Cash flow is king.

How a company generates cash flow matters.

Companies generate cash flow from operations, turning sales into cash. They generate cash flow from sales of investments and property. They generate cash flow through financing, sales of stock and debt.

Cash flow from operations tops the totem. After all, that’s the business – selling goods and services.  That’s as fundamental as it gets.

How a company flows cash to investors matters even more. The cash that flows to you and me, the investors, is most important.

Arguments arise when the discussion turns to how and when cash should flow to the investor. Which is the preferred conduit: buybacks or dividends?

Buyback proponents argue that buybacks are flexible. They remove cash from the books without committing to a rigorous dividend policy. Buybacks also reduce the share count far more than they reduce net income. Earnings per share rise. Rising EPS can propel the share price higher.

The theory rings true, until the empirical evidence is tossed in.

Data compiled by Fortuna Advisors, a consulting firm, supports the counter argument. Fortuna Advisors found that companies rank capital-deployment strategies. Cash is first deployed for organic investments. It is then deployed for acquisitions. Reducing debt follows acquisitions. After all that, companies finally deploy cash to buy back shares.

While this strategy seems sensible, it’s often otherwise. Companies habitually overpay for their shares. They buy high. They buy a low-return investment.

Dividends are the preferred conduit for flowing cash to investors. It’s a conduit that should be established sooner rather than later. I allow no distinction between high-growth or low-growth companies.

Companies that retain all their cash create a problem. It’s a problem that discriminant buybacks fail to solve. Companies frequently invest the retained cash in sub-par investments.

Robert Arnott and Clifford Asness published a revealing article in the Financial Analysts Journal. The article was titled  “Surprise! Higher Dividends = Higher Growth.”

The two money managers found dividends and earnings correlate positively. When current dividends are low or nonexistent, future earnings are frequently low. And when current dividends are high, future earnings are high.

Arnott and Asness measured many 10-year periods covering the past century. They found a 3.9 percentage points growth advantage. The advantage goes to high dividend payers over low dividend payers.

Dividends correlating with growth is less counter-intuitive than you might think. Dividends are “sticky.” Management is reluctant to cut dividends. Management knows the dividend obligation must be met. Therefore, management becomes more discerning when vetting investments.

High Yield Wealth recommendation Cisco Systems (NASDAQ: CSCO) offers proof. It proves the power dividends have to create shareholder value.

Cisco Systems began paying a regular dividend in 2011. Before the Cisco Systems  dividend, Cisco Systems hoarded its cash. It reinvested cash internally to poor effect. Cisco’s share price was no higher to start 2011 than it was in 2001.

Cisco Systems pays a dividend. The Cisco Systems dividend is also increased annually – to great effect. Cisco Systems investors have received a rising income stream. They have also benefited from a rising share price. The share price has doubled since the Cisco Systems dividend policy was implemented.

Another High Yield Wealth recommendation offers more proof. Altria Group (NYSE: MO) is the king of dividend aristocrats. It’s a perennial value generator.

The maker of Marlboro cigarettes has raised its dividend 49 consecutive years. Altria Group generates high returns on capital. It generates high returns for investors. Altria Group has produced an average annual 20% total return for decades.

If the choice is between dividends and buybacks, I’ll take dividends every time. You should, too.

Published by Wyatt Investment Research at