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Once again, it is reported that a major investment house has written to companies drawing attention to the importance of dividends, with the implication that they must be maintained. We agree that dividends are important, but beg to differ about maintaining them.
Historically much of the return from equity investment has been achieved by reinvesting income. Dividends, over time, asssume a major element of the total return. So of course they are important.
However, businesses now face a recession. This recession will be rather different to any we have experienced in the past 50 years, because it will be driven by the excessive cost of servicing existing debt in real terms. Businesses will earn less, which means they must reduce total dividends. A business that omits to cut its dividend as profits fall will either go bust quickly through paying out money that has not been earned, or go bust slowly through failing to reinvest for the future.
Dividends must fall. It is one of the reasons share prices have already fallen: the market has anticipated future dividend cuts. Far from demanding continued high dividends, investment managers should be welcoming cuts as an aid to business survival.
What we see in this example is the inherent short termism of the investment management industry. It is unrealistic to expect dividends to be maintained. Their importance lies in showing that share values have to fall, which is precisely the opposite point to the one touted around recently.
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