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The Folly of Dividend Stocks
Posted on 8/19/15 at 2:19 pm
Posted on 8/19/15 at 2:19 pm
quote:
But the bottom line is that the existence of a dividend, or even a fat dividend yield, could be essentially indicative of a company that has shrinking profits or no profits and is on the decline. That dividend could essentially be its way of liquidating. So while its incorrect to completely ignore the dividend when calculating your return at the end of the year, you would be a fool to believe that dividend made you better off in any way shape or form.
LINK
This has a ton of good points several of which Warren Buffett states constantly. Stock buybacks are much more efficient than dividends and hence why BRK.A or BRK.B doesn't pay them out. The double taxation kills the value of the dividend.
7
Posted on 8/19/15 at 2:32 pm to OleWarSkuleAlum
Don't care, bought XOM 
Posted on 8/19/15 at 2:47 pm to OleWarSkuleAlum
From a pure business perspective, the only time you should have a dividend is if using the money internally does not get you as good of a return as you currently get on your money.
So, (from a business perspective) a high dividend really just shows how few prospects for making more money a company currently has. Otherwise, they would reinvest that money themselves.
So, (from a business perspective) a high dividend really just shows how few prospects for making more money a company currently has. Otherwise, they would reinvest that money themselves.
Posted on 8/19/15 at 7:16 pm to SouthOfSouth
My finance professor would always say that dividends were an admission of failure by management to the stockholders.
Posted on 8/20/15 at 6:36 am to OleWarSkuleAlum
A vast majority of the long term returns from the S&P500 come from dividends & reinvestment. I'm talking 90-95%.
In the early days it was rare for a company not to pay a dividend. Divs were just part of what a stock was.
Even though double taxation exists, the qualified dividends which are taxed at lower rates can provide necessary income to investors at potentially higher after tax yields versus bond income.
In the early days it was rare for a company not to pay a dividend. Divs were just part of what a stock was.
Even though double taxation exists, the qualified dividends which are taxed at lower rates can provide necessary income to investors at potentially higher after tax yields versus bond income.
This post was edited on 8/20/15 at 6:38 am
Posted on 8/20/15 at 8:01 am to OleWarSkuleAlum
Even if the market is down, you are still making money with a dividend and even more in the future if you reinvest that dividend. I don't understand how someone can argue against compounding interest
Posted on 8/20/15 at 8:05 am to TigerTatorTots
quote:
This is a fact of life that many people who invest in dividend-stocks do not understand. The price of a stock is based on the underlying enterprise value of the company. To illustrate my point, imagine a company that is worth $1000 and has 100 shares worth $10 each.
The company decides to give a 10% dividend of $1 per share. At 100 shares this dividend payout is going to cost the company $100. Thus the company is now worth $1000 minus $100 = $900. There are still 100 shares but now each is worth $9 each.
Stocks MUST drop by the value of the issued dividend the day after the ex-dividend date ALL ELSE EQUAL. Some people claim that there is so much noise in the stock market that this is not a guarantee. Those people are wrong.
The worst part about dividends is that they are taxed twice. The company had to pay corporate income taxes to earn the cash. Then when you get the dividend, you are taxed on that again. When a company issues a bond and has to pay the interest, that money is a tax-writeoff. Dividend payments are not a tax-writeoff. You being the owner of the company are being taxed twice on your earnings.
The second worst part about dividends is that sometimes a company is doing bad but doesn't want to cut the dividend because then dividend-seeking shareholders get mad. So the company has to borrow money at 10% in order to pay out the dividend. You as a shareholder are part owner so you now own this 10% debt used to pay yourself the cash. You basically took out a 10% loan for the value of the dividend.
LINK
Posted on 8/20/15 at 8:40 am to OleWarSkuleAlum
quote:
The company decides to give a 10% dividend of $1 per share. At 100 shares this dividend payout is going to cost the company $100. Thus the company is now worth $1000 minus $100 = $900. There are still 100 shares but now each is worth $9 each.
That is extremely flawed logic. Dividends are not an expense, it's a financing transaction.
Posted on 8/20/15 at 9:27 am to sneakytiger
The stockholders are the owners of the company. Do you think a sole proprietor should put all of the business profits back into the company and not take a return on it?
Posted on 8/20/15 at 10:14 am to sneakytiger
quote:It's not flawed. If you had a stock worth $10, and then you get paid $1 dividend, do you think you now instantly have $11? No, you have $1 and a stock worth $9. The $1 that was paid to you was priced into the $10 value of the stock prior to the payout.
