In most cases, a listed company’s dividend policy is often reported to shareholders, but seldom explained.
All that is mentioned is what percentage of profits will be paid out and, in some instances, what that rate of growth will be (usually an absolute percentage or tied to an inflation index). This is puzzling because capital allocation is crucial to business growth and investment management.
For some companies with high asset-to-profit ratios, it becomes difficult to pay out earnings without having some erosion to their business, especially in times of inflation.
These companies (such as Abu Dhabi’s IHC) that are asset-heavy and generate greater returns for their shareholders by investing in a swathe of businesses across the world and integrate them using their management skillset. And ultimately disaggregate them when that business reaches critical mass.
In such a scenario, the expectation is that earnings retention will generate at least an amount equal to the amount that is retained. In other words, the incremental return should at least be equal to the amounts being retained. (Examples of such companies include Berkshire and IHC.)
Otherwise, we see instances where such companies quickly start to trade at below their book value levels.
In the case of most other companies, however, dividend payouts are reflective of the skillset the management has acquired in their special segment of the market. (And/or are protected by government regulations, such as Salik, Dubai Taxi, DEWA, ADNOC Gas, etc).
In such cases, investors benefit more if the profits are distributed and who then have the option to reinvest in the shares of the same companies or alternatively diversify their portfolio. This is in contrast to the management of the companies that try to diversify themselves, diluting their focus and likely venture into areas that are lower returning businesses.
In such cases, both management and investors are worse off, as there is value destruction that has taken place. Companies that announce long-term dividend policies that are stable and predictable are preferred by shareholders, as these payments reflect the long-term expectations of both earnings and return on incremental capital.
Since the long-term corporate outlook changes infrequently for these companies, dividend patterns too would not change often. In this category, we have companies like Salik (which recently approved the installation of two more tollgates), Dubai Taxi, Parkin, Fertiglobe and the ADNOC portfolio.
These companies have continued their laser-like focus on their operations and have resisted the temptation to unwisely retain their earnings, instead choosing to trust their investors while their managements continue to go about their business of retaining the edge that they have.
‘Deal-making’ is the easiest temptation to fall into, and there are a number of listed companies that have fallen for it. Those that have not have been amply rewarded by the growth in the share price value as well as their valuation multiples.
Shareholders’ boom times
Salik is the most recent example of being the beneficiary of higher generative earnings as it looks to not only expand the number of tollgates but also implement measures such as surge pricing.
The likely jump in earnings will not be linear as most analysts expect; it will be more of a hockey stick, as other synergies start to kick in other than the macro factor of population growth. Others like Fertiglobe and DEWA have navigated far more complex operations (in the case of the former the cyclicality of global commodity prices) and have continued to increase gross margins consistently, despite regulatory changes to the environment (corporate tax).
These are examples of where unrestricted earnings are not retained. (Take an example where the return on dividends is greater than the deposit rate, where it would be foolish for investors to not reinvest the dividends. Something that factors into the total returns for the investors, but is not reflected in the share price.)
The key word here for all companies going public as well as those that are already listed, is ‘demonstrated’. Managements that know the value of the edge they possess clearly demonstrate their motivations. Any other platitudes, such as maximizing value’ (a longstanding favourite phrase) no matter how eloquently stated, will be discounted by the market.
As long as management will not listen to the shareholders, neither will the market.
