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Dividends? How about Divishuddup!

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December 16, 2009 – Comments (56) | RELATED TICKERS: HAT , R

A few weeks ago I was laying in bed thinking about all the stupid ways people choose to invest money.  The topic was so aggravating it actually kept me awake for several hours.  Since that time the topic has festered in the back of my mind like an un-lanced boil on the rear end of Warren Buffet(that analogy got out of hand).  Consequently, I am going to lance that metaphysical boil for all to see in this blog (by "all" I of course mean the 15 or so people who actually read my blogs).

Dividends.  Of the class of stupid investing theories I find dividend investing the most offensive.  Why?  Clearly it isn't the stupidest, just see this blog by globalsailor as proof.  No, I find dividend investing so offensive because it is so openly accepted and touted.  For example:

Me:  What type of investor are you?

Moron:  I am a dividend investor.  (Said without any embarrassment or shame in their voice.)

At this point I usually slap them.

I know some of you are wondering, “What is wrong with dividend investing?”

I am glad you asked.  Let’s start with the very basic theory of dividend investing which is:  I the investor give a company my money because I believe in their business plan, want to fund their growth, and consequently want to own a portion of them.  The company in turn uses that money to expand their operations and the value of my ownership in that company grows.  Everything is going good until that company then gives me some of that money back.  Why are you giving me money back?  I gave you that money because I want you to grow!  I gave you that money because you can create more value with it than I can through growth!  If I wanted my money back I would just sell my shares! 

When a company pays out a big dividend they send me a clear message that they don’t know what to do with my capital.  They don’t know how to expand, they don’t have new innovation to invest in, they are essentially stagnant.  That sounds like a pretty poor investment to me.  However, let’s assume that a company has truly reached its full potential and truly has no good use for my capital, in this case I would prefer that company buy back shares than pay dividends.  Because at least buying back shares passes the cash through the pricing efficiency gate of the stock market.  

Motley fool says this about dividend investing:

A Fool’s View: Dividends & Income Investing

For those looking for safety and security from their stock portfolio, dividend-paying stocks remain attractive. Over time, dividend payers have historically outperformed other investments, with quite a bit less volatility -- a win-win for investors.

Sounds pretty good right?  My contention with this is:  Because only companies with positive cash flows can consistently pay dividends, the above mentioned historical performance mixes cash generation with dividend payout.  Historical performance fails to separate the two, and I believe the outperformance is a result of the positive cash generation and not the dividends.  While I agree that the volatility is lower, it was still quite erratic during the recent recession.

A final complaint with dividend investing is that it prevents dividend paying companies from optimizing the allocation of their capital.  Once a company pays a dividend, a whole plague of dividend seeking pigeons flock to it and demand consistent dividend payout for eternity.  Is this really the best for the company?  Next year if the company needs that cash for a great growth opportunity it can then choose to either skip the opportunity and maintain a good stock price, or make the right decision cut the (worthless) dividend get the good opportunity and see a huge decline in stock price as all the dividend pigeons take a dump on it and fly to their next roost.

In summary dividend investing:

Adds no true value to the investor has questionable historical results and prevents companies from efficiently allocating their capital.

Feel free to add important points I forgot, or voice your disagreement.  I certainly am not right about everything and contrary to the tone of my blog post I am open to alternative perspectives.

*I am sure that I could show a myriad of other reasons dividends are ridiculous involving tax implications, additional transaction loses on paying out the money, new inefficiencies in the stock price, confusion tracking true historical performance, etc. etc. etc.

**I expect someone to say that the basic theory behind investing is that the investor values the present value of all future dividends.  I would say this is an antiquated and incomplete argument since the majority of the value of an investment is in the ability to sell the stock at some point and not to receive dividends.

***I have several other investing theories I hate, and will post about, if this post gets an adequate response (either positive or negative).

 

56 Comments – Post Your Own

#1) On December 16, 2009 at 11:17 AM, Sozurmama (22.94) wrote:

I'm sure someone will argue that "dividend investors" are constantly buying back in with their money.....but then it would seem the money is changing hands for no apparent reason. People are strange animals :)

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#2) On December 16, 2009 at 11:19 AM, Turfscape (39.82) wrote:

While I disagree with your conclusions...I LOVE this title of this post!

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#3) On December 16, 2009 at 11:19 AM, throwerw (29.55) wrote:

Dividend investing makes sense in the context of somebody who wishes to derive all of their disposable income from their stock portfolio.  That way they don't have to sell any of their long-term investments... they can sit back and let their companies invest part of their earnings at a high rate of return and live off of the rest.

What if the company was unable to deploy all of its earnings at a similarly high rate of return?  As an investor, I would rather the company distribute those extra earnings so I could deploy them at a satisfactory rate of return with another company. I think this is the point of dividends, for the smart companies and smart investors at least.

 

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#4) On December 16, 2009 at 11:21 AM, neskolf (29.89) wrote:

anticitrade-

I enjoyed the read.  Here are a couple of points:

Let’s start with the very basic theory of dividend investing which is:  I the investor give a company my money because I believe in their business plan, want to fund their growth, and consequently want to own a portion of them

I own positions in a couple of companies for the dividend and when I invested into them, funding growth was not a primary objective.  I've gone in knowing that growth is likely to be limited.  If the company is able to grow responsibly, great.  If not, that's not necessarily a bad thing so long as their cash flow remains steady enough to pay the expected dividend.  I guess this is a long way of saying that anyone expecting a substantial dividend return along with substantial growth/appreciation is expecting too much of a company.

When a company pays out a big dividend they send me a clear message that they don’t know what to do with my capital

Perhaps, but not necessarily.  It could also indicate that the company's management is acutely aware of their limitations and have decided to forego risky growth for stable sustainablity.

You've definitely raised some good points.  In fact, I would add that dividend investing is risky in and of itself if the investor simply assumes that the dividend will be paid in perpetuity.  Like any other investor, a dividend investor has to exercise due diligence and vet their holdings from time to time.  Having said that, I think dividend investing is a valid facet to an overall investing strategy when incorporated into the strategy properly.

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#5) On December 16, 2009 at 11:24 AM, SkepticalOx (99.44) wrote:

Good post.

I just want to add a theoretical point to this (that you learn in B-school finance courses). Since the value of a stock is basically the present value of future cash flows, a company's dividend policy doesn't matter. If they choose to pay a dividend, then a future cash flow will decrease by that dividend amount, and therefore the present value will decrease. You can see this with the ex-dividend day effect where on ex-dividend day, a stock will drop by the net after-tax amount of the dividend (it is observable). Basically, a stock trading @ $10 that will issue dividend of $1 will drop by $1 on ex-dividend date, all else being equal and not counting tax. So you'll end up with $9 + $1 = $10. If the company doesn't pay div, then you'll still have $10 (hey look, it's the same!). More info on Wikipedia. (There's also the whole hoopla about creating household dividends).

