Barnes & Noble Should Cut Its Dividend

A reason why I cover businesses that have upped their dividend payouts annually for years and years is because it touches upon the nerve of permanent wealth creation–timeless demand for the core product. When I point out that Colgate-Palmolive has raised its dividend every quarter since the day on which President Kennedy, C.S. Lewis, and Aldous Huxley simultaneously died, I am not only sharing the insight that it is attainable to own something that sends you more and more cash each year.

I am also pointing out that the growing dividend payout ratio is telling you something about the products being sold. Toothpaste in general, and Colgate toothpaste in particular, is so enmeshed in the human experience that Colgate’s Board of Directors have been able to part with about a third of profits every year while not only maintaining its competitive position but improving upon it. An impressive dividend growth record is a signal that: “Our economic engine isn’t a vulture that licks the investor’s capital to the bone. There’s plenty here to go around and prosper.” Decades of dividend growth signal that the reinvestment needs of the business are low to manageable.

However, there are circumstances when a dividend payment can be a bad thing. If there is a clearly better use of retained earnings, or–gulp–the dividend is higher than the earnings, then the dividend is harming the long-term interest of the business via the Board’s short-term appeasement. It can even be a diversionary tactic that management uses to distract attention away from poor fundamentals–leave ole Oz alone beyond the curtain because there’s nothing to see here.

In 2015, Barnes & Noble (BKS) decided that it wanted to gin up some support for its stock by instating a $0.15 quarterly dividend. Given that the dividend yield is somewhere between 4.5% and 5.0%, this has likely attracted the attention of some income investors that are sick of living in a world where I-bonds have a fixed 0.1% payment portion that resembles the U.S. Treasury shaking out its seat cushion.

But there is a problem. With 75 million shares outstanding, the $0.60 annual dividend payment means that Barnes & Noble’s Board of Directors is approving of $45 million in cash distributions to shareholders. Meanwhile, it is only earning a profit of $0.32 per share, or $24 million. It has got $24 million coming in while it’s sending $45 million out. This mandates leveraging the balance sheet to the detriment of the corporation’s flexibility a few years from now.

What I don’t like, from the perspective of someone rooting for the corporation’s long-term survival, is that Barnes & Noble is doing this while its core business model is broken. It is closing book stores and earning profit margins that are only one sixth of what they were in 2004 while the gulf between it and Amazon widens. Barnes & Noble doesn’t have the luxury of resting on its laurels and going into cash cow mode.

The core business is rapidly deteriorating, and the management team is not retaining any of its earnings to make bold future investments that would mimic Wells Fargo’s switch from stage coaches to banking in generations past. Those $24 million profits need to be deployed to carve out Barnes & Noble’s future niche in an Amazon world. Instead, Barnes & Noble is making the pandering decision to pay out $45 million in dividends to shareholders. The stock is trading at $13 per share. Based on current decisionmaking, I don’t see how shareholders can expect a higher value than that five years from now.