Mature companies in stable businesses pay dividends because they have become entities whose purpose is generating earnings for their shareholders. Utilities provide the purest examples of such companies. A shareholder in Pacific Gas & Electric, for example, currently receives an 8% return on his investment in PG&E stock. Why buy a stock that yields less than a Treasury Bill (and on whose dividends you have to pay state tax, unlike a Treasury Bill)? Because the stock can be expected to grow as the demand for electricity in California grows. While collecting income comparable to the T-Bill, you stand to profit from an investment likely to grow at a rate comparable to that of the economy of California, historically a pretty good bet.
Now that you're thinking in terms of balancing immediate rewards in the form of dividends and deferred capital gains from appreciation of stock if a company is successful, several other strategies seek your attention. Over there is a guy in a blue suit hawking IBM stock, ``You can take home a yield of 3.6% off the top, and buy in to the most successful stock in history, with a record of 15% compounded sales and earnings growth...''. A fella in a plaid jacket and yellow shoes screams, ``People gotta eat! General Mills will pay you 3.7% and deliver growth as reliable as breakfast''. In the back of the room, behind the nickel slots, are disheveled mute characters wearing signs around their necks. ``Who are they?'', you ask. They are the stocks that pay no dividends, but each sign ends with the phrase ``huge capital gains, real soon now''.
Dividends can be seen as equalising the valuation of companies at different stages of maturity. Ford Motor Company cannot possibly promise you sales and earnings growth, starting from its share of a mature market, equal to that of Digital Datawhack, but it can pay you a solid 4.7% on your money while promising serious capital gains and dividend increases if Ford products gain increasing market share.
To decide whether dividends make sense for a New Technological Corporation and if so, at what level, we must decide where the shape of its business places it on the industry maturity curve: the key determinant of dividend policy when dividends are viewed as leveling the risk-reward tradeoff among stocks by paying earnings to an investor in equities with less potential for capital appreciation. However, since tax policy is so intertwined with the decision to pay dividends, we must first examine two additional tax considerations.
Editor: John Walker