With that said, the reasoning you gave is probably the better one. If the company is getting insane returns on investment that are beating the pants of the market return, why in the world would you as an investor to get that cash back and try to beat the market yourself? Berkshire is a good example. I'm pretty content with Berkshire not paying a dividend when a certain fellow by the name of Warren Buffett is investing that money.

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#6) On December 16, 2009 at 11:34 AM, anchak (99.85) wrote:

This is an interesting viewpoint.....

It discounts the risk component completely. Yield investing is a middle-ground position.....companies differ in their maturity curve - and approaches to deploy capital.

Most dividend investors focus on Risk Adjusted Returns....where if they can box in variability - the return stream from this style is fairly high.

In yours - Ultra Growth perspective - IF successful THEN BIG

but the math is Expected ( Return) = Prob of Success * Growth

and more importantly the Volatility associated with E(R) .....how does that matchup?

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#7) On December 16, 2009 at 11:34 AM, TigerPack1 (97.83) wrote:

In the beginning, several hundred years ago, the first stock companies were formed as a way to provide dividend income to each small owner of a large business.  When few taxes existed on such, and the U.S. had a gold standard for money with little inflation, interest rates at the bank or on safe bond investments hovered below 3% most every year.  But if you owned a growing business that paid out profits as dividends, you could enjoy considerably better "returns" on your money, than low single digits.

Over time, you are right, taxes have muddled the picture, new risks and rewards have been engineered by market participants, and speculation on higher business worth and stock prices has evolved as the largest driver of stock ownership.  In fact, in the olden days, trading stocks involved very high, fixed costs on an exchange, somewhat similar to trading real estate today!

The advent of low cost trading with deregulation and the computer/internet's invention, continual inflation of asset prices with unchecked money and credit creation, and expanding tax consequences (with new tax code written daily) make the search for dividend income a lower priorty for many investors and busienss owners today than when this organizational structure was first invented.

You are largely correct in that Wall Street and most market participants price stocks and make investment decisions based on projected business worth in 6 months, or 2 years, or 5 years.  In addition, the payout of dividends are taxed twice, while stock buybacks are only taxed once to greater benefit of shareholders.  This taxation situation has led the vast majority of companies to pay less and less in dividends or no dividends out of yearly profits over the past few decades.

Still, some investors prefer the potential for growing payouts through dividends, that do no exist with prefered shares, bonds, or savings instruments.  Warren Buffett is a big proponent of the return of some capital yearly as a way to finance larger and more diversified investment portfolios for buy and hold investors over decades of time.

-TigerPack

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#8) On December 16, 2009 at 11:45 AM, awallejr (81.36) wrote:

I guess you don't even follow all the MMLPs or BDCs that are designed specifically to return profits and capital back to the investor.  Or the whole concept of DRIPs (dividend reinvestment plans).  You'd just rather have a piece of paper that people will buy for say $10 today and maybe more or less tomorrow.

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#9) On December 16, 2009 at 11:54 AM, dudemonkey (37.14) wrote:

I think you can build a legitmate case that if a company can't use a particular dollar in a realistic effort to increase its own market cap by $1, it's more rational to pay it out to shareholders.  You could also make the case that an ever-increasing dividend motivates a rational company to be intelligent with their finances.  If the company fails either of these tests, management of that business may not be rational capital allocators.

I don't invest specifically for dividends, but I don't shy away from them either.  They're a piece of information about the company and the management, and I'm okay if a company wants to pay me to hold their stock.

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#10) On December 16, 2009 at 11:56 AM, portefeuille (99.60) wrote:

----------------

#5) On August 13, 2009 at 1:19 AM, portefeuille (99.96) wrote:
...
For some reason shareholders tend to like money flowing from the company to them (via dividends, buy backs, takeovers, ...) and to dislike money flowing the other way (via stock offerings). I wonder how they would like a negative dividend, hehe ...

----------------

(from here

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#11) On December 16, 2009 at 12:00 PM, dperque (33.67) wrote:

I think TigerPack is right on here - the game has changed, the rules have changed. Dividend investing has a place in today's market for the right investor, but that place is very small and that group of investors is even smaller.

Keep writing! 

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#12) On December 16, 2009 at 12:01 PM, Schmacko (58.18) wrote:

I have some disagreements with your assessment:

"I the investor give a company my money because I believe in their business plan..."

I personally have never given a company money in a stock offering so that they can raise capital.  Perhaps you are a much more wealthy individual than I, but I personally tend to get all my stocks through an online electronic exchange aka the secondary market.  The company I'm investing in has already recieved whatever monies it is going to recieve off their offering long before I hop in.  This may seem like nitpicking but generally companies that are initially offering shares for capital are growth companies that aren't planning on paying dividends anyway where as dividends come from matured value companies.

"....in this case I would prefer that company buy back shares than pay dividends."

I'm fully convinced stock buybacks are absolutely worthless vehicles for driving stock prices higher.  I've witnessed quite a number of stock buyback announcements (both in securities I held and those I haven't) and then watched negligible price appreciation in those securities prices over the coming months.  Add this to the fact companies generally do buybacks when the company is doing well (aka their stock price is high) and quite often issue more shares when the company isn't doing as well and need to raise additional capital (aka the stock price is low).  Everyone knows buy high, sell low is a bad idea.  Stock buybacks also seem to me like a way just to cover the shares that are distributed to executives in terms of compensation.  No, if a company wants to give wealth back to it's shareholders I will take the guaranteed money from a dividend over the smoke and mirrors of a buyback any day of the week.

"Adds no true value to the investor... "

I'm not sure how you can say easily measurable cash inflows provide no value....

A point you missed that I see alot in Latin American countries companies is that in some foreign countries companies are required to payout a percentage of their profits in dividends every year (often because the government has a large stake in the company).  If a government is going to make a company give away money I see no reason for me not to get some of it... especially if that company is in an emerging market and has higer growth prospects than most domestic US corpoations anyway.

On a very similar note you'll see public companies that are a subsidiaries and majority held by a either a holding company, a government, or directly by another corporation and that parent entity is directing the subsidiary to pay out dividends every quarter/month/year/whatevs because the parent entity wants the cash inflows that it brings.  I see no reason why I shouldn't get in on that action either.

I'm not a fullblown dividend investor and would never describe myself as one.  I like a mix of growth vs. value stocks to keep my portfolio diversified.  However dividend yield is one of the things I look at when evaluating a company and a company with a higher dividend yield than another in a similar business can often make the high dividend paying company more attractive to me.

I also get the feeling you aren't a buy and hold investor since you're putting your faith in your trading model.  I think from a buy and hold (for years) standpoint getting some return on your investment while you wait is nice and it definitely makes riding out downturns more bearable. 

 

   

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#13) On December 16, 2009 at 12:29 PM, edwjm (99.87) wrote:

Trees do not grow to the sky.  If a stock is never going to pay a dividend, what is the point of buying it?  Eventually the stock price will reach a peak and decline from there.  Tulips, buggywhips, internet stocks, and many other things have had their peaks and declined from there.  What do the investors have as a benefit then?  Some people are filthy rich and have gobs more money than they can use, but other have scrimped and saved all their lives and need income after they retire.