That is extremely flawed logic.
That's how it works. But in reality, dividend payments rarely approach 10%, and are usually less than 1%, so as mentioned the drop in price doesn't really get noticed among the noise.
Posted on 8/20/15 at 10:24 am to dwr353
quote:If he was already paying himself a salary to live on, he probably should put all of the profits back into it. Assuming the expected return is there.
The stockholders are the owners of the company. Do you think a sole proprietor should put all of the business profits back into the company and not take a return on it?
A sole proprietor is an owner AND an employee, so yeah, he needs some take-home. But as just a stockholder, why do you need to take a return if not taking anything results in the value of your shares to increase faster? Would you prefer to take $100k/year home for 10 years, or take nothing for the first 9 and then $2million in year 10? As a sole proprietor with no other income, you have to take the $100k/year. But as just a shareholder? I think I'd rather just wait and keep an eye on growth.
Posted on 8/20/15 at 10:59 am to Korkstand
quote:
think I'd rather just wait and keep an eye on growth.
Which is why reasonable dividends from a solid, profitable business is wonderful - it gives the individual stockholder the option to do either.
If I'm 67 and I count on my 35,000 shares of K to pay that quarterly dividend (as they have for over 50 years, as reliable as a Swiss Watch) as part of my retirement income? I take those dividends (and at a reduced tax rate).
If I'm 27 and I inherited 2,700 shares from Grandma? Maybe I let those dividends reinvest for 30 years before I take profits. Only downside is I have to pay taxes on the dividends as I go.
So, I agree that a high dividend can be a destructive "sales tactic" for the company to push its own stock - on the other hand, owners of large corporations should be able to profit from a business without having to reduce their positions. The easiest and most direct way to do that is dividends on common stock.
It should not be done at the expense of growth, modernization, increased capital value, etc.
This post was edited on 8/20/15 at 11:01 am
Posted on 8/20/15 at 11:00 am to Korkstand
In your example, assuming an efficient market and that the company's dividend is covered by operating cash flows, wouldn't the $10 company value already assume the business has at least $1 of capital to either reinvest or distribute to shareholders? I get your point if the dividend is really a return of capital, but in most cases, it is not. I also get the argument that dividends are not a tax-efficient mechanism to return profits to shareholders vs. a buyback.
This post was edited on 8/20/15 at 11:01 am
Posted on 8/20/15 at 11:26 am to Ace Midnight
quote:I was just pointing out that owning shares in a company isn't exactly the same as being a sole proprietor. But yeah, if you count on dividends as part of your income, and if it makes sense to do so given your circumstances, then it can work out.
If I'm 67 and I count on my 35,000 shares of K to pay that quarterly dividend (as they have for over 50 years, as reliable as a Swiss Watch) as part of my retirement income? I take those dividends (and at a reduced tax rate).
quote:Exactly. I think the "folly" OP is talking about is that the fact that a company paying dividends shouldn't necessarily be a selling point. You have to ask yourself why the company is doing so, and usually the answer is they simply don't have anything better to use the money on. And that doesn't exactly instill confidence about the future, you know?
It should not be done at the expense of growth, modernization, increased capital value, etc.
Posted on 8/20/15 at 11:31 am to sneakytiger
quote:Yes, exactly, and that capital is priced into the share value. As soon as that $1 is distributed, though, the share value drops accordingly.
In your example, assuming an efficient market and that the company's dividend is covered by operating cash flows, wouldn't the $10 company value already assume the business has at least $1 of capital to either reinvest or distribute to shareholders?
Posted on 8/20/15 at 11:33 am to Korkstand
quote:
You have to ask yourself why the company is doing so, and usually the answer is they simply don't have anything better to use the money on. And that doesn't exactly instill confidence about the future, you know?
True - K is the extreme case, but there are others. However, my analysis goes no deeper than - Blue Chip company in a mature market pays 3 1/4 to even 5 or 6 percent - somewhere in that range (closer to 4 or 5 is optimal, IMHO) - like clockwork - that is a perk of buying a business that does not see the kind of growth that small and mid caps do. The reliability of that dividend (again, 20, 30, 40 years - that's reliable - a company that has been paying 10 to 12 percent dividends for a few years to try to attract yield chasers - that has fewer potential positive outcomes, IMHO) is a reason to buy the stock and a perk of holding it long-term.
