One Thing Every Dividend Investor Should Know

By “following the money”, income seeking investors can assess if a company is committed to an increasing dividend.

| More on:
The Motley Fool

Companies like Canadian Pacific Railway (TSX: CP)(NYSE: CP) that generate more cash than required to meet operational needs have, in essence, three basic options – grow revenue by investing in R&D or buying a competitor, pay a dividend, or repurchase stock through a share buyback program.

Knowledgeable income-seeking investors choose companies that are committed to raising their dividend consistently over time. And by better understanding who owns a company’s shares, “following the money” if you will, investors can better determine the likelihood of regular, growing dividends.

So much cash, so few options

Canadian Pacific had a great 2013 — record revenue, an all-time low operating ratio and improved productivity across the board. And it has a lot of free cash — $530 million at the end of its latest quarter.

Earlier this month, Canadian Pacific unveiled a share buyback plan to repurchase up to 5.3 million shares, or about 3% of the total outstanding, over the next year. Based on the stock’s current share price, the value of the program could reach nearly $840 million.

An analysis of who owns Canadian Pacific stock reveals why the company’s first choice was a share buyback program, and not a dividend raise.

Based on data compiled by Bloomberg, U.S. investors own nearly 73% of Canadian Pacific’s stock, compared to just 47% for Canadian National. And U.S.-based hedge fund Pershing Square Capital, managed by famed activist investor Bill Ackman, controls nearly 10% of Canadian Pacific stock.

American investors in Canadian companies tend to prefer share buyback programs due to the heavy taxation of dividends from companies north of the border. On a possible dividend increase, Hunter Harrison, Canadian Pacific’s CEO, commented that, “U.S. holders are not crazy about dividends because of the tax treatment. U.S. investors would rather have a buyback than a dividend.”

Share buyback vs. dividend increase
Unfortunately, the case for share buyback programs enhancing shareholder value is a difficult one to make. Corporate boards often initiate share buyback programs at inopportune times. With Canadian Pacific’s stock approaching an all-time high, now is not the best time to begin buying in the interest of creating shareholder value.

Then there is the issue of who truly benefits. By reducing the number of outstanding shares and increasing various per-share measures, share buyback programs provide a boost to the value of stock-based pay provided to a company’s senior management, but does little for the average investor.

Foolish bottom line

Canadian Pacific will likely initiate a nominal dividend increase when it announces first-quarter results later this month. But it will be much smaller given the large financial commitment already made to the share buyback program that primarily benefits the large number of U.S. based investors in Canadian Pacific. Canadian investors seeking dividend income would be well served to always remember to follow the money.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

More on Investing

Close up of an egg in a nest of twigs on grass with RRSP written on it symbolizing a RRSP contribution.
Dividend Stocks

Turn $5,000 Into a Growing Nest Egg With These Dividend Knights

Explore the world of dividend investments. Discover why dividend knights are key for your retirement portfolio.

Read more »

analyze data
Investing

Should You Buy Emera While it’s Below $65?

Let's dive into whether Emera (TSX:EMA) is a utility stock worth buying right now, or if investors should wait for…

Read more »

A plant grows from coins.
Investing

1 Magnificent Growth Stock to Own for the Next Decade

This magnificent growth stock might be an excellent investment for growth-seeking investors who want to buy and hold a stock…

Read more »

Canadian Dollars bills
Dividend Stocks

Want Year-Round Income? 4 Dividend Stocks Paying Consistently

There are some stocks that are just easy buys, and these four should be some of them.

Read more »

Investing

3 Under-$50 Canadian Stocks to Buy for Superior Long-Term Returns

Given their solid financials and healthy growth prospects, these three under-$50 Canadian stocks are ideal for long-term investors.

Read more »

rain rolls off a protective umbrella in a rainstorm
Dividend Stocks

Building a $50,000 Portfolio That Can Weather Any Market Storm

This defensive investment portfolio uses three ETFs to ride out any recession.

Read more »

Two seniors float in a pool.
Retirement

Want to Retire Rich? 3 TSX Stocks to Add to Your Portfolio Now

These TSX stocks could deliver above-average returns in the long run, helping you build wealth over time and retire rich.

Read more »

a person watches a downward arrow crash through the floor
Dividend Stocks

Top 3 TSX30 Winners: Understanding the Recent Stock Drop

Three TSX30 winners in 2024 have experienced price drops this year and continues to underperform due to massive headwinds.

Read more »