sell a precise amount in £ is another valid difficulty, although some platforms (none I'd be comfortable using for a large sum) allow fractional share trading. Conversely, the dividend paid is beyond the investors control and so may pay out too much, or too little, and result in an "error" too.

Eco_Miser said:

A further point, though not really relevant to (relatively) small shareholders is that your shareholding and therefore voting power decreases as you sell shares.

This is not really a difference, because even those taking in income in dividends will suffer this effect vs those investors reinvesting their dividends. Edit: although I suppose if you mean absolute voting power relative to the entire share capital, then perhaps, although share issues/buybacks, director dealing, etc is likely to be influenced by dividend flows, and so the end result of a particular dividend policy is hard to predict.

Steve182

Eco_Miser said:

UK investors like a steady income. 

I don't see why UK investors attitude towards income should differ from investors in the same position in other countries ?

Retired investors in any country may be under the illusion that a steady income from divis is in some way better than top slicing.

Regardless, I'm not convinced that's the reason why UK companies, in particular FTSE 100's pay higher divis than say the S & P

Linton

Steve182 said:

Eco_Miser said:

UK investors like a steady income. 

I don't see why UK investors attitude towards income should differ from investors in the same position in other countries ?

Retired investors in any country may be under the illusion that a steady income from divis is in some way better than top slicing.

Regardless, I'm not convinced that's the reason why UK companies, in particular FTSE 100's pay higher divis than say the S & P

Other parts of the world like dividends. I believe the USA is different as the tax treatment is less favourable.  Also a major factor is that the UK, or rather the FTSE100, has a high proportion by market capitalisation of mature companies where the opportunity for growth is limited.

In many respects for the investor an ongoing steady income is better than the variability and management effort of top slicing. That is what retirees want, at least to cover essential expenditure. 

Dividends are a good way of extracting returns from cash generative companies. Eg utilities, infrastructure managers. Investing some of your assets in such companies provides better diversification than solely investing in potentially higher long term return but riskier growth investments.

In the UK and perhaps elsewhere there is a long history of companies wasting excess cash in mergers and acquisitions, vanity projects and failed forays into markets of which they had little experience. Shareholders are better off if they keep the companies they own under some level of financial constraint.

A final point, the valuation of companies paying dividends has a strong link to financial reality as yields can be compared with interest rates. The valuation of high growth companies is much more difficult, if not impossible, to justify.