Growth vs. Cash

Investors (actually “288 investment professionals” according to MSNBC and “290 mutual fund managers” according to the Globe & Mail) are apparently preferring growth to cash (dividends):

About 49 per cent of the 288 investment professionals quizzed by Merrill in November said they wanted to see companies increase capital expenditure, the highest response since this question was first asked in September 2002, 11 points higher than the corresponding figure three months earlier.

I am not sure what fundamentally changed in the average business to cause this increase in three months. Here’s what Benjamin Graham had to say about this in 1949:

A company’s management may run the business well and yet not give the outside stockholders the right results for them, because its efficiency is confined to operations and does not extend to the best use of the capital. The objective of efficient operation is to produce at low cost and to find the most profitable articles to sell. Efficient finance requires that the stockholders’ money be working in forms most suitable to their interest. This is a question in which management, as such, has little interest. Actually, it almost always wants as much capital from the owners as it can possibly get, in order to minimize its own financial problems. Thus the typical management will operate with more capital than necessary, if the stockholders permit it-which they often do. [italics theirs]

Jason Zweig, in his commentary in Chapter 19 of the Intelligent Investor Revised Edition, notes two interesting pieces of research: “Surprise! Higher Dividends=Higher Earnings Growth” (Arnott and Asness) and “Dividend Changes and Future Profitability” (Nissim and Ziv). However there has been some contradictory research as well: “Dividend Changes do not signal future Profitability.” Without pouring over these papers in detail it’s impossible for me to judge who is right. Zweig does say that “even researchers who disagree with Arnnott-Asness and Nissim-Ziv agree that dividend increases lead to higher future stock returns.” Either way, I think this comment by Zweig sums it up nicely:

Paying out a dividend does not guarantee great results, but it does improve the return of the typical stock by yanking at least some cash out of the managers’ hands before they can either squander it or squirrel it away. [italics his]

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