Thursday, May 22, 2008

* When Is Enough, Enough

I am reminded of the old story about a farmer that said to his wife, "I told you 'I love you' when we got married and if anything changes, I'll let you know." Most of us require a little more frequent feedback than once-in-a-lifetime. The same is true with my dividend investments.

In the U.S. and Canada, most companies pay dividends quarterly. In other parts of the world, it is not uncommon for companies to pay an annual or a semi-annual dividend. Looking at some ADRs for non-U.S. companies Barclays PLC (BCS), ING Groep NV (ING), Toyota Motor Corp. (TM) all pay semi-annual dividends.

That is not to say that North American companies sometimes choose not to pay quarterly dividends. For many years McDonald's (MCD) paid an annual dividend. Since 2000, Walt Disney Co. (DIS) has paid an annual dividend and Ruby Tuesday, Inc. (RT) has paid a semi-annual dividend. Going in the other direction, there are some companies and ETFs that pay monthly dividends. These include Realty Income Corp (O) and Alpine Total Dynamic Dividend Fund (AOD).

Ironically, in a June 19, 2000 BusinessWeek article, Harry M.J. Kraemer Jr., chairman and chief executive of Baxter International Inc (BAX) stated he would be very surprised if a "majority of companies did not move to an annual dividend within four or five years". There has not been much movement in that direction. To the contrary, MCD has moved back to paying quarterly dividends. Around the year 2000, several other companies such as AT&T (T), Wal-Mart Stores Inc. (WMT), Coca Cola Co. (KO), 3M (MMM) and Home Depot (HD) considered moving to annual dividends, but ultimately rejected the change. So why would a company risk annoying its shareholders' and moving to an annual dividend?

Reasons For an Annual Dividend
  1. Save on Administrative Costs: Many companies popular with kids such as McDonald's and Disney, have a large number of shareholders that hold a small number of shares. It cost 4 times as much to mail four $0.50 dividend checks instead of one $2.00 check.
  2. Generate Additional Income: In March of 2008, MCD paid $426.4 million in dividends. If that was not paid in March, but paid in December the company would have earned around $10 million in interest on the money (assuming a 3% rate).

Reasons Against an Annual Dividend
  1. Shareholders Have Come to Expect Quarterly Dividends: Some shareholders of dividend companies use the dividends to pay living expenses. Receiving a single annual distribution and allocating it over the upcoming year would be difficult for some. In addition, the transition would prove financially problematic for those with insufficient resources.
  2. Dividends Provide Frequent Assurances of the Company's Health: In November 2007 when HD held their dividend flat it was an indication to the market the extent to which the company was struggling. Since you can't fake cash, dividends are a strong scorecard in judging the company's financial health. If you had a treatable disease would you rather know in 3 months or 12 months?
For me, quarterly dividends provide a perfect balance between to much administrative work (for me and the company) associated with monthly dividends and too little financial feedback from the company associated with annual dividends. How do you feel about annual dividends?

At the time of this writing, I owned shares of AOD, HD, MCD, O and WMT.

Full Disclosure: No position in the aforementioned securities. See a list of all my dividend growth holdings here.

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