Dividends Are Dumb

Question everything.

It's a good motto if you ever find yourself in a government-conspiracy movie. And it'll also serve you well any time money's involved.

The folks who question seemingly self-evident principles can make an absolute killing.

  • Ask the Super Bowl bettors who took the so-called suckers' bet of the Giants over an 18-0 Patriots team.
  • Ask hedge fund manager John Paulson, who made more than $10 million a day in 2007 ($3.7 billion total) because he figured out housing prices could actually fall.  
  • Or ask some guy named Craig who questioned the virtual monopoly that newspapers had on classifieds (yes, that's a craigslist reference).

So when I heard the argument recently that dividends are actually a bad thing, I was willing to listen.

In fact, it's a more compelling argument than you may think.

These dividends are just dumb
Why do we invest money in a company? Ultimately, it's because we think that company can grow our money by using that money to invest in its growth.

When a company turns around and gives us that money right back (creating a taxable event in the process), it defeats the purpose. If we want out, we can simply sell our shares. And do so on our own timetables.

Hence, anti-dividend people maintain that even the modest dividends that companies like Halliburton (NYSE: HAL  ) , General Electric (NYSE: GE  ) , and Microsoft (Nasdaq: MSFT  ) pay out are just plain dumb.

But hear them out. The case against dividends gets stronger given the reason folks buy dividend stocks in the first place.

Frequently, investors who buy shares of companies that pay large dividends are seeking safety and stability. Why? Because a company that commits to a regular dividend payment is signaling exactly that -- safety and stability.

So it's ironic that a dividend can act like debt -- an obligation that makes the bad times worse. Although paying dividends is optional (while missing debt payments leads to bankruptcy), a company that chooses to cut its dividend signals weakness, often leading to a further weakening of its stock price. That's a double whammy no investor wants to face.

Yet I still heart dividends
So why am I still bullish on dividend payers?

I'll leave aside the empirical evidence that dividend payers have handily outperformed non-payers historically. Instead, let's look at a company's life cycle.

Early in a company's history, it feeds on cash like a baby sucks down formula. Investors don't care, though, because the company needs that capital to fuel its growth. Soon enough, that company either fails or becomes bigger and stronger.

At some point, it starts producing more cash than it's consuming. It can then build a war chest to ensure its survival through good times and bad.

But then what? If there aren't any compelling internal opportunities, a company has four choices:  

  • Sit on the cash.
  • Buy back shares.
  • Make acquisitions.
  • Pay dividends.

When you look at all four options carefully, dividends make a heck of a lot of sense.

Dividends stand alone
Sitting on cash is safe, but it’s a drag on a company's return on capital -- especially when interest rates are hugging 0%. Apple's (Nasdaq: AAPL  ) chosen this path, hoarding more than $20 billion. But few companies have the amazing innovation-driven growth that can hide this drag.

Buying back shares is almost like a dividend with no tax consequences. In fact, if a company can buy back its stock at low points, it can really juice returns to current shareholders. Unfortunately, most managements don't do a good job of timing. Even Goldman Sachs (NYSE: GS  ) , the reputed master of the markets, made massive repurchases of its stock throughout the heady bubble years only to have to sell new stock to raise cash when its stock price was hammered. Classic "buy high, sell low" behavior.

Acquisitions are the scariest of all. You see, management is often judged on its ability to grow the business, specifically earnings per share. That's why they’ll buy back shares at inopportune times. And that's why they'll pursue ill-advised acquisitions and poorly conceived internal projects with such gusto. This growth at an unreasonable price helps management but hurts shareholders.   

Which leads to the reason I love dividends. The issuance of a regular dividend instills management discipline by removing some capital from consideration. You can't waste what you can't touch.

Meanwhile, as shareholders, we get a nice income stream ... the classic stock play that yields like a bond.

With 10-year Treasury bonds currently yielding just 3.6%, dividend stocks are that much more attractive. Because of this, let me share three dividend plays that the dividend hounds at our Motley Fool Income Investor newsletter have identified and recommended.

Company

Description

Dividend Yield

Paychex (Nasdaq: PAYX  )

America's largest payroll processor for small and medium-sized businesses

4.1%

Clorox (NYSE: CLX  )

Maker of Clorox bleach, Glad trash bags, Kingsford charcoal, and Pine-Sol

3.3%

Philippine Long Distance Telephone

The Philippines' leading fixed and mobile telecom provider

4.9%

One of the companies above is a "buy first" recommendation -- and only six companies get that nod from the Income Investor analysts. If you'd like to find out the names of all six and gain access to all their recommendations and research, access is yours free for 30 days. Click here to start. There's no obligation to subscribe.

