Oran Hall | Why the market is upset over suspension of finco dividends
Published:Sunday | May 3, 2020 | 12:26 AM
ADVISORY COLUMN: PERSONAL FINANCIAL ADVISER
Mr Richard Byles, governor of the Bank of Jamaica (BOJ), announced a week ago that financial institutions have agreed to suspend cash and stock dividends for financial year 2020 and unpaid distributions for 2019 to conserve capital and improve their capacity to absorb losses and to lend in the event of a fallout from the coronavirus in an effort to maintain stability of the financial system.
Three major listed financial companies – NCB Financial Group, Sagicor Group, and Scotia Group Jamaica paid dividends of $28.8 billion last year and $17.5 billion the previous year. That is a lot of money. Granted, much of that went to major shareholders domiciled beyond the shores of Jamaica,
The market did not like this move, which was mutually agreed by the central bank and the financial institutions, and made its displeasure known by sending the prices of financial companies south.
Was this an overreaction? I hardly think so. Dividends mean much to some investors. They add to the yield on equity investments, more so when the stock market is lethargic and there is little or no appreciation in the prices of ordinary shares.
Dividends receive favourable tax treatment, being taxed at a lower rate than interest. They also provide liquidity to shareholders although only a few companies make as many as four dividend payments per year. Some pay twice; others pay once, and the yield can be quite small compared to the price of the stocks. Additionally, in a strong market, the contribution of dividends to total returns pales in comparison to capital appreciation.
Long-term investors know how beneficial dividends can be. It is not unusual for dividends received by such investors to exceed the price at which the stocks were bought because of their steady increase in line with the growth of profit levels over the years.
Investors have the option of reinvesting their dividends either by a formal dividend reinvestment arrangement or by doing so upon their receipt of the dividend. The benefit of this approach is the opportunity it creates for capital appreciation – increase in the price of the stock – on a larger portfolio.
Most investors prefer a high dividend rate to a low rate, but do you know that there is a big advantage to a low dividend rate? It makes more of the profits of the company available for reinvestment, thus reducing the need to borrow, for example, thereby raising the chance of the price of the shares increasing as profit levels increase.
This recent announcement by the governor of the central bank no doubt took some investors by surprise, being so used to receiving their dividends. Further, this kind of intervention is not usual, but do you realise that companies do not have a legal obligation to pay dividends? Paying a dividend is left to the discretion of the directors, who recommend it and how much it should be, but the shareholders must approve it.
Among the factors that determine if a company pays a dividend, and how much, are the following: whether the company made a profit in the year to which the dividend relates, or in previous years, the working capital position of the company, the plans it has for expansion and its dividend policy. A company may pay a dividend if it does not make a profit in a particular year if it has sufficient retained earnings to do so, and it may pay out more dividends than the profit it makes in a particular year if it has sufficient undistributed profits from previous years to do so.
So, many shareholders will be disappointed, but from what the governor said, this is not a cancellation, just a suspension. It is quite possible that these dividends will be paid in the not-too-distant future.
Investors living abroad risk receiving less in foreign currency if the Jamaican dollar loses more of its value between now and when the dividend payment is eventually made. Pension funds will miss out for now on the contribution they would normally expect dividends to make to them. Both defined benefit plans and defined contribution schemes will be affected in the short term, and other shareholders will be affected in different ways, but regular dividend payments will resume.
I doubt any investor’s portfolio is so concentrated in financial-sector stocks that this development will seriously affect portfolio returns – a timely reminder of the importance of diversification.
Oran A. Hall, principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.