Should investors look to invest in stocks that have a history of dividend payments? Or are those your grandfather's stocks doomed to be sentenced to those stogy funds labeled "income", and only chosen by those with a life expectancy measured in days? Should the management styles of old time executive officers like Armand Hammer "Occidental Petroleum", who thought dividends important to investors be remanded to the graves these executives now occupy?           

Interestingly enough, this debate is not one that has just been invented. The debate on the wisdom of declaring dividends was a "current" and "hot" topic in my graduate business school days in the mid-seventies. As in most debates at the University of Chicago the race was on to find a mathematical model or formula that would determine the wisdom of sending shareholders a share of profits in the form of a check. Fortunately the vagaries in the tax code came to the rescue and became the driving force behind the debate. Simply put, corporate earnings are essentially taxed twice, once at the corporate level, and again to the shareholder level on the paid dividends.  If the corporation can earn a rate of return even close to that of the average shareholder on retained earnings it is better advised to do just that. The payment of dividends according to the formula essentially became an admission by management that they were not capable of earning returns even slightly less that Ma and Pa Kettle. For a while, I even bought in to this hogwash and did some Armand Hammer bashing.

While I cannot dispute the mathematics or the oddities in the tax code, I believe that the debate did not move forward to the part where management actions or attitudes became corrupted by the newly derived formula. Imagine if you will that you are investing in a small business and you are discussing the terms of the investment with the would-be manager. You could be naïve enough to ask "After a couple of years and we are profitable, when do I get my share?" What if the answer was "Never?" The explanation went on to discuss tax rates and how it would never be the opportune moment to write you a check, although making millions in salaries and stock options for employees were not so encumbered.

The management style described above may work out well. It is certainly possible for the company to grow over time with the investor's value in his or her investment growing right along with it. The investment may become liquid and all the gain may be collected some day at capital gains rates, way less than the ordinary income rates paid on dividends. The problem I am beginning to recognize, even if I still project my life expectancy in years rather than days, is the change in management style and attitude that has accompanied the no dividends due to taxes policy. To old-line managers like Armand Hammer, investors always deserved a return in the form of real cash, meaning real income was needed to pay the return, and the business therefore was run with that in mind. It would be hard to conceive under that style massive salaries and bonus arrangements without the income necessary to send even a modest check to shareholders. One could certainly question, for instance, why an increasingly mature firm such as Microsoft has not seen fit to include shareholders on the extensive dole employees have enjoyed.

The bottom line here is that we should probably look a little more favorably going forward on those companies still paying dividends, most with dividend reinvestment plans if they are desired. In the coming weeks we will try and identify some investments in companies paying dividends and compare them to those who do not.