Anand Chokkavelu owns shares of Microsoft and Halliburton. Microsoft and Paychex are Motley Fool Inside Value recommendations. Apple is a Stock Advisor choice. Clorox, Paychex, and Philippine Long Distance Telephone are Income Investor picks. Motley Fool Options has recommended a diagonal call on Microsoft. The Fool has a disclosure policy.


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  • Report this Comment On February 26, 2010, at 11:35 AM, afw3 wrote:

    I believe in dividends that are a good rate of return, secure and have future growth. I like to have a lot of them for retirement and since they are in my IRA they don't create an immediate tax situation.

  • Report this Comment On February 26, 2010, at 2:51 PM, akamaiii wrote:

    NYSE highest dividend yielding stocks top 100:

    http://www.TopYields.nl/Top-dividend-yields-of-NYSE.php

  • Report this Comment On February 26, 2010, at 5:14 PM, PositiveMojo wrote:

    The utilization of capital is critical to the economic performance of any company - of any size. As you rightly point out, using capital in the form of dividends is a serious decision that can have long term repercussions.

    However, rewarding stockholders with dividends may be a good decision, especially if many of them are key employees that are heavily invested in the company. Better that than selling off stock to buy that vacation home. It all depends on the objective, the economic impact and human/social impact of the company.

  • Report this Comment On February 26, 2010, at 5:44 PM, Boomerchef wrote:

    Dividends are the income I live on. I expect the company to grow as inflation goes up. So I don't sell stocks to have income, though I will trade one stock for another.

  • Report this Comment On February 26, 2010, at 5:47 PM, starfish36 wrote:

    There is a large and growing tension (read "conflict") between executive compensation at many companies and the absence or niggardly amount of dividends that these companies choose to pay (or not to pay). Reinvestment in the business usually makes sense, but paying enormous compensation to executives who have nearly destroyed the companies that employ them, companies that are supposed to be run for the benefit of the shareholders makes no sense at all. We have seen the "talent" of these executives, and it seems to be lame in most matters other how they quickly they can grow the size of their wallets. In a day when shareholders are uninformed, when they cannot begin to match management's inside knowledge and when 20% or less of the shares of a corporation can totally control it, management is free to treat the company as though it owned it outright. That frequently means increasing management's compensation while pretending that the increases are necessary to avoid losing talent -- like the "talent" that made the crash of 2008-09 and the near depression that followed it a reality. Shareholders need to do more than change their investment practices; they need to demand a real and increasing return on the investments they have made, including compensation as supposed owners of the place.

  • Report this Comment On February 26, 2010, at 6:29 PM, stan8331 wrote:

    Dividends are a powerful force to juice total returns. They may be somewhat less compelling in non-retirement accounts due to the incremental tax consequences, but they really shine in a Roth IRA, where all the compounded returns over the life of the account will be tax-free.

  • Report this Comment On February 26, 2010, at 6:32 PM, Eagle68 wrote:

    In my opinion, dividends are the only reason to own a stock. The idea that you as an "owner" of the company have any control over what the company does is ludicrous, as starfish 36 points out. Stock prices go up and down daily, even hourly, and a stock's price might be down just at the time you need to sell it for income. But as long as the dividend is not cut, you have that steady stream of income, and eventually you will recover the cost of the stock, and what follows will be 100% profit.

    Not to mention that the fact that a company pays dividends will entice investors like myself to buy the stock, thereby providing a flow of capital to the company and supporting the price of the stock.

  • Report this Comment On February 26, 2010, at 7:11 PM, baillireny wrote:

    Well, it's nice with dividend increments, but from what level? If you in 7 years can expect a 5,6% dividend, based on todays valuation, that still doesn't do the trick. Why not buy a stock with 8% dividend - today?

    http://top-stock-investing.blogspot.com/2010/02/guide-to-gol...

  • Report this Comment On February 26, 2010, at 7:34 PM, Joyer wrote:

    Dividends make sense because the stockholders actually own the comapny. Who should share in the profits of the company other than the owners of the company? The board that continually chooses to not share that wealth should be fired.

