Progressive Corporation of Auto Insurance fame has changed the landscape of dividend payment to shareholders. And they did so in dramatic fashion. Progressive introduced a new dividend policy for 2007 and I have been waiting to see if any other companies would follow suit. So far, it looks like everyone is watching how this policy is playing out in a bear market to see if investors “jump ship”.
A Variable Dividend
Progressive introduced the idea of a once-per-year variable dividend that will be based solely on the performance of the company. This type of dividend will award shareholders for their belief in the company and appears to actually treat shareholders like owners by offering up a piece of the profits in good years and leaving them high and dry in bad years.
Here is what Progressive CEO Glenn Renwick has to say about the dividend policy that he championed:
“If the business has a good year, the owners should share in the profit, and if the business has a bad year, why should the owners get anything?”
An excellent observation–one that’s so obvious, it makes one wonder why everyone’s not thinking that way.
My contention is that investors, including myself, are fickle. As investors we really have no control over the operations of the company and when our cash flow (dividend) is not paid, the only recourse that a dividend investor has is to sell the stock.
Conversely, when there is a big dividend to be had, I would want as many shares as possible. One may think that this will lead to erratic cycles in the stock price of Progressive as “yield hunters” trade the stock over the course of time.
How The Variable Dividend Works?
Progressive’s board has opted to pay a variable dividend based on the firm’s after-tax underwriting profit. That means the premiums Progressive takes in, less claims paid out and expenses of running the business. Shareholders will get 40 percent of those profits in a great year, 20 percent in an average year, zero in a bad year.
So, what consitutes a Great Year, Average Year, and Bad Year?
It’s not entirely carved in stone , but It helps, of course, that Progressive is solidly profitable and generates far more capital from its operations than it can profitably deploy in its business. But should things turn bad, which has happened to many once fine companies, Progressive won’t be stuck trying to defend an unaffordable cash dividend that shareholders have come to expect. In these volatile days, locking yourself into a significant fixed dividend can be a bad idea.
Could This Dividend Policy Work For Other Companies?
If other companies could stomach what seems to be the inevitable swings in stock price, then this policy may work for them because they would pay out what dividend they could afford and no more.
While this would produce stronger companies in that sense, investors who are seeking regular income (who, as our population ages are more and more), may steer clear from companies offering an unpredictable payout. This lack of investor confidence could ultimately result in a lack of capitalization that would ultimately harm the operations of the organization.
Because the strength of a company and the performance of management is ultimately gaged on the price of the company’s stock, this dividend policy seems risky for those managers, investors and companies that are more conservative.
I guess we will have to wait a couple of years to see how this policy plays out for Progressive. While it seems very good in theory, it certainly bucks the trend of traditional dividend theory.