sundev wrote: ‘I’ve never understood the infatuation with dividends, it seems most people believe them to be free money without considering the corresponding decrease in company value.’ Well volatility means that stocks can go up or down so yes it could happen. But you are talking total return not yield. If you are focussing on yield, there is less of an issue. The stock price could go down, but you are looking for a steady dividend, so this is less of a concern. The thing is if you want to guarantee your stock going down, cut the dividend. Institutions will drop you in a heartbeat. Your cost of capital will increase, your market purchasing power will plummet. Pension funds, insurance cos like the dividend. Capiche?
mossy695 Wrote: ------------------------------------------------------- > If you own a dividend paying stock in a tax-preferred > account, like a Roth IRA, you should see the value > of the stock fall by the after tax value of the > dividend, but you receive the full value of the > dividend as you pay no taxes on it. This should be > a way of capturing tax alpha. True, but share buybacks are tax efficient methods of putting cash in shareholders’ hands. Outside of a tax-preferred account they are superior in that they do not create a taxable event, while inside a tax-preferred account they are equivalent. Matt - I agree for the most part, however dividends can be a large drag on a stock if a company cuts their dividend or even fails to increase it, which can create exponentially negative effects on the stock price. i.e. BP strived to maintain a dividend when it could have severely damaged their ability to continue as a going concern. <> So Apple and Microsoft during their non-dividend paying years were dying companies? You could also argue risk is increased during a downturn if the company is forced to adhere to their dividend policy when it’s draining them of cash, forcing them to borrow for liquidity, increasing their cost of capital and lowering their credit rating. I do agree with your generalities in that dividend payers require more stable cash flows and thus tend to come from less risky companies, but if those same companies substituted equal buybacks at quarterly intervals (forgetting our historical love affair with dividends and transaction costs) would they not be identical? Finally, remember I’m not arguing that non-dividend paying stocks are better than dividend paying stocks, I simply contend that dividends benefits are often misunderstood and overrated. Mudda- come again? Yes it “could” happen? If you’re referring to stocks decreasing after paying a dividend, it most certainly does, all things equal. If not, one could purchase a stock right before it trades ex-dividend and dump it for the same price the next day and pocket the cash as profit. Unfortunately it does not work that way. And if a company doesn’t grow but maintains a fixed dividend, you better believe institutions and investors will be concerned with the stock price even if they do get their steady stream of income. One of the focal points of L3’s IPS construction is providing for annual spending needs while maintaining the purchasing power of the portfolio. Getting hit by inflation and decreasing stock price will most certainly reduce the purchasing power of the principal.
Sorry, I thought you were raising the philosophical point of dividends being considered a sure thing. Didn’t read the whole post & not too interested in the technical minutiae. As you were.
Sun - In theory you are correct, investors should not have a preference for dividends or share buybacks as they should theoretically have the same effect on an investor’s holdings. The problem is in practice. In practice you must realize that investors perceive dividend payments differently than share buybacks. This perception, or bias, causes investors to favor dividends over buybacks. Theory would say this is wrong, but practice and historical returns would say this is right…
^Indeed, dividends vs buybacks should have the same net effect. Was that L1 or L2? Either way I’ve already forgotten. Anway, in practice the day a stock goes ex-dividend it never goes down by the exact amount of the dividend. Just as stocks never react perfectly to the reduced dilution from a buyback. What I’m personally more concerned about is 1) if a company announces a dividend does that mean they’re running out of things to do with their cash; and, 2) if they announce a buyback would I purchase their shares at that same price? If on March 9, 2009 a whole bunch of companies bought back their shares, as they should have, then everyone is a winner. My perception is it is more likely you get a scenario like the oil companies announcing big repurchases when oil was at $147 only to see their stock drop right after they bought.
as noted above, they have the same effect on the investors holdings, but a bird in hand is better than two in the bush. the fact that cash is received gives the investor a choice - they can spend it, reinvest in the stock of the company paying the dividend or anywhere else. This choice has value. Investors are not given a choice with respect to buybacks. sure, they can choose to invest in a company with a certain buyback track record or buyback plans, but when it comes to actually making the reinvestment, the investor can only change his/her mind by buying/selling the stock.