I would give this post a negative recommendation were that possible.

 Full disclosure:  I am a retired schoolteacher 70 years old.

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#14) On December 16, 2009 at 12:31 PM, davejh23 (< 20) wrote:

I agree with throwerw:

"Dividend investing makes sense in the context of somebody who wishes to derive all of their disposable income from their stock portfolio.  That way they don't have to sell any of their long-term investments... they can sit back and let their companies invest part of their earnings at a high rate of return and live off of the rest."

Your argument seems to imply that everyone should be a growth investor, but I'd argue that growth investing takes much more work, and requires a bit of luck...some growth investors may be wildly successful, but I'd guess that a larger percentage fail at their investing goals.  The wealthiest family I know personally has most of their wealth in dividend paying stocks...of course many of the shares were bought generations ago...but each generation has added to their holdings, and now they all easily live off of dividend checks.  Although their portfolios may have fallen significantly recently, they didn't fall as much as many "growth" stocks, and they've recovered nicely too...only one of their stocks had a dividend cut also (you can probably guess which one) and it didn't affect their total dividend income that much.  Many high beta growth stocks fell 90% when the market crashed, and they may have outpaced the market on the way up, but if the market falls again, they'll outpace the market on the way down again.  Some people don't want to deal with that...if fact, may could care less about their portfolio balance as long as their income remains intact.

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#15) On December 16, 2009 at 12:41 PM, TMFBabo (100.00) wrote:

@edwjm: While I disagree with the statement that all dividends are bad uses of capital, I also disagree with the assumption that stock prices will peak and never go back above that previous peak.  Through inflation and/or real growth, stock prices will often exceed previous peaks in the long-term.  You can cite the NASDAQ bubble or some other extraordinary circumstance to disagree with me, but that brings me to my next point...

If you do see a stock's price go too high too fast, you should consider selling that stock to buy something else.  Stocks are undervalued, fairly valued, and overvalued at different points in its fluctuations, so why should you continue to hold a stock at the time that it's overvalued? If you're lucky enough to have one of your holdings hit new highs, you should strongly consider locking in those profits and buying something undervalued that is far from its peak!

By the way, I'm not trying to slam dividend investing.  I will one day be shifting my money to companies like Proctor and Gamble, which is in my eyes one of the best companies in the world.

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#16) On December 16, 2009 at 1:05 PM, JakilaTheHun (99.93) wrote:

TigerPack,

In addition, the payout of dividends are taxed twice, while stock buybacks are only taxed once to greater benefit of shareholders.

I'm not sure that I'd agree with that.  A stock buyback theoretically increases the value of the stock, but it does not exempt one from capital gains taxes once they eventually cash in.  Hence, both dividends and "stock buybacks" (via capital gains) are taxed twice.  

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#17) On December 16, 2009 at 1:22 PM, JakilaTheHun (99.93) wrote:

Anticitrade,

I actually agree with you and disagree with you at the same time.  Or rather, I agree on many of your points, but strongly disagree on others. 

I agree that "Dividend Investing" doesn't necessarily make a lot of sense sometimes.  But my problem isn't the practice itself --- rather my issue is that many dividend investors will base their investing decisions solely around the payouts of dividends, while completely ignoring the actual risks that the businesses face and potential threats that might undermine that dividend.  

One company that has been a particular source of irritation to me is Frontline (FRO).  The company has a policy of making huge dividend distributions, but oftentimes, their distributions have actually exceeded their cash flows and their entire policy seems astonishing reckless.  Yet, I see people flocking to the stock on the basis of the "great dividend".  In fact, the stock has been valued, for quite a long while, based on completely unrealistic projections.  Compared to its peers, it trades at an absolutely astronomical premium!

So yeah ... I think that investing solely for dividends is quite dumb because if the company's cash flows and financial picture don't support it, they're eventually going to be forced to cut the dividend anyway.  

 

Where I disagree with you is on your critique of the concept of dividends.  Dividends are a distribution of profits.  Not only that --- you might view them as an affirmation of profits.  In an earlier era before the SEC Acts of '33 and '34, 10-K and 10-Q filings, and a great level of public disclosure, this might have been a particularly good thing.  Now, it seems less relevant, but I'd argue it's still not a bad thing.  

Rather, I'd argue that the culture surrounding dividends is the problem.  The concept of "Dividend Investors" (which you effectively critique) create this culture where investors always expect to receive a dividend and they never expect it to get cut.  This isn't realistic for a lot of businesses, so it deters them from ever paying out dividends.  For many other businesses, they continue to pay out dividends even when it's not fiscally prudent to do so.  

But on a more philosophical level, a dividend is a great way to distribute profits back to shareholders and it is a great affirmation of profits.  I don't mind investing in companies that pay out dividends; sometimes, I even prefer it.  But it doesn't make sense for all companies. 

I am buying some dividend-generating companies right now due to the lower volatility and the guaranteed payout in a time of uncertainty.  I view them as better buys right now than bonds because there is more of an upside if the market continues to rise; consequently, there's more of a downside if the market falls, but they are still much less volatile than most of my stock buys.  

I'm also buying a lot of REITs which are required by law to pay out dividends.  Ironically, I really don't give a crap about the dividends with them; I'm just buying because they are undervalued based on net asset values and cash flows.  But the fact that almost all of them have had to cut their dividends has created the opportunity of a lifetime since it chased out all the "Dividend Investors" *temporarily*.  

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#18) On December 16, 2009 at 1:32 PM, JakilaTheHun (99.93) wrote:

Also (for some reason I forget to mention this in my last post),

Dividends allow one to make a profit even if the stock eventually tanks.  

If you buy in at $50 and the following chain of events happens:

Y1:  Stock = $55, Dividend = $2

Y2:  Stock = $60, Dividend = $2.50

Y3:  Stock = $70, Dividend = $4

Y4:  Stock = $75, Dividend = $5

In Y5, the company begins to flounder as competition undermines their niche.  As such the stock tanks

Y5: Stock = $30, Dividend = $0

 

In this scenario, if you bought and hold for the long term, you collected $13.50 in profits, even if you lost $20 in value on the stock.  Hence, it wasn't a total waste.  If the company had not paid out a dividend, it's likely that the stock would have jumped slightly higher during the "good times", but it would still be trading at $30 in Y5.  You would've lost $20 rather than $6.50 in that case. 

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#19) On December 16, 2009 at 2:21 PM, RonChapmanJr (56.93) wrote:

Dividend investing allows for residual income with very, very little work.  For people without the time or inclination to follow stocks closely, this can be a great thing.

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#20) On December 16, 2009 at 2:27 PM, WillSurfForFood (76.45) wrote:

I understand your point but the case for or against dividends is more complicated. You are assuming that all companies are striving for unending growth which is not really possible. Eventually the ROI on growth sees smaller and smaller returns. At some point it is better to start returning some of the profit to shareholders. You may not like these types of companies but they can be good investments, there have been studies showing that dividend companies outperform non dividend companies. All this means is too many people often overpay for growth potential. 

