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Lessons from Big Blue and A&P

The juxtaposition was unsettling.

Tuesday’s lead story in The Wall Street Journal’s Business & Tech section was about how revenue at International Business Machines (IBM) has fallen for 13 consecutive quarters.

Below the fold was a story about how the venerable supermarket chain A&P is returning to bankruptcy court for a second time since 2010 and is unlikely to survive.

Two storied names in American business and two tales of decline. For dividend investors, IBM and A&P are cautionary tales.

The Gusher Dries Up

First, Big Blue. Despite its woes, America’s flagship technology company is still a profitable giant, earning $3.45 billion in the second quarter and paying a hefty dividend of $5.20 per share, for a 3.2% yield. But IBM has an existential problem: it hit the bonanza with mainframe computers and nothing that it has ventured into to replace the shrinking mainframe business has come close to replicating its one-time gusher.

Like all good corporate bureaucracies, IBM is managing the decline of its core business well. But its new efforts in technology services, business services, and software are struggling. All the reorganizations and right-sizings in the world aren’t going to create some 21st century version of the mainframe business. Some company we’ve barely heard of, or some group of crazy entrepreneurs who haven’t even formed a company yet, is likely to do that, not IBM. So if I want to be cruel and perhaps overdramatic, I’d say you can enjoy IBM’s dividends while they last — and for reasons of pride the company will undoubtedly do all it can to preserve its dividend — but be prepared for declining equity value and a shrinking company.

Troubles at the Checkout

While A&P’s business is much more prosaic and low tech, the former Great Atlantic and Pacific Tea Company, whose stock symbol was GAP when it was public, is another example of a category-killing company that lost its core.

Begun in 1859, by the Depression year of 1930 A&P was the world’s largest retailer with 16,000 stores and sales of $2.9 billion. It adopted the self-service model in 1936 and grew to 20,000 stores by 1950. Its decline started later that decade when rivals opened larger, more modern stores and A&P failed to adapt. But there was another problem, as noted by author Marc Levinson in his acclaimed The Great A&P and the Struggle for Small Business in America (Hill and Wang, 2011):

“Many poor decisions in the early 1960s sped A&P’s downfall, but one factor stands out: A&P paid generous dividends. From the time of its public share listing in late 1958, shareholders both inside and outside the family called for dividend increases. The John A. Hartford Foundation was A&P’s largest shareholder, and it is here that the dual role of Ralph Burger, serving as head of both A&P and the foundation, was problematic: high dividends may have been in the foundation’s interest even if they damaged the company’s long-run prospects. In the year ending February 1961, nearly half of A&P’s earnings went for dividends. In 1962 and 1963 the payout topped 70 percent.”

The Bottom Line

Two lessons: first, as it says in the Book of Ecclesiastes, there is a time for everything. Some companies never make it, but even for those that do, staying on top forever is unlikely. For investors, the hard part is knowing when to get in and when to get out.

Second, be careful what you wish for. We all love dividends and want companies sitting on piles of cash to share the loot with shareholders. On the other hand, we want those companies to remain competitive and to change — profitably — with the times. If we, the shareholders, become as piggish as CEOs and take too much, we’ll be killing, not nurturing.