Dividends? How about Divishuddup!
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).