  • Report this Comment On February 26, 2010, at 7:37 PM, TheDumbMoney wrote:

    I know it is actually trendy now to be a devotee of Graham, but I'll say it anyway: I am. One of Graham's great points was that speculation is different from investing (though all investing inherently involves a degree of speculation). When you buy a share of a company, you shoud think of it as a claim on the future earnings stream of that company. In that context, dividends are simply the present earnings stream you have purchased. There is no more of a contradiction between giving money to a company so it can give you dividends, than there is in taking out a CD with a bank just so that it can give you interest payments!!! (Not quite the same, but close enough.) When a company does not pay dividends, your "claim" to the future earnings stream is reflected solely in the appreciation or depreciation of the stock price, which is subject to all kinds of speculation to which a dividend itself is not subject. A dividend payment (particularly a long-term and rising dividend) therefore removes a significant amount of uncertainty, and speculation, which increases your "investorness" and decreases the extent to which you are merely speculating (i.e., gambling). And also what Chokkavelu said: companies seem to behave much less rationally with their cash flow than one would expect, given the rationality required to generate it! The AOL/Time Warner deal is the classic example. But even Google has arguably wasted a great deal of money by overpaying for companies rather than returning money as dividends. The GS example is great, too. And how about Daimler buying Chrysler? How about when widget companies all of sudden decide they need to start INVESTING their money in the stock market (internet boom), or buying real estate (2005/06 real estate boom, and apparently currently now happening in China with their real estate boom). These are not good things. SHOW ME THE MONEY!!! :-)

  • Report this Comment On February 26, 2010, at 8:04 PM, MrViklund wrote:

    interesting to hear some one that doesn't like dividends for once. But I disagree. Dividends are good for the most part. What I do agree with is that very small dividends like 0.09 cents a share or something is just plain useless. The company needs that cash better itself and no one will buy the stock of a company only for the dividend if it's that low. But if paying dividends is dumb then buying back shares must be even dumber. But for a company which has a very low dividend it may be a better return for investors if they stopped paying that dividend and bought back some shares. But in general stock buy backs are useless.

    You are also wrong about Apple. I don't know where you got your facts from but 20 billion is not accurate. Apple's war chest is almost 40 billion in cash and securities.

  • Report this Comment On February 26, 2010, at 8:26 PM, mikecart1 wrote:

    Joyer above is correct. Article writer is not.

    Case closed.

  • Report this Comment On February 26, 2010, at 8:35 PM, MrViklund wrote:

    mikecart1.

    If you read the article you will see that the author does not think that dividends are dumb and are in agreement with Joyer.

  • Report this Comment On February 26, 2010, at 10:48 PM, jesse2159 wrote:

    I love my dividends!!! I'm like a kid who gets a toy in the mail. It simply makes my day and it also pays for the stock I purchased.

  • Report this Comment On February 26, 2010, at 10:55 PM, abbatie100 wrote:

    Will MF be speaking anytime soon about or making a recomendation about oil , gas , or precious metals ? What is the hedge if the dollar's value begins to wobble ?

  • Report this Comment On February 26, 2010, at 11:31 PM, fgraham65 wrote:

    Can someone explain why, with all the hoop la about dividends, when they are paid the value of the stock goes down enough to make the net result a no change in the value of your stock.?

    fgraham

  • Report this Comment On February 26, 2010, at 11:33 PM, fgraham65 wrote:

    If dividends are so great, why do they not change the value of your investment one bit when they are paid?

    fgraham

  • Report this Comment On February 26, 2010, at 11:35 PM, Superdrol wrote:

    Dividends are a way of leveraging an investment since the company cannot actually control the stock price on a micro level. The same argument can be made towards getting regular bond payments vs getting a compounded lump sum at the end. The concept is really simple we just want some money period.

    Contrary to the popular belief management dosent always make the decision when using retained earnings when it comes to renvestment. Dividends also help keep a company o my opinion on more convincing if they are actually paying out cash.

  • Report this Comment On February 26, 2010, at 11:43 PM, topsecret10 wrote:

    On February 26, 2010, at 11:33 PM, fgraham65 wrote: If dividends are so great, why do they not change the value of your investment one bit when they are paid?

    fgraham

    The amount of the dividend theoretically reduces the price that you paid for the stock,or If paid In "script" It Is re-Invested In more shares of the stock.... TS

  • Report this Comment On February 26, 2010, at 11:48 PM, Superdrol wrote:

    Yeah well theoretically that is the idea that ex dividen date the stock decreases in value relative to the dividend payment but outside influences affect day to day prices though. Case in point I bought 3,000 shares of a stock the day before ex dividend date to get the dividend. The next day there was some economic news which forces the price higher. It was a commodity company. So essentially I got the dividend and I unloaded the next day at .67 cents per share gain. Even after the dividend subtraction. The market never acts rational for very long.

