The Wall Street Journal reports (subscription required) on a disturbing trend taking place in board rooms across America: Public companies are borrowing money to pay dividends to shareholders.
Companies say that they're doing it to take advantage of low interest rates, but here's what's so dumb about that: The low-interest rate environment makes dividends less valuable too because the cash can't be invested at a high rate of return. Worse, these companies are needlessly amplifying risk: The bankruptcy courts are littered with the corpses of companies that paid dividends instead of paying down debt, and the result was that shareholders, workers, and creditors were wiped out completely in the name of a short-term increase in yields.
Need another reason that bond offerings to support dividends are a bad idea? There are tremendous frictional costs. The act of selling bonds to pay cash to shareholders costs millions in investment banking and administrative investments -- and the paper-shuffling act distracts management from finding ways to actually create value.
Borrowing money to pay dividends to shareholders is a high-risk proposition without any meaningful upside -- kind of like jumping in front of a steam roller to pick up a penny (or a Lehman Bros. stock certificate -- or Enron, or Circuit City, or any of the other infinite number of companies that plunged into bankruptcy after taking on excessive debt to buy back stock or pay dividends).
Anyone taking a loan to pay dividends is simply an idiot, shenzi type variety and should not be in a quoted company. Actually, CMA should police on this.
Wisdom to detect when share prices hit rock bottom.
When interest on bonds keep going up, you know the bear run is on high street. When interest on bonds start leveling, the bear has met the bull and they have hit rock bottom. When the interest rates on bonds start coming down, the bull has overpowered the bear and you better be riding the bull.