Take a company like Starbucks, 10 years ago it would have been dumb for the company to issue a dividend but now perhaps not so much. How many Starbucks stores should there be per block. Sure they are trying to grown in China and other places but at some point attempting to grow becomes counter productive. They could start buying coffee producers but this often leads to "deworseafication" as Peter Lynch would say. At some point they should start returning profits to shareholders.

A dividend also tends to keep a company a little more in tune with shareholders interests in my opinion. Issuing a bunch of stock options to company insiders becomes really expensive with a dividend. A company like Cisco should probably start issuing a dividend but they also continually dilute there shares so it would be painful for them. 

 I hold dividend and non dividend paying companies.

 

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#21) On December 16, 2009 at 3:02 PM, DivMonk (68.09) wrote:

Dividend stocks have a place in my portfolio.  Or maybe instead of calling them "dividend stocks", I should call them "stocks that happen to pay a dividend", because dividends are one of the smaller things I look for in an investment. 

A smaller company generally should not pay dividends, because hopefully they can put the capital to better use than I can.  When I invest in a smaller company, I expect growth through reinvestment of earnings. 

As a company gets larger and larger, however, it is not reasonable to expect continual 15%-20% growth over the decades.  (Companies like Berkshire can do this because they invest in other companies instead of growing a product line organically, but the majority cannot.  In fact, Berkshire basically runs off of growing dividends.  Most of its owned shares pay dividends (Coke, Costco, Walmart, etc.), and its wholly owned subsidiaries pay Berkshire a percentage of their profits each year as well, which Buffet skillfully reinvests in other companies.)  If a large company can manage 9+% growth while giving a 3% yield for a long amount of time, that's favorable.  If, instead, a small company grows into a medium or large company, and growth slows down yet they don't pay dividends, then capital is often wasted. 

Take a look at Cisco as an example.  Shareholders haven't had gains from that company in 10 years, despite reasonably sustained growth.  It's capital is largely wasted.  Johnson and Johnson, which has also had flat stock while growing income, has rewarded shareholders through continually growing dividends, which are now triple what they were 9 years ago.

It's also not necessarily true that dividend companies grow more slowly than similarly sized non-dividend payers.  If they are well managed, they can often sustain considerable growth while also providing a 1, 2, or 3% or more yield.  All of my dividend-paying companies were chosen for their decent growth prospects, and the fact that they pay a dividend is a bonus.  An extra 1 or 2% annual portfolio goes a LONG way over the decades.  

Lastly, you discuss the irony of a company giving money back that it has been given.  Yet ultimately, that's the entire point of a company- profits.   If I buy a restaurant, I plan to earn money from it every year.  That's what the owner of a typical and mature business does- they earn part of the profits and reinvest part of the profits for growth- and growth of future profits.  Also, to nitpick, most investors haven't given their companies any money- they instead gave the person they bought the shares from money.  Companies only receive investment capital from shareholders by IPOs and other share offerings.  

So, while you raise a few reasonable points, I mostly disagree with your post.  The only thing about dividends that bugs me is double taxation.   

 

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#22) On December 16, 2009 at 3:11 PM, globalsailor (46.51) wrote:

Thanks for the note anticitrade.  So here was my real question: where do economic rights begin and voting rights end?  I used BRK-B as an example because the stock has 1/30 of the economic rights and 1/200 of the voting rights.  It took a while to figure out that if BRK were to ever do a dividend, the B's would get 1/30 not 1/200 of what the A's would get.

Oh and for some good companies dividends make sense.  Some companies produce quality goods or services but believe that the market is saturated and don't think that it is worth the cost of exploring new businesses.  Grant it, these aren't high growth companies, but they're stable and will give you cash while you wait.

So, what is a dividend investor?  Somebody who wants to invest in very stable companies that don't take too many risks.  This person is probably within fifteen years of retirement or needs the money for an important expense.  They probably won't beat the market, but they won't lose too often either. 

I'm a college student so I'm not really on that list.

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#23) On December 16, 2009 at 3:18 PM, chk999 (99.97) wrote:

For a different viewpoint, read "Stocks for the long run" by Jeremy Siegel. Over long periods of time, most of the return comes from reinvested dividends.

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#24) On December 16, 2009 at 3:23 PM, vriguy (77.51) wrote:

You are setting up and demolishing a straw man as only a fool invests purely for a dividend - without regard to important aspects like safety, expected growth, the type of business, etc.  For most folks PG and JNJ are wonderful investments - and yes, they pay dividends. Will they grow at a torrid pace? no.  Are they safer than some faster growing small cap? hell yes.

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#25) On December 16, 2009 at 3:29 PM, TMFBabo (100.00) wrote:

I'd also like to add that there are many companies with extra cash flow and bad management.  In these cases, I'd prefer that the company pay out the extra cash in a heartbeat.

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#26) On December 16, 2009 at 3:38 PM, goalie37 (92.77) wrote:

While I disagree, I think this is a great post.  I am going to think on this a bit and reply.

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#27) On December 16, 2009 at 3:45 PM, goalie37 (92.77) wrote:

A couple thoughts come to mind.  If earning a dividend is a waste of time, does this also apply to bonds and saving accounts because they pay interest?  What about owning a small business because as the owner you might make a profit?

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#28) On December 16, 2009 at 3:50 PM, anticitrade (99.61) wrote:

First of all, thanks.  This response was above and beyond even my wildest expectations (and believe me, my expectations can be pretty wild).
I think it is fairly obvious that there are some situations where dividends has a place (I certainly feel more this way than I did when I wrote this post).  However, I will still try to address your arguments that I believe are not fully justified.


Sozurmama, SkepticalOx, dperque,

I totally agree.

Turfscape,

I also like the title of this post.  I was thinking of using: “Dividends?  I Dividon’t.”

Throwerw,

Dividends as an income stream makes some sense (if you live bizarro world).  However couldn’t you just sell a few shares once a month and accomplish the same thing?  The transaction costs should be pretty negligible and you wouldn’t have to depend on the companies paying a consistent dividend.  However the “sitting back” you mention does sound pretty nice.

If the company cannot deploy their capital in worthwhile investments I think they should buy back their own shares of the company.  Theoretically they could do this in such away to better control their own stock price (buying when its low).

Neskolf,

Glad you enjoyed it.  You make a lot of good points.  I agree that a lot of companies with extra capital on hand are pressured into using it irresponsibly (a lot of mergers and acquisitions come to mind). 

My only real argument against your points is that buying back shares should accomplish the same objective as paying out dividends.  However, I recognize that these two methods are not valued equally in the market.

Anchak,

I don’t completely understand your comment (feel free to elobrate).  I discounted the risk component because I believe with a constant dividend payout the risk is just allocated in a greater percent to the company instead of to the investor (company is locked into a regular dividend)…  And because the investor owns the company, he also still owns the same amount of risk except now he also owns an expectation inefficiency. 