  • Report this Comment On February 27, 2010, at 4:37 AM, memoandstitch wrote:

    Buffett doesn't like dividends (Berkshire doesn't pay dividends).

  • Report this Comment On February 27, 2010, at 10:46 AM, Sonic75 wrote:

    I love dividends! These days, due to the changes in Canadian tax laws, Canadian income funds are morphing into corporations. That means that many of them will slash their dividends BUT some solid ones will maintain their payouts. Yellow Pages (YLO.UN on TSX) is one of the solid ones. It will pay around 14% until the end of the year and then cut the dividend to 10-11%. It's worth looking into. Heck, if the interest rate on your margin is 4%, you can then borrow money from your stockbroker and put 10% interest in your pocket! All this with money you don't even own!!!

  • Report this Comment On February 27, 2010, at 12:12 PM, edallan wrote:

    Not discussed above is the use of dividend reinvestment plans as a means to increase one's investment in a particular company, even if on a minor basis, at essentially zero cost.

  • Report this Comment On February 27, 2010, at 1:26 PM, Gardnermiles wrote:

    I constantly see the sum of 500,000 portfolio. What if you are in the 20,000 portfolio. Those small dividends help buy some of our needs. Of course sometimes Wall Street manipulators reduce the stock value so we tighten our belts even further. Hope the economy improves and jobs improve to the point I can become a big time investor. There are plenty of us living in the poverty level.

  • Report this Comment On February 27, 2010, at 1:52 PM, FoolishJayhawk wrote:

    "So when I heard the argument recently that dividends are actually a bad thing, I was willing to listen."

    Hey Anand,

    Just wondering, where did you hear/read this?

    --FJ

    PS: By the way, is that CFA title a new thing? I had not seen it before... Congratulations!

  • Report this Comment On February 27, 2010, at 2:20 PM, TheDumbMoney wrote:

    fgraham65 wrote: "Can someone explain why, with all the hoop la about dividends, when they are paid the value of the stock goes down enough to make the net result a no change in the value of your stock.?"

    Sure. That's because before the exdiv date (the last date on which you have to buy the stock, before a dividend), the stock goes often goes UP, because of people trying to cash in on a dividend. Then, after that date (when purchasing the stock will no longer result in the receipt of the upcoming dividend), the stock naturally goes down. This is playing out right now, and will continue to play out with a little Israeli stock called ITRN. Go check out what has happened to its stock since it announced a surprisingly large dividend. Once owning the stock no longer gives one that dividend, the price goes down.

  • Report this Comment On February 27, 2010, at 2:21 PM, TheDumbMoney wrote:

    But that doesn't change the benefits of owning the stock in the long term, taking advantage of long term appreciation and many, many sets of dividends.

  • Report this Comment On February 27, 2010, at 3:21 PM, busterbuddy wrote:

    Big Fools are those who speculate with options and derivatives. Dividends are the only solid investment vehicle. Combined with Good yielding bonds there are not better investements. Jim Cramer in his book, "Confessions of a Wall Street Addict", relates that 50% of his hedge fund was always in sound solid Dividend paying stocks. Mostly those he could threaten if they didn't maintain or increase their dividend.

    Short Term Capital Gains should be taxed to the maximum. Dividends should be tax free and Long Term Capital gains greater than 3 years should be have little tax.

  • Report this Comment On February 27, 2010, at 3:52 PM, greyhound44 wrote:

    I love my XOM dividends!

    I have scores of thousands of shares - many inherited - with an average basis under US$20.

    Guess I'll kepp those!

  • Report this Comment On February 27, 2010, at 5:13 PM, gporter1008 wrote:

    Jobs is an All League Consensus, 'Technology and Marketing Superstar'. $40 Billion in cash on AAPL's balance sheet today is proof enough of talent versus luck over time. No one is that lucky.

    Buffett is the proven Financial Investment Superstar, ditto above ...however:

    Yet neither guru knows, nor can they predict what will impact their customers' willingness and abilities to purchase their fabulous companies' goods and services even one month from now in light of the many external factors/'exogenous variables' that are operating completely beyond their control.

