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ikkyu2 (99.45)

Outperform with Dividends in your Roth

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May 14, 2009 – Comments (2) | RELATED TICKERS: GASS , XOM , AOD

Dividends are not good for long-term shareholders because of double taxation.  Dividends are paid out of after-tax corporate profits, which are taxed at corporate income tax rates; then they are taxed again at the dividend rate as personal income to the shareholder.  The company ownership, therefore, gets taxed twice on each dollar passed through to itself via dividends.  Investors think they like dividends, but if they were thinking like the fractional company owners whom they actually are, they would hate dividends.

Dividend paying stocks held in tax-advantaged traditional accounts like 401(k)s and IRAs would seem to be immune, but in fact are not, as the dividend is eventually taxed at income tax rates when withdrawn.  Only dividend stocks in a Roth vehicle are immune, and few shares overall are held in such a vehicle.

The right way for management to use spare cash to support shareholders is share buybacks.  Exxon Mobil pays a small dividend but also returns a great amount of cash to shareholders by buying back shares.  The trouble with this strategy is that it makes it difficult for non-shareholders to find an attractive entry point for the stock, but that is not the company's problem.

This blog entry was inspired by another CAPS blogger, JTShideler, who asked why the market punished GASS, a small liquid-gas shipper, when they suspended their dividend today.  To my mind, the question becomes: is GASS planning some share buybacks with their spare free cash flow, or are they battening down the hatches for a massive decrease in their future cash flows? 

2 Comments – Post Your Own

#1) On June 03, 2009 at 12:55 AM, rjohnson10 (71.66) wrote:

 

I have to disagree, I really don't like investing in stocks that don't pay dividends, though a mix of both is important.

 -  In my taxable accounts, stocks that don't pay dividends genearate more taxes for me.  In order to lock in gains for non div paying stocks, you have to sell stock.  Selling the stock generates dividends.  My dividend stocks provide constant, and growing returns so I hardly ever sell them.  

- Stock buybacks aren't necessarily the best thing either, if a stock is overpriced, companies aren't getting good value for their dollar.  I don't want to buy an overpriced company, I don't want companies I own to spend money on overpriced companies.  If the price is undervalued, that's a different story of course.

- Dividends are, for now anyway, taxed at special rates (15%) which is below many folks tax rates.

- Investing in dividend stocks is quite frankly, easier.  I value stocks by their ability to generate and raise the dividend.  As long as the dividend grows, and the payout ratio and debt levels remain the same, the stock price will necessarily grow in tandem with the dividend.  These payout ratio's and debt levels will commonly send red flags before a stock really hit's a troublesome point.  It's a lot harder to value companies that don't payout dividends.

I could go on and on, but I do think it's important to have a mix of stocks, big dividend payers, small cap stocks with potential for big growth etc...

 

 

 

 

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#2) On June 03, 2009 at 11:56 AM, ikkyu2 (99.45) wrote:

Agree that dividends are convenient, provide a revenue stream without frictional costs, and are a generally excellent metric of a company's financial health.

So I don't think we disagree, I was just talking about some of the downsides, and you have quite rightly mentioned the many upsides.

My Roth IRA, which is my main investment vehicle, is chock full of dividend payors. 

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