For the record, I consider myself a strict fundamental value investor.

Tigerpack,

Thanks for the background information.  It seems that the basic dividend philosophy has become a bit outdated, especially given the low transaction costs. 

Awallejr,

You are correct sir.  I also don’t understand the “cash back” deals when people buy a new car.

Dudemonkey,

You make some good points.  Although I don’t think being locked into a dividend policy helps motivate a company to be any more rational with their finances.  It seems like it may do more to motivate them to control their growth (maybe good maybe bad).

Port,

A negative dividend is easier for me to justify than a positive one:  “Hey everyone, we want to build a new plant so why don’t you all chip in a few more bucks and we will get this sucker built.”

Schmacko,

It does seem like nitpicking.  You don’t have to be in on the initial public offering in order to invest in a company because you like their business plan.  Even if your investment does not directly go to the retained earnings of a company, when you buy a share you do make more capital available to them (although they would have to issue more shares to take advantage of it, or compensate their employees with stock options or treasury stock).  Generally, stock buy backs are not of a sufficient magnitude to drive massive changes in the stock price.  However, as a fundamental investor, I am keenly aware of how much value the company has per share of stock.

As previously mentioned, I suppose there are circumstances where regular cash inflows have some value to investors.  But I think the low transaction cost of selling shares makes this value pretty easy to dispute.

I was not aware that companies in Latin America were required to pay out a dividend each year.  If value is being paid out to the government for being a shareholder, I completely understand investors wanting their share (although, I would prefer the company to use their money to buy out the governments share).

I would really like to be a buy and hold investor but with the way stock prices are changing lately, I find myself moving through stocks much quicker than I expected.  However, my investing philosophy is based on a buy undervalued and sell when overvalued strategy. 
Thanks for your thoughtful comment, you educated me on several aspects of dividend investing I was unaware of.

Edwjm,

Oh blerg.  The market is full of stocks that have never, and will never pay a dividend.  Are you suggesting that these stocks are worthless because they don’t pay out a dividend?  I agree that a stock is worth the present value of all future cash flows to the investor, some of these cash flows are in dividends others occur when the stock is sold. 

 “Some people are filthy rich and have gobs more money than they can use, but other have scrimped and saved all their lives and need income after they retire.”

I am sure those “scrimpers and savers” are fully capable of selling shares of a stock when they need cash and don’t necessarily require the dividends vehicle to get their value.  I do agree that growth stocks are not necessarily a good strategy for people who depend on that money in the short term.

While the posting system does not allow for negative recs, I will do you the favor of always subracting the number of recs by one when I look at this post (if only in my own head).

Full disclosure:  I am young, reckless and completely devoid of piss and vinegar.

Davejh23,

Check out my comment to throwerw.  I agree that investing in the right growth companies is not a simple task.  In fact I would even argue that investing intelligently in general is not a simple task.  I think people deceive themselves into thinking that dividend investing has less risk and requires less work/luck.  I am sure that this market has a number of examples of times when dividend investing proved itself to be risky.  

I don’t believe everyone should be a growth investor (I myself am really more of a value investor).  If you are trying to decrease your investment risk I think index funds are really your best vehicle.  It would be interesting to see how the S&P 500 index fund performed against an index fund made entirely of dividend stocks…. (good comments by the way)

Bullishbabo,

Thanks for your comment.  It nicely compliments my own response to edwjm (and congratulations on your score).

Jakila,

I am not sure about all the tax implications, but it seems to me that if you are taxed on the dividends and you then plow that money back into the company, when you eventually sell you will have been taxed twice on all the money that you plowed back in?  (I am not really sure as I skipped any class with the word tax in it during my MBA)

Disagreeing and agreeing with any of my posts is probably a prudent path.  Actually your fist point about investors being blind to the company underneath the dividends is one of my biggest complaints with this style of investing (I am glad you mentioned it).

The distribution of profits has been discussed pretty heavily in my previous responses so I will focus on your unique idea of “affirmation of profits”.  I think we both agree that with the new transparency that the SEC and the internet bring to financial statements that the “affirmation of profits” is probably best done by an investor looking directly at the financial statements.  However, many investors don’t do this, so I can see how dividends may issue a positive cash flow flag for them (although if companies are obligated to maintain dividends regardless of cash flows this flag is somewhat suspect). 

The argument I can’t disagree with is that dividend stocks absolutely add diversity to a portfolio and lower some of your risk.

Your final comment (at least as I write this) I do have some disagreements with. 

Using your same scenario I would argue that the final stock price without dividends being paid out should be:

$30 + $2*I^4 + 2.5*I^3 +4*I^2+5*I^1

Where “I” = (1+ whatever rate of return the company makes on their capital)  If we assume the company gets 10% return on their capital then the true value of the stock at the end would be: 46.6  The real return for you would then be:  -6.8% while the return in the dividend scenario (assuming that you can get 10% return on your money which seems pretty optimistic) they would be equivalent investments.  However, the whole point in investing in this company is that it can do MORE with your capital than you can.

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#29) On December 16, 2009 at 3:59 PM, PaxtorReborn (29.91) wrote:

I think what it boils down to is dividends aren't as relevant for active traders, but can be the reason to buy a stock for investors (as long as you regard the fundamentals as Jakila suggested).

IMO dividends are very important in large or mega caps, but can be a warning sign in small caps.

 

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#30) On December 16, 2009 at 4:44 PM, WillSurfForFood (76.45) wrote:

One last point, you state that buying back shares is preferable to paying out a dividend. In theory they should amount to the same thing but in practice I think the dividend is usually better. Take a company like Cisco ( I used to work for them and they were a good place to work), they dilute their shares by issuing a lot of options and they occasionally use earnings to buy back shares. Really this only helps to support the stock price against the dilution and helps the people granted options. It really doesn't do much for the investor holding on to shares, much better for that person if the company didn't issue so many options and just returned some money as a dividend. A dividend encourages people to hold on to shares. Also companies often seem to be a bad judge of when to buy back shares. Most of the buybacks occur when the economy is great and the stock prices are most inflated.  If a company has a commitment to pay out 30% in earnings as dividends then I'm all for them buying back shares with additional money, makes it easier for them to raise the dividend in the future. The tax implications of receiving a dividend is one reason to prefer a company not issue them.

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#31) On December 16, 2009 at 5:23 PM, Option1307 (29.89) wrote:

Awesome post Anticitrade, way to get a lively discussion going!

I see your point and I have to say I agree with many parts of it; however, I've always believed that Dividend investing can make up a percentage of any portfolio. Depending on where someone is in life/etc. dividends can make some sense.

It seems that you have a more agressive style of investing, which is great b/c I think you're young-ish and can afford to take risks. I'm in the same situation as you. But for someone who is closer to retirement, has little time for investing, etc. dividends can be great and provide a means of income with very little work/thought.

Again, great post!

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#32) On December 16, 2009 at 5:27 PM, awallejr (81.36) wrote:

"You are correct sir.  I also don’t understand the “cash back” deals when people buy a new car."