    So, if any financial analysts’ predictions of Apple's, or Berkshire Hathaway's balance sheet cash positions one year from now, or more, can be taken to the bank as near certainties in your minds, then please consider the following 'Six External Factors' [exogenous variables] that no US business man can know and control:

    1. Climate changes catastrophes, witness:

    - USA hurricane destroys New Orleans-Katrina, hurricane season 2010 just ahead; Earthquake destroys Port A Prince Haiti; Chile, Earthquake destroys Santiago Chile; Japan earthquake destroys various cities; Tsunami warning Hawaii, American Samoa, stay tuned; USA, extreme winter storms in the North East shut down the US Federal Government and paralyze NYC; USA Pacific North West, 2009 - 2010 extreme lack of snow and rain in the Pacific North West creates drought conditions in 2010 - 2011 that seriously threatens the Columbia River hydro energy supply for Washington, Oregon, Utah, Montana and California.

    -The rate of change of Pacific Rim (ring of fire) geological catastrophes is accelerating.

    -Tectonic plates are moving, can Portland Oregon's 8.8 earthquake not be far ahead?

    2. Terrorism is expanding its foothold into North America. Safe havens exist both north and south of USA borders for Muslim extremist operations to expand, get funded with Mexican drug-cartel -laundered money; 'enemy combatant' training camps exist on western soil and even inside US borders; increasing numbers of even more devastating attacks than 911 we hear are being staged to be launched at US interior cities and vital infrastructure.

    3. Pandemics are more threatening now as viruses and bacteria are adapting to our best medicines faster than US pharmaceutical companies can invent and qualify new medicines for release through the Federal Government.

    4. The US Economy which depends upon consumer confidence in continuing employment and business profits growth is declining and now is at a record low.

    5. Consumer psychology is depressed and drives irrational market stampedes to an internet-speed torrent of news events 24X7, 365 from around the world.

    6. Federal Gridlock. “GOP v DEMs in deadly embrace”, you name your favorite topic here. Lose/lose American citizens as we watch the watchers piddle our time and money away.

    Define the "Perfect Economic Storm" in terms of the confluence of any two, or more, of these 'exogenous variables' in your financial predictions and forecasts, and then anyone smarter than me please tell us what will happen to ANY company's balance sheet in the world and what should be done with its cash reserves?

    To wit I will reply, that your data relative to these Six external variables are 'guesses' regardng now uncontrolable future events that have all the statistical characteristics of 'random variables'.

    If the financial experts don't understand that forecasts based guesses about random variable data don't get this, then I'd recommend you call Warren or Steve and have one of them kindly explain it to you.

    On the other hand, to the pundits that do get this, a very valuable contribution you could make would be to pose a series of business and world event 'scenario forecasts', stating your assumptions (guesses). Then demonstrate with solid mathmatics what your scenario models indicate might happen based upon those assumptions.

    Otherwise please predictably continue to state, "Buy some of this if it feels right because, my name is [X] and I like it, and then hang on, at your own risk, and wait and see!"

  • Report this Comment On February 27, 2010, at 6:32 PM, TMFEditorsDesk wrote:

    @afw3 and stan8331,

    Good reminders that keeping dividends in a retirement account shields the tax effect of dividends.

    @Graybear1951, Boomerchef, starfish36, and Eagle68:

    All good additional reasons to like dividends!

    @dumberthanafool,

    Haha, I like that thought...Ben Graham as trendy...good points all around!

    @truthisntstupid,

    Enjoyed your post...I hope others will read it as well:

    http://caps.fool.com/Blogs/ViewPost.aspx?bpid=344638&t=0...

    @MrViklund,

    Regarding Apple's cash hoard, I counted only cash and short-term investments...the long-term investments, while certainly a factor in valuing Apple, isn't counted as "cash" (since the liquidity and volatility characteristics are significantly different).

    @abbatie100,

    Fellow Fool Tim Hanson writes a lot about using foreign stocks as a hedge against the U.S. dollar (which makes sense since he's an advisor in our Global Gains service)...check out his CAPS blog:

    http://caps.fool.com/Blogs/ViewBlog.aspx?t=01000000000214846...

    Gotta run...more responses to comments later!

