Allow me to present a list, ranking the groups of people who are the most fun to troll:
3. Bad personal finance bloggers
1. Dividend growth investors
Note: this list is fully scientific and will endure any vigorous analysis you might do to try to prove it wrong. Don’t even bother trying. It’s like creationism. Nobody can even try to disprove that God created all the animals, especially the adorable puppies.
When it comes to dividends and my portfolio, I follow one golden rule. I try to forget about the dividend as much as possible, at least when it comes to the equity part of the portfolio. Bonds and preferred shares are different, obvs. I don’t care if a stock is paying 1% or 5% or nothing, I look at book value, earnings, cash flow, potential catalysts, and all the usual junk us value guys go for. I will make a note of a company that’s paying an exceptionally large dividend that looks likely to be cut at some point soon, waiting to jump in until after the dividend cut.
In the investment community, my opinion of dividends is squarely in the minority, a mere whisper among shouts and grunts louder than a women’s tennis match with Maria Sharapova and Serena Williams. Dominating the landscape are dividend growth investors (DGIs for short) who have a fairly simple investment philosophy of buying companies with a history of a growing dividend. As long as these dividends can continue to grow over time at a rate greater than inflation, they’re good.
I have a few problems with dividend growth investing. First of all, DGIs have a bias towards picking large, multi-national corporations, which are almost always household names. Coca-Cola will always be preferred to Cott Corporation – which makes store brand soda, mostly in Canada – even though the latter is up 790% over the past 5 years. As we’ve discussed to death, the easiest way for an investor to beat the market is to venture into the world of small caps. Your chances of beating the market buying mega caps are slim to none. They are the market.
And second of all, DGIs are doing it wrong. As I outlined over at The Motley Fool, it isn’t so advantageous to focus on a growing dividend. If you bought a stock like Rogers Sugar that has a high current yield without much dividend growth and compared it to a stock yielding 3% with 7% dividend growth, it takes 24 years for the value of the faster growing dividends to catch up to catch up to the slow growing ones. 24 years! How many stocks do you plan on holding for 24 years?
But let’s take things a step further. Why should investors even care if companies payout dividends? There are a few reasons often stated by investors, including sharing in a company’s success, ensuring they get paid, and limiting the amount of cash that management has available to use on reckless acquisitions. And they’re taxed efficiently. I’m not sure any of these factors are as important as DGIs think they are.
Larry Swedroe agrees with me. A few choice quotes:
It’s long been known that many investors have a preference for cash dividends. But from the perspective of classical financial theory, this behavior is an anomaly…
Simply stated, a cash dividend results in a drop in the price of the firm’s stock by an amount equal to the dividend. That must be the case unless you believe that $1 isn’t worth $1.
Thus, investors should be indifferent between a cash dividend and a “homemade” dividend created by selling the same amount of the company’s stock. One is a perfect substitute, minus any frictions like transaction costs and taxes that come with the other. Thus, without considering frictions, dividends are neither good nor bad.
Now let’s disprove all those reasons for dividends above.
Like Larry said, if a $10 stock pays a $1 dividend, that stock is worth $9 and the investor has $1 in his back pocket. If that $10 stock didn’t pay that dividend, it would still be worth $10. What’s stopping an investor from selling 10% of his shares to create his own dividend? Transaction costs are the only thing that would come into play, and those are dwindling down to almost nothing. Besides, most investors aren’t at the point yet where they’re using their dividends for living expenses, so they have transaction costs reinvesting those dividends.
If investors think that management paying out dividends somehow quells their appetite for big acquisitions, they’re wrong. Management can issue more shares or borrow money to finance buying a competitor, which can be more harmful than just cutting a cheque for the damn company. And besides, for every crappy acquisition, there’s a good one. Dividends are barely a deterrent for management to spend shareholder money.
Even the taxation issue isn’t as clear as DGIs make it out to be, since capital gains are also taxed more favorably than regular income, and they have the benefit of being offset by capital losses. Hell, an investor could just withdraw from their losing investments and avoid tax for years. The portfolio as a whole wouldn’t change if they did that compared to collecting the cash flow from dividends.
Even the sharing in the company’s success argument is bunk. Berkshire Hathaway has never paid a dividend, and you don’t hear Buffett’s longtime shareholders bitching about it. Retained earnings are still an asset on a company’s balance sheet.
One last thing dividend lovers will bring up are studies that show stocks that pay a dividend are more successful than ones that don’t. While I’ve never actually read these studies, I think I can offer a rebuttal. Generally, companies that pay a dividend are mature enough that they don’t need to invest their excess cash back in the business. Most people would call a mature business that generates excess cash successful. So basically what those studies say is that successful, mature businesses tend to be better investments than businesses that aren’t successful. Is it the dividend that makes dividend payers a better investment? Or are they a better investment in the first place, irregardless of the dividend?
Look, dividends are never going to go away. Investors like getting that periodic cash payment. Hell, I like getting it, and I’m not really pro-dividend. But once you realize that they’re really not that important, then you can expand your investment horizons to companies that don’t pay them out. Once you realize they’re just noise, they’ll be easy to ignore. Because they don’t matter.