More a tax gimmick than anything short term. You don't pay taxes on "dividends" in  MMLPs until after you pass your cost basis.  So technically the first 100% return is tax free, but all subsquent payments are then taxed normally.  However, you do get hit harder come sale time since your basis will eventually be zero (assuming you do eventually sell, but then it would be at capital gains rates). You would have to hold the stock for quite some time before reaching that point. BDCs are like REITs in that they are obliged to return 90% of their profits back to shareholders.

I wouldn't dis the dividend payors as a general rule since it really is too simplistic to do.  While certain types of companies you don't want to be paying dvidends, like a budding tech company for example, other companies are designed specifically for paying dividends, such as the MMLPs.

Also people do invest in utility type companies (phone companies, cable companies, electric utility companies) for the income with a hedge towards future payout growth.

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#33) On December 16, 2009 at 6:01 PM, kaskoosek (85.41) wrote:

A stock that will never pay a dividend is pure and entirely a "bubble".

 

Try to think about it a bit more and then get back to me.

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#34) On December 16, 2009 at 7:54 PM, truthisntstupid (87.13) wrote:

Well. let's see

If UPS earned a return on equity of 25% in 2006 (and it did, and it also did so the past couple years) then it could grow tremendously by retaining all its earnings and buying even more vans, buildings, planes,etc.  If it could maintain this ROE and retain all earnings, it should grow at about 25% annually.

UPS had over $47B in sales in 2006.  It employed 428,000 workers.  Growing 25% a year would require it to about double those numbers every 3 years.  UPS cannot possibly realistically retain all those earnings and keep being able to reinvest them into the business for a 25% growth rate.  No way.  Otherwise, UPS will be taking over the world in a few years.

But since UPS pays a dividend, its sustainable growth rate is less than 25%.  Sustainable growth rate is: (1 - payout ratio) X  Return on Equity.  UPS can lower its sustainable growth rate to a much more realistic figure by a combination of dividend payments and stock buybacks. 

UPS paid out about 40% of its earnings in 2007.  (1 - 40%) X 25% suggests a 15% growth rate.  UPS can't realistically expect to double in size each 5 years either, though.  (I'm sure you're familiar with the rule of 72.)  So the earnings that aren't going out in dividends and exceed the amount that can be reinvested in the business with any realistic expectation of producing an adequate return typically go into share buybacks.

Share buybacks are usually a bad deal for the shareholder.  The company in question, as someone previously observed, seems always to buy back shares at the exact worst times - when the company and the economy are humming along nicely and the share price, consequently, doesn't make it the best investment.

So - what next?  You may think about acquisitions.  Ever notice that little balance sheet thing called goodwill?   Companies rarely get what you as a value investor would call a great bargain on acquisitions.  They pay retail.  And the result of that shows up on the balance sheet as goodwill.

Lastly, I'm sure there should be plenty of people around who could tell you all about planning on X amount of growth each year to sell off shares and provide them with income.  One down year does irreparable damage to a person who thinks they are going to fund their retirement this way.  Two down years and there's probably no coming back.  Plenty of mutual fund investors last year learned why some of us dividend investors call this dollar lost averaging.  It's dollar cost averaging - in reverse.  And it's disastrous.  Just as dollar cost averaging causes you to pay a lower average price per share when you're buying, dollar lost averaging will cause the amount of money you get for your shares to average lower when you are funding your retirement, bills are due, and you have to sell when the price is down.  When the price is down, to generate $500 in income you'll be forced to sell more shares than you would if the price was up.  But you have no choice - this is how you planned on funding your retirement.

People who invest for dividends may not be as studious as they should be, you say?  You are right.  Some probably aren't.  But by education and study dividend investors can usually avoid losses because they can and should be reading and learning how to watch companies for telltale signs of a possible dividend cut pending.  High payout ratio, negative cash flow from "one-time nonrecurring"  items that after all do keep "recurring,"  slowing rate of growth, eroding margins, eroding moats...there is a long list of things a dividend investor wants to keep an eye on.  This is not the lazy way if it's done properly.  But it can be a very, very safe and dependable way to build a retirement income. 

If a company has a relatively low payout ratio and is a market leader with a strong, wide moat, and a dividend growth rate averaging 15%  (PEP)  when you buy shares if the company can maintain that dividend growth rate you stand to see your dividend DOUBLE every five years or so.  There are people who started buying shares of companies like Pepsico, Procter & Gamble, Altria, and others twenty and thirty years ago that will never have to sell any shares.  Pepsico has increased its dividend for 37 consecutive years; Procter & Gamble something around 55 years.  Neither one is stressed by its dividend, PEP has a payout ratio of only 52%, P&G has a payout ratio of (I think) about 40%.  Neither could have reinvested all those billions of dollars back into their business each and every year and managed to have achieved a return that would have justified keeping the money.  Companies can't beat the law of diminishing returns.  A corporation needs to provide for a realistic rate of growth at a high return on equity.  Excess cash beyond what can be realistically reinvested should be returned to the shareholders.

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#35) On December 16, 2009 at 8:31 PM, Option1307 (29.89) wrote:

Neither could have reinvested all those billions of dollars back into their business each and every year and managed to have achieved a return that would have justified keeping the money.  Companies can't beat the law of diminishing returns.  A corporation needs to provide for a realistic rate of growth at a high return on equity. 

This is really such an obvious point, but I don't think many people realize this. I'm glad you brought it up. Good thoguhts all around.

I think you are both essentially right. It jused depends on what reason you are investing for.

There are people who started buying shares of companies like Pepsico, Procter & Gamble, Altria, and others twenty and thirty years ago that will never have to sell any shares.

Couldn't agree more here. For example, my grandmother has been living very comfortably off of here Altria dividends for many years now (7+ yrs.) and will continue to do so. For her, and others like her, dividends are a steady stream of cash with little/no effort.

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#36) On December 16, 2009 at 8:52 PM, anticitrade (99.61) wrote:

truthisntstupid,

Bravo my good man!  I am speachless.  Literally, speachless (thankfully, I still seem to be able to type).  Your comment pretty much sums up everything I learned from my post today.

The major flaws with my argument were:

Dividend stocks add value to a portfolio because they add diversity and can lower overall risk.

Companies that are generating more cash than they can responsibly use need a good avenue to disperse those earnings to investors.  While I still contend that stock buy-backs are theoretically the best avenue for this, it appears that there is a significant deviation from the theory and the practice.

Finally, investors of an advanced age gain additional value from a position in a stock that pays a regular dividend.  This value comes from the arguably lower risk and ease of receiving their value (don't have to sell shares).

Thanks all for your comments! While I am not ready to start filling my portfolio with dividend bearing stocks, I will probably stop slapping people who do.

Someday in the near future I hope to do a follow up post about the next investing style I hate......