    -Anand (TMFBomb)

  • Report this Comment On February 27, 2010, at 9:10 PM, sevenofseven wrote:

    "Can someone explain why, with all the hoop la about dividends, when they are paid the value of the stock goes down enough to make the net result a no change in the value of your stock.?"

    I believe the reason the stock goes down (separate of any market action) by the amount of the dividend is that the market cap or value of the company is reduced by that amount per share because of the payment of the dividend.

    If you own a company whose value is $100 and there are 100 shares outstanding, the price per share is $1/shr, and you pay a dividend of $10, then the company value is now $90 or $0.90/shr.

  • Report this Comment On February 27, 2010, at 9:11 PM, sevenofseven wrote:

    You are simply taking your share of the company out on that ex-dividend day.

  • Report this Comment On February 27, 2010, at 10:31 PM, fgraham65 wrote:

    Sevenofseven, I think you're exactly right. That also still leaves me wondering how dividends are that good...."...separate of any market action", an investment does not change in value one bit when a dividend is paid. It has cost the company nothing and it has also added nothing to the value of one's holding.

  • Report this Comment On February 27, 2010, at 10:32 PM, fgraham65 wrote:

    forgot to sign last post....fgraham....

  • Report this Comment On February 27, 2010, at 10:36 PM, fgraham65 wrote:

    And, on top of adding nothing to the value of one's holding, it (the dividend) has created a tax event.....

  • Report this Comment On February 28, 2010, at 1:36 PM, marc5477 wrote:

    The reason I like dividends is simple:

    1 - Hedge against disaster

    2 - Related to 1, hedge against incompetence of executives and directors (a lesson many have learned now)

    3 - I dont like being told what to do and that is exactly what happens when you dont take your profit as cash. Someone is basically telling you that they can handle your money better than you can, (if your an imbecile then this might be a good thing). I think this is borderline dishonest. I would at least like a say in what happens to the profit my shares made. If I want to re-invest I will do so on my own terms. Its funny how no one ever objects to this.

    I treat stocks like I would a brick and mortar business. If you go buy a business, you ultimately want to get paid in cash. If a customer walks into your store and wants to pay you in hamburgers or mops you probably will reject their offer yet because you would rather have cash and buy those hamburgers yourself rather than be stuck with hamburgers you might not like or extra burgers that you might not eat.

    The problem with most companies however, is that they force the hamburger down your throat whether you like it or not. I like freedom and so I like dividends.

    Note that I am not advocating that people should completely ignore growth type companies but I am saying that one should always be more weary of any company that force feeds you hamburgers.... eh yea sort of.

  • Report this Comment On February 28, 2010, at 1:36 PM, marc5477 wrote:

    The reason I like dividends is simple:

    1 - Hedge against disaster

    2 - Related to 1, hedge against incompetence of executives and directors (a lesson many have learned now)

    3 - I dont like being told what to do and that is exactly what happens when you dont take your profit as cash. Someone is basically telling you that they can handle your money better than you can, (if your an imbecile then this might be a good thing). I think this is borderline dishonest. I would at least like a say in what happens to the profit my shares made. If I want to re-invest I will do so on my own terms. Its funny how no one ever objects to this.

    I treat stocks like I would a brick and mortar business. If you go buy a business, you ultimately want to get paid in cash. If a customer walks into your store and wants to pay you in hamburgers or mops you probably will reject their offer yet because you would rather have cash and buy those hamburgers yourself rather than be stuck with hamburgers you might not like or extra burgers that you might not eat.

    The problem with most companies however, is that they force the hamburger down your throat whether you like it or not. I like freedom and so I like dividends.

    Note that I am not advocating that people should completely ignore growth type companies but I am saying that one should always be more weary of any company that force feeds you hamburgers.... eh yea sort of.

  • Report this Comment On February 28, 2010, at 1:38 PM, marc5477 wrote:

    Disclaimer to the post above: I actually love hamburgers.

  • Report this Comment On February 28, 2010, at 1:48 PM, mountain8 wrote:

    "When a company turns around and gives us that money right back (creating a taxable event in the process), it defeats the purpose."

    I'd just like to point out that 1) I didn't give these companies anything; I don't have access to IPOs. Ergo, they are not giving me my money back.

    Yes I own part of these companies and it's good I don't own a lot because a lot of the execs would dissapear. They are paying me dividends out of income. I earned it by risking my cash on them. I only get <4% on most and their bonuses are probably around 20%, maybe more. It's funny how the employees (CEO etc) earn (chuckle) more than the owners.