Sweep the Leg Wrote: ------------------------------------------------------- > ^Indeed, dividends vs buybacks should have the > same net effect. Was that L1 or L2? Either way > I’ve already forgotten. Anway, in practice the > day a stock goes ex-dividend it never goes down by > the exact amount of the dividend. Just as stocks > never react perfectly to the reduced dilution from > a buyback. True, if the futures are up big after the stock trades ex-dividend you won’t see the full effect of the dividend reflected in the opening price and vice versa. Externalities make the ceteris paribus assumption impossible in practice. > If on March 9, 2009 a whole bunch of companies > bought back their shares, as they should have, > then everyone is a winner. My perception is it is > more likely you get a scenario like the oil > companies announcing big repurchases when oil was > at $147 only to see their stock drop right after > they bought. One would hope these instances would offset, but a very valid point. If buybacks were treated as dividends in that they were done quarterly at equal yields this would eradicate this concern. Muddahudda- yes I was interested in the minutiae - it’s not always necessary to break things down to their basics, I’m just a person who prefers to understand something fully before forming an opinion. Shawno-completely agree, but for those enrolled in a DRIP you’re in effect taking the bird from your hand and putting it back in the bush, removing the value in the choice and equating the strategy to a buyback. Note I’m not saying reinvesting dividends is a bad idea, only that it replicates a company buyback in its effect. Thanks for all the replies, was a good debate and dug a bit deeper than most discussions of dividends. I think Matt’s post 3 above sums it up pretty well. I’ll stop clogging up the board with my long posts.
sundevl21 Wrote: ------------------------------------------------------- You could also > argue risk is increased during a downturn if the > company is forced to adhere to their dividend > policy when it’s draining them of cash, forcing > them to borrow for liquidity, increasing their > cost of capital and lowering their credit rating. > I do agree with your generalities in that dividend > payers require more stable cash flows and thus > tend to come from less risky companies, but if > those same companies substituted equal buybacks at > quarterly intervals (forgetting our historical > love affair with dividends and transaction costs) > would they not be identical? Finally, remember > I’m not arguing that non-dividend paying stocks > are better than dividend paying stocks, I simply > contend that dividends benefits are often > misunderstood and overrated. now you’re just getting ridiculous. here’s what i said. the only connection you have to make is that risk/volatility generally goes up when a company is growing or dying (i.e. they are not paying dividends) here’s what you said. So Apple and Microsoft during their non-dividend paying years were dying companies? i guess you don’t understand the definition of the word “or”. i know, its complicated. “You could also argue risk is increased during a downturn if the company is forced to adhere to their dividend policy when it’s draining them of cash, forcing them to borrow for liquidity, increasing their cost of capital and lowering their credit rating.” the mere option to suspend dividend and use cash to attain business stability is what makes dividend payers less risky/volatile. even if they have to issue debt at higher than normal prices, the cost of debt is still lower than the cost of equity. what is the option of non-dividend paying, growth companies? issue equity at depressed prices, likely lower than shares were bought back. the effect of suspending dividends has little to no effect on a stock’s long-term value, whereas issuing equity at depressed levels or any value for that matter (i.e. depressed price as well as greater discount to market value) after having bought it back year after year after year is clearly negative to a stock’s long-term value. are you forgetting that it costs money to issue equity? 2-5% depending on liquidity and size. generally, dividend payers do not issue equity, non-dividend payers do. this comes back to risk and the detriment and cost of equity.
and to touch on buybacks and dividends. any company that will never need to issue equity should not buyback. you buyback so that your price is inflated for a possible future equity issue. but why is this even a discussion. the similarity between buybacks and dividends is nearly 100%, but they are not comparable due to the differences between the two types of institutions who use each. these companies tend to be in different sectors or are have different capitalizations. a company that pays dividends would not buyback for the sake that the return of the rest of the market is likely higher than the return of the dividend-payer, thus why they return the excess cash to the investor to use for higher return, equal risk investments.
MattLikesAnalysis Wrote: ------------------------------------------------------- > the only connection you have to make is that risk/volatility generally goes up when a company is growing or dying (i.e. they are not paying dividends) > > here’s what you said. > > So Apple and Microsoft during their non-dividend paying years were dying companies? > > i guess you don’t understand the definition of the word “or”. i know, its complicated. I’m pretty proficient in the usage of the word “or,” thanks. I didn’t understand your comment because it applied to every company - if you’re not growing you’re dying. A company that’s perpetually shrinking will eventually go under or get bought out, and I’ve yet to see a company continue long-term with absolutely no growth. If by dying you meant late late stages of decline, then I misinterpreted what degree of dying you implied. No need to get smart. Finally, once again I wasn’t claiming paying dividends is a poor choice, I just didn’t see the blatant advantage over those that repurchase shares with excess cash. The casual investor seems to view it as a free bonus for holding a stock and seeks out high dividend yields because they feel they will at least attain that annual return, failing to see its effect on the stock price. The real advantages are more latent, because I guarantee the average yield-seeker doesn’t consider the effect on a company’s capital structure as a reason for seeking dividends. Thanks for the input.
growing = above average growth; you need every available dollar for high ROI projects dying = below average growth; you need every available dollar to stuff in your loss sinkhole plenty are between these two classifications. not enough opportunity for the dividend cash which can eventually, in the LR, turn into not enough opportunity for any cash and then you begin to die. but the stage between growing and dying is often and should be the longest part of a company’s life.
