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Dividend Mania


I reported a while ago in Mandalay Syndrome that the convertible bond market was thrown for a loop when the company significantly raised their dividend soon after issuing new convertible bonds. I described why this event reduced the value of those bonds and sent hedge fund managers scurrying to analyze this new risk. Companies quickly learned that their faucet of liquidity (the convertible bond market) would shut down unless these bond managers were protected against these surprise events. When General Motors recently issued a large amount of convertible bonds, they offered this protection: any increase in dividends would be met by a commensurate increase in the number of shares issued per bond, effectively raising the conversion ratio and lowering the strike price of the imbedded option. Other issues like Halliburton have done the same thing and I suspect this will and must be incorporated in most bond issues going forward. This does nothing, however, for all the convertible bond issues currently out there and the entire convertible market has lost relative value over the last month (for this and other reasons): we estimate that convertible bond funds lost 3% last month.

As an aside comment, I find it interesting that common stock holders will pay more for a stock when the dividend is increased for no other reason than to return cash to the shareholders. The new tax laws lowering the tax rate on dividends certainly increases the after-tax retention of cash for the stock holder, but does it really do anything to the long term value of a company? If a company's stock price drops to where the current dividend is still safe and provides a better than market (for the risk) rate for the holder, it is natural that some buyers will come in looking at the stock as part bond and part equity and provide support at that stock price. But when a company raises the dividend because of the new tax laws and is simply returning cash on the balance sheet to shareholders, then it is quite different. If a company is not growing and cannot find a better use for its cash, like investing in their business, it seems to me to be a negative, not a positive signal. If a company's business is growing and they increase the dividend commensurately, that seems to me to be a positive signal. Not because they raised the dividend, but because the business is growing. Treasury Secretary Snow has commented that the new tax laws on dividends would drive the market 20% higher. I believe that is folly. Dividend policy in itself does not change the value of a stock. You must analyze the reason for a change to determine whether it is positive or negative.
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