Why? Investors calculate the value of dividends in relation to stock price. A $10 dividend on a $100 stock pays a 10% dividend yield.  If the stock falls to $50, that same dividend spells a 20% dividend yield. Investors flock to such high dividend yields, supporting the price.

Another benefit of dividends, for both shareholders and companies: managers are less tempted to squander cash on bad ideas, from research rabbit holes to overpriced acquisitions.

Also, regular cash dividends give investors reason to stick with a company and even buy more shares in times of trouble. The result is a base of higher-quality shareholders, those with patience, focus and stock-picking skill. In fact, all of the companies with the longest sustained history of paying cash dividends are among the favorites of quality shareholders. 

For example, I compared a list of the top 20 dividend stocks from the annual ranking of so-called Dividend Aristocrats to a database of 2,695 stocks followed by my QualityShareholders Initiative at George Washington University.  All 20 of those stocks ranked in the top third for quality shareholders; 14 were in the top 15% and nine landed in the top 10%.  

Topping the list: Procter & Gamble
PG,
+0.29%,
3M
MMM,
-1.01%,
Coca-Cola
KO,
-0.03%,
Colgate-Palmolive
CL,
-0.05%,
Johnson & Johnson
JNJ,
+0.69%,
AbbVie
ABBV,
-0.21%,
Abbott Laboratories
ABT,
+0.33%,
PepsiCo
PEP,
+1.75%,
Automatic Data Processing
ADP,
+1.51%
and Kimberly-Clark
KMB,
-0.39%.
  

Dividend-paying stocks can be excellent long-term investments, but not every dividend stock is a great buy.  Companies may pay high dividends because they are at dead-ends, without opportunities to grow profits or margins.

By the same token, not all companies should pay dividends. If a company has dazzling growth opportunities, either in its existing businesses or ones it can acquire, it and its shareholders are better off skipping the dividends.  

To help understand the difference, and before loading up on dividend paying stocks, see if the company’s board or managers explain how they think about dividends.  Directors have almost total discretion over dividend policy so this is an excellent measure of their stewardship.

Directors also should show that they understand that their job is to allocate every corporate dollar to its best use. Possible uses include reinvesting in the current business, acquiring new ones, buying back underpriced shares in the open market, or paying cash dividends.

Companies who explain their dividend policy well — whether they pay regular dividends or not — are companies worth looking at as investment opportunities, because it signals that managers and directors think like owners. Among the Dividend Aristocrats, if they attract high quality shareholders they’re probably good stocks to own, especially in troubled times.

Lawrence A. Cunningham is a professor at George Washington University, founder of the Quality Shareholders Group, and publisher, since 1997, of “The Essays of Warren Buffett: Lessons for Corporate America.”  For updates on Cunningham’s research about quality shareholders, sign up here. 

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