Sundevl your intuitions seem pretty mmuch on the mark. As for an infatuation with dividend-paying stocks, only retail investors seem to think dividends add value. The marginal (professional) investors generally don’t care. As is pointed out, dividends are doubly disadvantageous (level and timing) to the taxpaying investor, so are generally to be avoided. (Fund managers are measured on pre-tax returns, so they don’t exhibit the bias against dividend payers that most investors should.) A lot of silly arguments above about correlations between a firm’s being a dividend payer and being more stable or mature or more downturn resistant or whatever. If the investor wants to buy a company with more stable earnings, why not just identify a more stable company and buy it, regardless of their mechanism for returning excess capital? buying a dividend payer because you’re looking for some other characteristic about firm performance is … odd. On a secular basis dividends are dying. They’ve been in disfavor since the safe harbor provisions passed in 1984 allowed for meaningful share repurchase. It’s taking a long time to remove them from capital distribution practice becasue they are notoriously sticky. Companies will in fact pass up NPV-positive investment opportunities rather than cut dividends. (Read any survey from Graham and Harvey, e.g.) If professional investors have a bias, it’s against dividend payers for exactly this reason: dividends reduce financing flexibility The one economic reason that firms have for paying dividends is to allow for capital distribution to targeted shareholders without diluting their stake. For e.g. family-controlled firms this can drive the decision. Excepting this situation however share repurchase is always preferred. You can use this to your advantage. If you believe marginal investors are irrationally favoring dividend payers, then those stocks should be predictably mispriced.
Don’t forget that some countries have mandatory dividend laws. For example, Brazllian companies must pay out at least 25% of profits as dividends.
I would wager that a company that pays dividends returns its capital to investors more effectively than a company that does share buybacks, all things equal. Dividends are paid in nearly all markets. Buybacks are more frequently done in “good” markets.
naturallight Wrote: ------------------------------------------------------- > I would wager that a company that pays dividends > returns its capital to investors more effectively > than a company that does share buybacks, all > things equal. Dividends are paid in nearly all > markets. Buybacks are more frequently done in > “good” markets. This is one important reason why dividends are discouraged: managers will bypass profitable projects in favor of making dividend payments. From http://faculty.fuqua.duke.edu/~charvey/Research/Working_Papers/W71_Payout_policy_in.pdf : "Our analysis indicates that maintaining the dividend level is a priority on par with investment decisions. Managers express a strong desire to avoid dividend cuts, except in extraordinary circumstances… Overall, we find that repurchase policy is better explained by the Miller and Modigliani (1961) framework than is dividend policy. That is, managers clearly indicate that operational and investment decisions are more important than share repurchases. In contrast, for dividends, the level of payout is viewed as being on par with incremental investment, and external funds would be raised before dividends would be cut. " A telling conclusion: "We also find that many of those firms that do pay dividends wish they did not, saying that if they could start all over again, they would not pay as much in dividends as they currently do. "
I think there is a pretty good track record for a buy and hold dividend strategy. It is not for the impatient, it takes time and consistant investing. The main focus should be on companies who are growing earnings and as a result can grow their dividend payout. With years of consistant reinvestment your cost basis is pushed down and your actual yield can be significant. Many of the blue chips have been relatively flat for the last 10 years, but look at the dividend growth. Many of these large companies average 12-15% increases in dividend payouts annually. Lets face it, Warren Buffett isnt holding onto his shares of KO because he’s earning the current 3% div.
Dividends are something like 7% of market returns post 2000…Pre 1999 it was 40% but the game was different.
Years ago the stock market was a meaningful means to investing in companies and improving wealth. Now a days you have better odds down at the casino.
Dividends used to be a majority element in stock investing. Ben Graham’s original II and SA spends a large amount of space talking about dividends and securing "dividend income. Some tax laws passed in 1981 made dividends much less attractive.
Apologies for bringing this thread back, and maybe it’s just me, but does anyone else get royally annoyed by CNBC comparing dividend yields to treasury yields?? (or even corporate bond yields for that matter) Cisco’s dividend initiation caused another round of stupid comments all day long and it boggles my mind that no one stops them. They continue comparing the two as if it’s apples to apples, and as someone who works in a place where CNBC is on all day, it’s driving me insane. A bond yield provides the guaranteed total return you’ll receive if you hold it to maturity (and if the company doesn’t go under if it’s corporate debt). A dividend yield doesn’t guarantee anything other than that you won’t have a -100% return. It’s not accretive and arbitrage theory indicates it will be offset by a decrease in stock price. Not to mention that risk asset aspect they seem to ignore that you could lose a lot more if the stock collapses…