Thanks for a very encouraging response to the article I wrote last Saturday entitled “The best run companies do not pay a single dividend”.

I appreciate all of your comments and observations including those made by Chinaboleh, Alphabeta, gungho92, kcchongnz, Kevin Wong, Always A. Beginner and JT Yeoh to name a few.

Some may agree with what I said last week, and yet there’re many who will disagree. Looking at the title of my last article I can understand why.

I’m glad we’re discussing how companies ought to compensate its shareholders.

Once upon a time long before any exchange market existed for stocks to be traded, a company could be formed with the help of shareholders who were its principal financial backers.

In return, a company would share some of its profits with the said shareholders. To distinguish it from the company’s profits, they called these payouts to shareholders as dividends.

Over time dividend has come to be recognized as a return on one’s investment. In fact, the fruits of our labor, politics, social movement or any human enterprise for that matter regardless of whether they benefit one or all were simply known as dividends.

But let’s not digress.

The business of these early ventures were very precise in their objective such as a coal mine in UK or a trading monopoly such as East India Company which operated in Indian subcontinent and Qing China – whereby all profits generated were divided amongst the shareholders following each trading cycle or voyage.

Dividends were paid either in cash or in kind namely the remaining cargo (depending on the capital needs of the company) which could be sold by the shareholders for profit.

Many a time, shareholders had to forgo or defer their dividends – recognizing that companies had a greater claim on cash which was the lifeblood of a business.

Even the greatest trade monopoly on earth like East India Company which once accounted for half of global trade could not guarantee a steady stream of dividends to its shareholders – as its cash reserves were spent and often stretched to the limits as the company rode one crisis after another from commercial stagnation and trade depression in Europe to famine and wars in India that proved detrimental to the company’s survival forcing the company to turn to the state for help before finally turning defunct in 1874.

In fact, the failure to build a war chest or contingency fund against hard times is the one reason companies fail to survive a crisis – much less a series of bad events that befell EIC and could befall any company today that is less mindful of growing its cash reserves – and secure their place far ahead into the future.

With the advent of the stock exchange, shareholders had the option of liquidating their stock holdings at will. Soon shares became a commodity of value far exceeding the returns one could amass from the dividends.

By listing the shares on a stock exchange, a company can compensate its shareholders through capital gains, bonus stocks and stock splits that are in actual fact dividends that reflect a company’s profits without the need to expend its cash reserve.

That’s the principal reason as to why Warren Buffet has for the last 49 years not paid a single cash dividend to shareholders in his Berkshire Hathaway company.

Every cash was ploughed back into the business of investing in ‘a great company with an undervalued stock price’ so as to build an enterprise with even a greater value.

That’s why he’s the most successful stock investor of all time.

Apple that was close to extinction back in 1995 was brought back to life by Steve Jobs and became the largest traded company on earth – without expending a single cent on dividend, share buyback or any of the shenanigans that managers today are fond of resorting to in order to artificially push their stock price above their fair price.

Managers who do the latter have lost their focus, their job is to protect enterprise value by boosting product innovation and profits and a healthy cash reserve – not depleting them.

Tim Cook did a ‘great job’ that no founder would dream of doing to his company – squander close to a quarter of trillion dollars on dividends and share buyback between 2012 and today simply to endear himself to Wall Street and in the process made himself even richer as he held stocks.

That’s how smart people ‘steal’ cash from the company they work at – they do it legally before a cheering investing community who’re happy to be rewarded today conveniently forgetting the company’s great reserves and tomorrow’s margin of safety is being diminished at a senseless rate.

Now that’s not to say all businesses must emulate the same ‘cash-free’ dividend model. Not all businesses are successful at turning their financial success into a ‘daily’ stock rally so to speak.

Hence, they will continue to reward their shareholders in various ways including paying a huge cash dividend in order to compensate for a slower growth in stock value.

But do remember why these companies like Coca Cola, McDonald’s and Johnson & Johnson are so willing to expend a huge amount of cash on dividends – it’s for the simple reason management are stockholders too. It’s a legal way of lining their pockets too.

The ones that pay the highest dividend cannot bring about the greatest capital gain. Only the most undervalued of stocks with a great revenue and profit story to tell such as Xinghe Holdings Berhad can deliver that.

Let’s go back to measuring stocks on fundamentals and not prejudge and blackball them just because of their national origin. The fact they're Chinese, Malaysian or American is secondary. At the end of the day, each stock must be judged on its own merits.

More about this at http://klse.i3investor.com/blogs/Xingheanalysis/78527.jsp

Of course, Xinghe is no Apple. But, it has the better stock price potential of the two – upto 14 times its current stock price.

And that’s a flipside view of the coin which is worth remembering.

                                                                                                                                     Ezra, 28 June 2015