SHAREHOLDERS THE LIKES OF you and me have become a cake-and-eat-it bunch. Driven in part by greed, in part by envy over what others might get that we are not getting, and in part by a dread of being perceived to be stupid about how we handle our investments, we demand rewards for our investment dollars, both immediately and over the longer haul. Dividends are a nearer term reward, and big builders, collectively, have begun to wise up to the fact that they have to woo shareholders' favor with cold hard cash to keep them buying into their strategic visions for growth.
So, as publicly traded home builders build a more grown-up, more sophisticated profile on the Street, they've begun to play the dividends game—albeit at a level that yields but a fraction of other industry investments—to manage shareholders' expectations for gains at every turn. Lower than average dividend yields reflect big builders' boards of directors' hope that shareholders basically trust that capital's better plowed back into bigger growth opportunities during this fast-and-furious run-up in corporate growth.
Looking ahead, two creditable housing industry analysts tell BIG BUILDER that they expect companies in the home building industry to increase dividends modestly this year. Where they differ is in their take on why the recent trend has been to increase dividends—and what the larger pay-outs may mean.
“I wouldn't expect to see any significant changes in dividend policy among the builders for the rest of the year,” says Rick Murray, an analyst at Raymond James. (Raymond James has acted as investment banker or market maker for a few builders not mentioned in this article.)
Although most builders have a dividend policy by now—and some are increasing their dividends on a regular basis—“dividends in the home building industry are still de minimis both in terms of amount and yield,” Murray says. Builders historically have not paid dividends, and the initiation of dividend policies is a relatively recent development in the industry, he notes.
Carl Reichardt, who follows big builders for Wachovia Securities, agrees that 2005 will probably end up with a modest dividend increase trend. “But if somebody decides to get aggressive, others could follow,” he says. “It was almost a game of ‘can you top this?' in 2004 after the tax laws changed,” he says, referring to the reduction of dividend taxation the previous year. (Wachovia Capital Markets or one of its affiliates has performed investment banking services for Lennar, Pulte, Ryland, and others. In addition, Wachovia or its affiliates intend to seek or expect to receive compensation for investment banking services from KB Home.)
Dribs and drabs cash and stock dividend increases occurred among the builders in late 2004 and early this year, but Reichardt says the noteworthy increases came 12 to 18 months earlier. KB Home and Lennar increased their dividends substantially after investors expressed frustration with stagnant stock prices and low total return. This year, though, public builders are so preoccupied with reinvesting available cash in land positions, it's unlikely they'll move the dividends needle much, Reichardt says.
Dividend Dilemma Why are builders increasing their dividends? Murray agrees that the early 2004 dividend tax cut accounted for some, but adds that, for companies that have not paid dividends historically, “even a token dividend really broadens the number of funds and institutions that can own the stock.” Aside from mutual fund bylaws, Reichardt says that the proliferation of shares resulting from stock dividends can increase liquidity in the issue, allowing more institutional investors to own the stock without having to fear that large trades will move the price against them.
Reichardt says builders are also motivated by a desire to reward shareholders. Historically, builders have been obsessed about financial liquidity, especially since the late-1980s savings and loan crisis. They tend to hoard cash and they are generally reluctant to pay dividends, he says. But builders have become better stewards of the near-term needs of their shareholders, he observes. “Higher dividends signal one thing—the companies have confidence in their ability to deliver larger, more consistent returns to shareholders,” he says.
But every dollar paid in dividends is a dollar lost to growth. Mid-tier builders are at a crossroads, Reichardt says. KB and Lennar have been more aggressive about increasing dividends while Centex and Pulte have stated their preference for pursuing growth opportunities. Ryland may be the builder most likely to become aggressive with higher dividends this year, he says. Not coincidentally, Ryland's operating strategy is less capital intensive, as its focus is on merchandizing homes rather than developing land.