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#37) On December 16, 2009 at 9:09 PM, truthisntstupid (87.13) wrote:

Anticitrade

Having read your blogs before, I am sure you are pretty intelligent.  Intelligent people have open minds.  Twenty or thirty years ago I felt the same way and had much the same attitude toward dividends you describe in your blog.  If you are ever curious enough to want to see more of the dividend investor's viewpoint, I would suggest a shortcut as opposed to waiting twenty or thirty years.  Buy and read "The Ultimate Dividend Playbook"  by Josh Peters.  I think you would be very surprised.  By the way, Josh Peters is the guy who runs the monthly newsletter DividendInvestor at Morningstar.

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#38) On December 16, 2009 at 9:23 PM, ozzfan1317 (78.57) wrote:

Dividends have their place in most portfolios but you should still closely research a company before buying except maybe KO which will probably still be here 200 years from now.

I own non dividend payers as well. My current non dividend holdings are Ebix,Dar,Ktii,

However a dividend is a good thing as well it makes it a lot easier to stomache a big drop if a portion of your portfolio is paying you to be patient. 

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#39) On December 17, 2009 at 1:26 AM, motleyanimal (85.87) wrote:

Strong companies can afford to pay dividends. The weak do not.

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#40) On December 17, 2009 at 9:54 AM, Turfscape (39.82) wrote:

motleyanimal wrote:
"Strong companies can afford to pay dividends. The weak do not."

So is Apple a weak company? I would imagine a LOT of people would disagree with that sentiment...

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#41) On December 17, 2009 at 10:08 AM, SkepticalOx (99.44) wrote:

#40. I think the "can" part of his statement is important. Apple CAN choose to pay a dividend, but right now it's basically a money-making machine so both the company and investors are content.

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#42) On December 17, 2009 at 6:11 PM, Robuh (24.52) wrote:

This is pretty silly. Dividends are the only reason to own a stock. Why else would I want ownership of a company? To sell it to the next person that can never hope to get anything out of ownership? Dividends are the fruit born from a successfully grown and matured business. 

Expecting perpetual dividends is foolish. But what is far more foolish is the expectation that a company can perpetually grow. Running a company over the long term is incredibly difficult. Look at the companies on the DJIA now compared to 30 years ago. 

Until you acknowledge that all companies have a lifecyle (they're born, they live, they die) and you want to get something out of that life you're just buying tulips at $300 a bulb.

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#43) On December 17, 2009 at 9:21 PM, truthisntstupid (87.13) wrote:

Turfscape

 Only a person living in their own separate reality would try to claim Apple is a weak company.  Still, a share of stock is a claim to ownership of a "share"  of its future cashflows.  Skeptical ox put his finger right on it.  Stocks are or should be valued on the basis of the net present value of their expected future cash flows.  This is even true for companies that pay no dividend.  In their case, what counts is the capacity to return value to their shareholders.

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#44) On December 18, 2009 at 1:02 AM, simplemts (< 20) wrote:

"#40) On December 17, 2009 at 9:54 AM, Turfscape (25.19) wrote:

motleyanimal wrote:
"Strong companies can afford to pay dividends. The weak do not."

So is Apple a weak company? I would imagine a LOT of people would disagree with that sentiment..."

 

No, Apple is a strong company that COULD afford to pay dividends but does not.  His statement did not say that ALL companies that do NOT pay a dividend are weak.  He is simply referring to the fact that when a company is paying a dividend  it is sending a signal that it is strong.  Obviously, a company can become weak and that is when it cuts its dividend.

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#45) On December 18, 2009 at 2:52 PM, truthisntstupid (87.13) wrote:

I have one last comment.  I am a typical dividend investor, mindful of things a typical dividend investor should pay attention to.  When you read my post above, does it sound like a typical dividend investor is "blind to"  the company and conditions surrounding a typical dividend investment?  An analysis evaluating the company's financial liquidity, solvency, future prospects, profitability, and cash flows are all part of any dividend investor's evaluation of a prospective investment.  I don't know where people get the idea that most dividend investors are ignorant and do no due diligence.  I'm sure there are many that seek to attain their "margin of safety"  simply by diversifying the hell out of their portfolio, which may just provide satisfactory results for many income investors.  There may be many people that use such a "shotgun"  approach to dividend investing, but I feel there's probably more that like to study and learn and avoid the potential downfalls of such an undisciplined approach. 

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#46) On December 19, 2009 at 9:00 PM, bullshiite (32.80) wrote:

Why do companies pay dividends?

Because the weighted average cost of capitol, of dividend payments to shareholders, is less than the cost of capitol from another source.  

Also, I think of dividends as more of a marketing tool that a company can use to attract a specific type of investor, mutual fund manager, etc. 

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#47) On December 20, 2009 at 9:51 AM, chk999 (99.97) wrote:

Here's a very interesting post from mungofitch who is one of the MI board stalwarts. In it he does a blended strategy that shifts between dividend stocks and growth stocks. This is really worth reading.

 

http://boards.fool.com/Message.asp?mid=28174010&recscode=2

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#48) On December 23, 2009 at 11:05 AM, walt373 (99.83) wrote:

The major appeal of dividends is that the cash received from dividends is totally in your control. When a company makes money, that money technically is owned by the company's owners. But sometimes it is not used in the owners' best interests - the money is wasted in overpriced acquisitions, reinvested in the business at a rate of return that is below the cost of capital, used to pay management huge salaries, or just sits on the balance sheet doing nothing. Often times, the investor could do much better with the cash themselves if it was returned to them, even when a chunk of it is used to pay taxes. Of course, sometimes it's better for a company to not pay a dividend - if the company has good reinvestment opportunities or if the company has some very good capital allocators (example, Berkshire). But for many companies, this is not the case.

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#49) On December 23, 2009 at 11:47 AM, anticitrade (99.61) wrote:

Walt,

If you can use the money better than the company can itself, why are you giving them money in the first place?

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#50) On December 23, 2009 at 12:53 PM, truthisntstupid (87.13) wrote:

Anticitrade

We're still having this conversation?  You strike me as too intelligent to be this hard-headed.  I realize you are a very good trader and do very well with the investing style you have chosen.  But other people just don't want to rely on realized gains from price movements to realize the value of their investments.  We invest in order to participate in the company's growth too - we just have a different way of going about it.  In my UPS example, the fact that it generates far more cash than it can responsibly use doesn't make it a poor investment.  It just makes it a different kind of investment. Shareholders that bought it for the dividend years ago are now receiving a yield on the original cost of their shares that is much higher than the dividend yield was at the time they bought the shares because of the annual dividend growth.  You are taking the view that the only thing that makes sense is to buy and sell businesses at a profit and attempting to invalidate someone else's desire to just keep their shares of the business for the income.  And as I pointed out, and as Walt points out, if the company keeps more money than it can responsibly use, the shareholder's return on equity will take a hit.  The company has a duty to the shareholders to maximize return on equity.  That's 25% for UPS in my example above.  So for every dollar of shareholders' equity, the company generates $1.25 in profits.  That's pretty good and people want a piece of that.  Tackling projects that are below the company's cost of capital just because "they have this money they need to do something with"  will cause return on equity to decrease and it won't be as good an investment.  A company needs to target a realistic and achievable rate of growth at the highest possible return on equity or shareholders will put their money someplace else. 

