Twat of the day (9)

Iain Martin in The Telegraph asks a dumb question:

How will pension funds cope without dividends from banks, a ruling imposed by ministers at the instigation of Brussels?

It would appear that he is yet another financial commentator who hasn't even done the crash course in dividend policy, as follows:

1. Share prices are ultimately the net present value of future income streams. The timing of dividend payments is actually not so important, what matters is the likely total amount of future dividend payments.

2. Businesses in need of capital - because they are going through a short term bad patch or because they are reinvesting profitably in growing the business - shouldn't pay dividends. 

3. Mature businesses with no particular expansion opportunities, on the other hand, are well advised to pay out all profits as dividends, if they hoard the cash they just end up earning interest on the money (thus earning a lower return for shareholders than if the shareholders got cash dividends and put it in the bank themselves), or they end up spending it all on something stupid (see GEC/Marconi)

Microsoft is an excellent example of points 3. and 4. It only started paying dividends in 2003 once it had reached some sort of upper limit: "Microsoft long had opposed calls from some shareholders to use some of its cash reserves to pay a dividend, arguing its vast prosperity was better spent on research and product development."

4. Raising capital is expensive; paying dividends (or buying back shares) is expensive in terms of transaction costs, it would be madness to do both at the same time. We are constantly told that banks need more capital; if they can afford to pay dividends, obviously they don't.

Therefore, a pension fund which owns shares in banks does not need the dividends in the short or medium term!

If profits are retained/reinvested/used to pay off other liabilities, the value of the shares goes up faster than if the bank paid out dividends. If the pension funds are investing long term (and I would like to think they are), they should be quite happy to wait for a few years; what they lose in cash income, they gain in capital growth. If a pension fund needs cash in the short term, all it has to do is sell off some of its shares; this does not 'erode' capital because the remaining shares are increasing in value faster than they would be doing if the bank paid out dividends.

Twat, honestly.

In any even, as a final thought, it appears to be the case that the value of pension funds' investment in bank bonds is far, far higher than the value of their bank shares; remembering always that bail out has not been particularly good for shareholders but it has been supremely good for bondholders, as I have explained before, so pension funds have done very well out of the bail-out, all things considered.