And I agree most folks buy stocks to sell them at a profit, not to hold until death for the dividends. However, dividends are the proper tool for some sectors and some categories of stocks, because, at a certain point that is the most obvious, expected, tangible benefit from owning a successful business - realized profits (not capital gain, although that is a valid profitable outcome for some businesses and some sectors).
This post was edited on 8/20/15 at 11:35 am
Posted on 8/20/15 at 11:52 am to Ace Midnight
quote:Agree 100%. There comes a point where growth can't be accelerated with more cash, and at that point paying out dividends makes sense. There is much to like about the reliability and low risk of a mature company that pays steady dividends. However, as has been mentioned, stockholders get used to that, and if an opportunity does present itself, it may be hard for the company to cut back on the dividends in order to fully take advantage of it.
True - K is the extreme case, but there are others. However, my analysis goes no deeper than - Blue Chip company in a mature market pays 3 1/4 to even 5 or 6 percent - somewhere in that range (closer to 4 or 5 is optimal, IMHO) - like clockwork - that is a perk of buying a business that does not see the kind of growth that small and mid caps do. The reliability of that dividend (again, 20, 30, 40 years - that's reliable - a company that has been paying 10 to 12 percent dividends for a few years to try to attract yield chasers - that has fewer potential positive outcomes, IMHO) is a reason to buy the stock and a perk of holding it long-term.
And I agree most folks buy stocks to sell them at a profit, not to hold until death for the dividends. However, dividends are the proper tool for some sectors and some categories of stocks, because, at a certain point that is the most obvious, expected, tangible benefit from owning a successful business - realized profits (not capital gain, although that is a valid profitable outcome for some businesses and some sectors).
Posted on 8/20/15 at 12:23 pm to Korkstand
quote:
quote:
In your example, assuming an efficient market and that the company's dividend is covered by operating cash flows, wouldn't the $10 company value already assume the business has at least $1 of capital to either reinvest or distribute to shareholders?
Yes, exactly, and that capital is priced into the share value. As soon as that $1 is distributed, though, the share value drops accordingly.
What you're talking about is the book value. Yes, when that money is distributed, the company loses book value (though - while I'm admittedly no accounting expert - that value was probably never on the quarterly books if dividends are consistently distributed). The analogy would be closer to being correct if you had a company that all it did was hold $10 with no potential for future earnings and then pay out $1 a year.
Book value is one of many factors that go in to establishing a stock price - along with dividend payouts, income, future earnings potential, etc. That is why you have some companies valued pretty close to book value (e.g. Chevron, Exxon) and others trading at many times their book value (e.g., Amazon, Google)
If the stock price remains constant, the value to the investor has not changed at all. Potentially the company has lost out on some growth potential by distributing the dividend, but the value of the company/stock has not changed by a dividend distribution - unless dictated so by the market.
All that said, I'm not advocating dividend heavy positions/investing, but that issuing a dividend does not automatically change the price of a stock.
Posted on 8/20/15 at 12:27 pm to OleWarSkuleAlum
quote:
This has a ton of good points several of which Warren Buffett states constantly. Stock buybacks are much more efficient than dividends and hence why BRK.A or BRK.B doesn't pay them out. The double taxation kills the value of the dividend.
Most of these articles and research tend to fixate on investors in high tax brackets, someone who is in the 0% QDI and LTCG range really doesn't care and there is no double taxation of dividends. It's very funny to me that when it is most advantageous, ie least costly, for a company to buy back stock most are unable to do so due to economic conditions, then wait until the stock is fully valued again and proceed with buy backs as they have no better use for excess cash, overpaying for the stock. I have read a number of academic studies comparing the effect of dividends vs buy backs and remain agnostic. You are also glossing over whether a company has a high dividend due to impairment or one that consistently pays somewhat over the market dividend rate. SDRL is a recent example of the former, seems like many on here were enamored with it and even believed the company would continue to pay when it's equivalent yield was in double digits and the company was cash constrained.
Posted on 8/20/15 at 12:28 pm to Korkstand
Assume there are two identical companies, both with a share price of $10. After funding all other commitments, both companies have $1 of cash remaining, with zero growth prospects for reinvestment. Company A chooses to distribute the money to its shareholders in the form of a dividend. Company B chooses to retain the cash. What should happen to each company's share price relative to the other?
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