It is said that the only two guarantees in life are death and taxes. Actually, there is a third guarantee. If you invest in stocks that offer a dividend you (shareholder/owner) are guaranteed a portion of that corporation’s profit. In 2011, Caterpillar Corporation earned $5 billion in profits. You might ask, “What does Caterpillar do with all of that money?” Well, in fact, the company gives a good chunk of its profit back to the owners of the corporation, the shareholders. This “give back” of profit is called a dividend, which is distributed quarterly. In Caterpillar’s case it gave back to its shareholders about 25% or $1.2 billion of 2011 profits.
Who decides the dividend amount and how is the amount determined? The company’s upper management makes this decision. After all, the shareholders have entrusted the company’s management to oversee the day-to-day operations, which include determining the appropriate dividend. The Chief Financial Officer plays a significant role in recommending the dividend and bases that decision on the current profits, future needs of the organization, expectation of growth or contraction of earnings, economic climate and, equally important, the expectations of shareholders.
Let’s take a look at a few companies, including a Maine company, and their dividend practices. Johnson and Johnson is a good example of a company that prides itself in having distributed an increasing dividend to its shareholders over the years. Most recently, the company earned $3.40 per share during the year and issued dividends of $2.28 per share or 67% of its income to shareholders. Ten years ago, the company issued dividends of $.80 per share. Typically, large, mature companies will give a greater dividend as a percent of its income, as compared to a company that is in growth mode. For example, Microsoft, which started business in 1976, gave its first dividend in the year 2000, 24 years after the company’s inception. This came about in response to mounting shareholder pressure. Shareholders demanded they receive a portion of the nearly $50 billion in cash that was sitting in Microsoft’s bank accounts.
On the other hand, another technology company, Apple Inc., earned profits of $25 billion in 2011, or $35 per share, but to date has never distributed a dividend to its shareholders. Companies like Apple still consider itself to be in a major growth mode and choose to create shareholder wealth by pouring the profits back into the company for research and development and other expansion activities, with the expectation that the company’s stock price will rise as a result of that investment. In 2002, Apple’s stock price hovered around $10 per share. It is currently selling for $550 per share. Had you invested $10,000 in Apple in 2002 your investment would have grown to $550,000 today!
In Maine, there are approximately 40 publically traded companies. Clearly, their distributions pale compared to companies like Johnson & Johnson and Home Depot, but still some of those companies offer dividend distributions to its shareholders. An example is Bar Harbor Bancshares (BHB), a regional Maine bank. In 2011, BHB earned $2.85 per share and distributed $1.14 per share or 40% of its income in the form of dividends.
In summary, shareholders can enhance their wealth in one of two ways. They either receive dividends, a distribution of the company’s net income, and/or they enjoy an increase in the company’s stock price. The best scenario would, of course, be that your company offers a dividend and its stock continually rises, enhancing wealth in both ways. Although in life, death and taxes are guaranteed; history has proven that stock increases are not. However, investing in companies that issue a dividend guarantees additional income.
Trivia Question: In 2010, which company paid out a higher portion of its income to shareholders in the form of dividends: Coca-Cola or Pepsi?
Click on video for the answer to the trivia question along with a short tutorial showing the dividend distribution for a Maine company: Bar Harbor Bank and Trust
Tom Giordano is an Assistant Professor of Accounting at University of Maine at Augusta. He writes on financial literacy concepts with respect to the stock market and provides a short tutorial to compliment each article.. His next article will speak to the Price Earnings Ratio: How much should I pay for a stock?