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Mark Hulbert
Sept. 15, 2010, 12:01 a.m. EDT · Recommend · Post:
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By Mark Hulbert, MarketWatch
ANNANDALE, Va. (MarketWatch) -- No good deed goes unpunished!
Take Cisco Systems Inc. /quotes/comstock/15*!csco/quotes/nls/csco (CSCO 21.81, +0.36, +1.68%) , which on Tuesday announced that it would soon begin paying a dividend, thereby returning to shareholders some of the $40 billion cash hoard that it has acquired over the years.
You'd think that this would be unanimously applauded as a Good Thing. But you'd be wrong.
Many commentators instead took the occasion of the dividend announcement to more or less write Cisco's obituary as a dynamic technology company. Paying the cash out as a dividend, these commentators complained, was a tacit acknowledgment by Cisco's management that it couldn't find any ways of investing the money that could promise a handsome profit.
In what has to be the ultimate insult to a technology company, in fact, some commentators are now comparing Cisco to a utility company.
I disagree.
A good case can be made that Cisco's dividend decision actually contributes to increasing its potential to be a dynamic player in the technology arena.
I base this counter-intuitive claim on a famous 1986 article by Michael Jensen, who now is an emeritus professor of business administration at Harvard Business School. Writing in the May 1986 issue of the prestigious American Economic Review, Jensen predicted that companies would be less efficient to the degree they hoarded cash above and beyond what was needed for current operations.
The reason? That cash too often burns a hole in managers' pockets, and they end up doing a poor job of investing that cash -- engaging instead in foolish pursuits like empire building. These perverse incentives exist, according to Jensen, because "growth increases managers' power by increasing the resources under their control."?
Many dismissed Jensen's theory at the time, since it ran counter to the prevailing view in corporate finance. Theory held that companies that retained the most cash should have the fastest earnings growth, since they would be able to invest that cash in their future. In contrast, companies that paid out the most of their cash in dividends should have the slowest earnings growth.
Several subsequent studies have confirmed Jensen's theory, however.
Consider an article in the December 2001 issue of the Journal of Finance: "Dividend Changes and Future Profitability,"? by Doron Nissim and Amir Ziv, both professors at Columbia Business School. They found that, between 1963 and 1997, earnings grew faster than average in each of the two years following a firm's decision to increase its dividend.
Similarly, consider an article in the January/February 2003 issue of Financial Analysts Journal: "Surprise! Higher Dividends = Higher Earnings Growth,"? by Cliff Asness of AQR Capital Management, and Robert Arnott of Research Affiliates. They focused on corporate earnings growth over 10-year periods between 1871 and 2001, and found that earnings grew the fastest following years in which companies' dividend-payout ratios were the highest.
What if Cisco ends up finding a new project to invest in, but because of having paid out some of its cash through its new dividend, doesn't have sufficient resources?
In that event, of course, it would have to turn to the equity or debt markets to raise the necessary capital -- incurring perhaps significant financing costs. But at least according to Jensen's theory, those costs would be more than outweighed by the benefits of having managers' empire building submitted to the discipline of the marketplace.
Note carefully that Jensen's theory and subsequent research on the subject of dividend increases is based on averages across many companies and many years. There is no assurance that these patterns will prevail for Cisco in particular.
But it is worth keeping this research in mind when you are confronted by those who are otherwise quick to criticize Cisco's decision to initiate a dividend.
Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.
Mark Hulbert is editor of the Hulbert Financial Digest, which since 1980 has been tracking the performance of hundreds of investment advisors. The HFD became a service of MarketWatch in April 2002. In addition to being a Senior Columnist for MarketWatch, Hulbert writes a monthly column for Barron's.com and a column on investment strategies for the Journal of the American Association of Individual Investors. A frequent guest on television and radio shows, you may have seen Hulbert on CNBC, Wall Street Week, or ABC's World News This Morning. Most recently, Dow Jones and MarketWatch launched a new weekly newsletter based on Hulbert's research, entitled Hulbert on Markets: What's Working Now.
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3:57 p.m. Sept. 14, 2010 | Comments: 1
- denkab | 11:20 p.m. Sept. 14, 2010
"Mark Hulbert: Cisco's obituary may be premature http://on.mktw.net/a3gpmg" 11:02 p.m. EDT, Sept. 14, 2010 from MktwHulbert
"Mark Hulbert: Top performer tracks corporate insiders http://on.mktw.net/ddi9MI" 11:46 p.m. EDT, Sept. 13, 2010 from MktwHulbert
"Mark Hulbert: Investment lessons of 9-11 terrorist attacks http://on.mktw.net/axL9Ip" 11:48 p.m. EDT, Sept. 9, 2010 from MktwHulbert
"Mark Hulbert: What stocks would gain from deflation? http://on.mktw.net/9G5xdO" 11:09 p.m. EDT, Sept. 7, 2010 from MktwHulbert
"Mark Hulbert: Advisers who do well in up or down market http://on.mktw.net/cIuzY5" 12:15 a.m. EDT, Sept. 7, 2010 from MktwHulbert
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