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#51) On December 23, 2009 at 1:02 PM, anticitrade (99.61) wrote:

Truthisntstupid,

Once again, I agree with you.  My point in my last comment is if as Walt says:

"the money is wasted in overpriced acquisitions, reinvested in the business at a rate of return that is below the cost of capital, used to pay management huge salaries, or just sits on the balance sheet doing nothing"

If a company can only choose between paying out dividends and doing what Walt describes, I think I can find a better investment.  The dividends may be great, but you still should be concerned about yoru principle.

I apologize if my comment seemed more disagreeable than I intended.

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#52) On December 23, 2009 at 1:08 PM, truthisntstupid (87.13) wrote:

I've almost talked myself into buying UPS because of you!!  Haha.

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#53) On December 23, 2009 at 2:49 PM, stocki711 (98.87) wrote:

On dividend investing:

"Adds no true value to the investor has questionable historical results and prevents companies from efficiently allocating their capital."

I believe it adds negative value as stated many times. To comment on a non-dividend stock also being "taxed twice", my response is that a dividend stock is double taxed 4 times a year (usually) thus the value it gives to stockholders in less than the total value paid out. Also, a dividend stock is "taxed twice" because there is hopefully a capital gains tax  on any stock you buy. I would even say that you lose more on dividend stocks than if it didn't pay a dividend because generally dividend stocks are buy-and-hold types. If it didn't pay dividends and over tax you along the way than you would only pay 10% on your entire capital gains. 

I also think that share-buybacks do nothing but concentrate your ownership of the company. This does not effect the overall value of the company since the company has less cash in place of the shares and should be reserved for companies expecting growth greater than the market return. I would also think you'd need high margins (or lack of much new capital) to really get a good return and should probably be reserved for up-and-coming tech companies who can use extra cash if and only if they are growing. 

I wonder why more companies do not have a significant equity securities portfolio. A lot of companies with excess cash purchase fixed income instruments instead of equity securities which has been shown countless times to usually out perform all other asset classes including bonds. Diligent stock picking as done by Berkshire over the past 30 years has given the largest, most consistent return of any other investment I know of in that time frame. He did this without dividends (minus one $0.10 payment) and share-buybacks. Most of the value he created did not come from Berkshire Hathaway Textiles but from conservative equity acquisitions. Why don't more companies take those dividend payments and convert them into any other investment made by the company. Even if the company slightly under performs the market they are likely to do better than an average shareholder could because the over taxing of dividends causes the shareholder to lose value before receiving their payment. 

I agree with Anticitrade that "Moron:  I am a dividend investor." this kind of investing bothers me quite a bit but is also the reason anyone can out perform the market consistently. There is only one type of investor and that is a value investor who considers a margin-of-safety and buys assets for pennies on the dollar.

Finally, a defense of dividends:

If you can use the cash flow (dividend) to reinvest that money at higher returns than a company can than you should buy dividend stocks. Berkshire Hathaway has successfully used this principle to help with long-run out performance. They use cash flows of 4% on their $60B portfolio to finance many of their acquisitions and loans given out. He knows he can get more than a 4% return on these dividends (GS and GE warrants) so he buys dividend stocks to have a steady cash flow ready. This is the transitive postulate from earlier. "If company cannot get a return higher than market average than they should pay out dividends to shareholders." So if shareholders can get a higher return than the company they should buy the shares to use the free cash flow for their own use. This is also similar to how Berkshire purchases reinsurers for access to cheap money (float). 

I say all of this with my largest holding being Verizon and I will never sell it. I love the 7% dividend I currently have and think it is the safest and strongest investment I own. I understand I currently receive a true dividend of about 6.5% after taxes and that is frustrating but if there is any reason to be a dividend investor it is to eliminate some of the volatility from the investment.  

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#54) On December 23, 2009 at 3:59 PM, truthisntstupid (87.13) wrote:

Berkshire Hathaway also used that principle to become Berkshire Hathaway.  More than three decades ago. Buffet's strategy began to change.  He started buying whole companies, taking them off the market.  Us little people may be willing at times to sell our little pieces of ownership at ridiculously undervalued prices, but a wise businessperson who owns entire companies is not.  Buffet shed his opportunity to trade these businesses on the market, trading it for a return he viewed as far more valuable.  That return is the dividends, large and growing ones, he receives from companies he owns outright.  Dairy Queen doesn't simply sit there stagnant.  It never stopped growing.  The same can be said of the other Berkshire companies.

We don't see these payments because they are made under the larger umbrella of Berkshire, but they were significant then and only went on to become moreso.  These cashflows of the companies he bought are a large part of what built Berkshire. 

"Our favorite holding period is forever."  That is something a dividend investor would say.  Otherwise. how would he ever receive value from his investments?

Darn few of us will ever be buying whole companies.  That does not stop us from employing the very same investment philosophy.  Mr. Market doesn't pay dividends.  Only the underlying companies do that.  And you can short a good dividend stock all you want. After reevaluating the financial soundness and solvency, profitability and cash flows along with the competitive advantage they believed the company had when they bought it, if you manage to drive the price down, dividend investors will only be lining up to buy more.  Dividend investors try to seek their return outside of the market.  The market is only where they have to buy their shares. 

Most dividend investors do thorough research to assure themselves of a prospective investment's ability to maintain and grow their dividend.  They analyze payout ratio, margins, return on equity, cash flow.

Return on shareholders' equity becomes more than just a number.  Return on equity is assets/equity X revenues/assets X profits/revenues.  The last two are actually asset turnover,  and a good indication of just what kind of return on equity a company would get in the absence of financial leverage. 

An investor investing money into market-leading companies for dividend income looks at all these things, and also wants a competitive advantage that will make it harder for competition by other companies to threaten his company's ability to maintain and continue to increase his dividend each year.  The quality of a company's moat is important, and the less subjective this evaluation is, the better.

 We buy the dividend.  We research the hell out of a prospective dividend investment and trust in our research to provide for the safety of that dividend.  We attempt to seek safety in research and do not overly concern ourselves about fluctuations in share price.  If we've done the work we should have, most of the time a falling share price merely signals an opportunity to buy more, because we are watching that company's financial position.  If that financial situation starts deteriorating, we will often be the first ones out.

 

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#55) On December 24, 2009 at 1:49 AM, walt373 (99.83) wrote:

Walt,

If you can use the money better than the company can itself, why are you giving them money in the first place?

As a self-proclaimed value investor, you should know the answer to this question. There are many companies that are terrible capital allocators. But, even the worst company can be the best investment, at the right price.

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#56) On December 24, 2009 at 10:52 AM, truthisntstupid (87.13) wrote:

The last two are asset turnover, and a good indication of just what kind of return on equity a company would get in the absence of financial leverage.

Oops.  The last two, revenue/assets X profits/revenues, make up return on assets, not asset turnover.

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