Value Kolumne von Hans Peter Schupp

26. MAY 2023

When dividend payments do not make sense

It’s May. Like every year, the merry month for all dividend hunters. Shareholders of German stock corporations can expect a record amount of dividends for the past fiscal year. Listed companies in Germany plan to distribute a total of around 75 billion euros to their shareholders this year – 9 percent more than last year. This is the result of calculations by the Deutsche Schutzvereinigung für Wertpapierbesitz (DSW) and the „Institute for Strategic Finance“ (isf).

Shareholders of DAX-listed companies are the main beneficiaries of the dividend bonanza. The 40 groups in Germany’s top stock market league pay out an estimated 52.5 billion euros, thus contributing the lion’s share of the money. The three carmakers Mercedes-Benz, BMW and Volkswagen alone account for a combined total of around 15.5 billion euros.

However, do dividend payments make sense at all? For those who enjoy the warm windfall for their private consumption or to top up their pensions, or those who rely on distributions for business purposes, perhaps. And yet they suffer a decline in assets as a result.

We believe the focus on dividend payments is the inferior investment strategy for several reasons. First, companies should focus on reducing their debt before returning money to their shareholders. A certain amount of debt makes sense in some cases. But when money is borrowed for new investments and a dividend is paid at the same time, it doesn’t make sense to us. We rather like it when companies buy back shares. All shareholders get something out of that.

Then there is the issue of taxation. Dividends are subject to capital gains tax. And this is not set uniformly throughout Europe. In Germany the tax rate is 25 percent, in Italy 35 it is percent. As an investor, you do get it back, but reclaiming is time-consuming and costly, and the waiting time for a refund is very long – in Italy, you sometimes have to wait two years. Moreover, due to the double taxation agreement within the European Union, the tax rate of the country in which the company is based always applies.

Therefore, it is much more convenient for shareholders if companies buy back their own shares. This spreads the profit over a smaller number of issued shares, and earnings per share (EPS) increase. The value of the individual share increases. But corporations often say: We don’t want to carry out too large a buyback program, because that would change the ownership structure. Well, you can say whatever you want about that, but it’s not consistent.

The dividend yield is not a selection criterion for us

The next problem arises for those investors who do not want to consume the money. What do you do with the money? They reinvest it. And mostly in the same company, so as not to change the structure of the portfolio, i.e. not to create an imbalance. And that is expensive, because as in any private portfolio, transaction costs and taxes weigh on the return.

All this argues against dividend payments in our view. Dividend yield is therefore not a selection criterion for us, even though the average dividend yield in the current portfolio is over 4 percent.

However, the objection remains that share buybacks at any price are not always sensible either. This is because there is often a risk of overconfidence among company managers. Especially when the companies are doing well. Then decisions are often made with the risk of buying too expensively. It may be that shares are bought at the drop of a hat, no matter how high they are already valued. But in our view, that is still better than the company making an acquisition that is valued too highly. In that case, it is better to give the money to the company’s own shareholders than to give it to third parties at an overly stretched price.

US companies as a role model

Perhaps European companies, and by extension German companies, could take a cue from U.S. companies. According to LPL Financial, total spending on share buybacks by S&P 500 companies will amount to $900 billion this year. That’s down only slightly from 2022, when companies spent $922 billion. Money that directly benefits shareholders.

Translation for convenience only!

The author: Hans Peter Schupp is a board member of FIDECUM AG and portfolio manager of the Contrarian Value Euroland fund.