What Dividends Really Tell You

Last week, we looked at why companies list on the stock market and how investors can share in their growth. But what happens after a business becomes profitable? Does it keep investing every cent back into the business, or does it start rewarding shareholders?

The answer often comes down to dividends.

For many investors, dividends are simply cash landing in their investment account. But for experienced investors, they tell a much bigger story. They reveal how management thinks, where the business is in its lifecycle, and whether its profits are built to last.

Why do some companies pay dividends while others don’t?

Every profitable company has a choice.

It can reinvest its profits to grow the business, launch new products, acquire competitors, reduce debt, or return some of those profits to shareholders through dividends.

Fast growing businesses usually choose to reinvest. If management believes it can generate attractive returns by investing back into the company, shareholders often benefit more from long-term growth than receiving cash today. This is the essence of growth investing.

For example, a retailer such as Shoprite Holdings may choose to invest heavily in opening new stores, expanding its distribution network, or improving technology if those investments are expected to generate attractive future returns.

More mature businesses, however, often have fewer opportunities to grow rapidly. Once they have funded their operations and future projects, it may make more sense to return excess cash to shareholders. Companies such as Nedbank Group and Standard Bank Group have long histories of paying dividends because they generate substantial cash while operating in relatively mature industries.

Neither approach is right or wrong.

The best companies don’t pay dividends because they have to. They pay them because they believe it is the best use of shareholders’ capital. Likewise, the best growth companies don’t avoid dividends because they’re unwilling to reward investors. They simply believe they can create even greater value by reinvesting those profits.

How can we use dividends to understand companies better?

A dividend is much more than a payment. It’s a signal.

When a company consistently pays and gradually increases its dividend over many years, it often tells you that management is confident about the future. After all, cutting a dividend is something companies try hard to avoid, so boards are usually cautious before increasing one.

Many South African companies have built reputations for steadily rewarding shareholders over long periods. Businesses like Clicks have combined earnings growth with a history of increasing dividends, reflecting strong cash generation and disciplined capital allocation.

On the other hand, a company that doesn’t pay dividends isn’t necessarily a poor investment. Mining companies, for example, often experience fluctuating earnings as commodity prices rise and fall, while younger businesses may prefer to reinvest profits rather than distribute them.

Investors should also be careful not to chase high dividend yields.

Sometimes a dividend yield looks attractive simply because the share price has fallen sharply. If profits are under pressure, today’s generous dividend could become tomorrow’s dividend cut.

The real question isn’t, “How much is the dividend?” It’s, “Why is the company paying it, and can it keep doing so?”

What makes a dividend sustainable?

Anyone can pay a dividend once.

The companies that create long-term wealth are the ones that can keep paying them year after year.

Sustainable dividends come from sustainable businesses. That means consistently growing earnings, generating healthy cash flow, maintaining sensible debt levels, and paying out only a reasonable portion of profits.

This is why experienced investors don’t focus on the dividend alone. They also look at free cash flow, payout ratios and balance sheet strength to judge whether today’s dividend is likely to survive tomorrow’s challenges.

Dividends are about far more than receiving cash in your account. They offer valuable clues about a company’s financial health, management’s confidence, and how the business creates value for shareholders over the long term.

But dividends aren’t the only way companies can reward investors.

Many businesses choose not to pay out cash at all. Instead, they return value by buying back their own shares, a strategy that has become increasingly popular among companies around the world. Next week, we’ll unpack how share buybacks work, why companies use them, and what they can tell us about a business.