  • Report this Comment On February 28, 2010, at 11:52 PM, TMFEditorsDesk wrote:

    @memoandstitch,

    Buffett actually loves dividends…when they’re paid to him. Check out his holdings in public companies. What he doesn’t like is paying out dividends to his Berkshire shareholders. He believes he can allocate that capital better than his shareholders. As one of his shareholders, I agree. As I allude to in the article, if the company has better internal uses for the capital, it should keep it rather than pay a dividend.

    @sonic75,

    As I’ve stated often, margin is a very dangerous game. I advise against it.

    @edallan,

    Yes, dividend reinvestment plans (DRIPs) are very popular as a method to steadily add to you interest in a great company.

    @FoolishJayhawk,

    I’ve come across various versions of the anti-dividend argument over the years…my devil’s advocate argument above is my best shot at distilling them into what I thought were the most compelling cases against dividends.

    The piece that spurred the article was this CAPS post from anticitrade:

    http://caps.fool.com/Blogs/ViewPost.aspx?bpid=313058&t=0...

    Good eyes. I’ve been a CFA for a number of years…but I only started using it in my byline recently. I’ll take the congrats anyway…thanks!

    -Anand (TMFBomb)

  • Report this Comment On March 01, 2010, at 2:19 AM, jomueller1 wrote:

    There is no black or white. Dividend done according to situation is quite OK. GM management did not understand that. They paid dividend from borrowed money at times. Surely that draws a company down. In good old US style "there's no business like show business" they tried to satisfy the fixed income crowd and send a message that the company is stable.

    Dividends should be cut when the profits are not there and management should suffer along with it like the little sales guy who lives on commission only. The investors should be a little more flexible and understand that profits may go up and down with the economy. There is no one way path to riches.

  • Report this Comment On March 01, 2010, at 4:16 AM, memoandstitch wrote:

    @Anand

    Buffett never buys a company because of its dividend. The fact many companies in his holding pay dividends doesn't mean he loves dividends. It's just that Buffett likes matured companies and they pay dividends. It's a correlation rather than causation. He never says this company is good because it pays/doesn't pay dividends.

  • Report this Comment On March 01, 2010, at 6:47 AM, daveandrae wrote:

    My .02

    Always think in terms of TOTAL RETURN (capital appreciation + dividends) and equity investing will make more sense to you.

    Case in point, right now, Pfizer is trading at roughly 12 times it's 5 year average in earnings.

    1.47/17.55 = 8.37%.

    Roughly 4% of this earnings power is paid out to the investor through dividends. The other 4.37% of net income is reinvested back into the business on behalf of the investor's account. Usually through share buybacks or outright acquisitions.

    This compares to 3.7% for a ten year US treasury bond and, say 3% for a 5 year CD.

    Thus, each year, the Pfizer stock buyer is accruing roughly 5% more in additional interest vs. the treasury bond holder or CD buyer.

    Over a ten year holding period, this 5% in additional interest begins to compound on itself. If you were to add, say, another 5-6 stocks to the portfolio with the same type of earnings power, then the margin of stock interest over bond/cash interest becomes very large.

    If no dividend were paid at all, and Pfizer retained all 8.37% of its annual earnings, like, say, Cisco does, then the aggregate result over a ten year holding period should still be the same. This assumes, of course, that you paid the same price ( a cost basis of 8-9%) for each stock.

    This is why you don't need a lot of insight or foresight to have a favorable result over a ten year holding period when you're holding a 100% equity portfolio.

    The danger to the investor lies in investing his capital in the upper levels of the market ( say anything over s&p 1150 under current conditions) , or investing in speculative companies with diminished earnings power.

    Thomas Edmonds.

  • Report this Comment On March 01, 2010, at 4:05 PM, muddlinthrough wrote:

    'Never get into a flame war on the Internet, it's like a medal in the Special Olympics. Even if you win, you're still retarded.'

    Okay, lots of jokes are contextual. I could argue that the original meaning of retarded was the opposite of advanced--like the firing of a spark to the ignition of a car--and I mean no disrespect to those fine citizens who are probably not reading this commentary due to their different abilities (such as winning said medals in events not being discussed here), not to the disability of being unable to comprehend what's being discussed.

    @gporter1008 sure, the future is unpredictable. Lots of data points, and you've no clearer insight as to which way it's going to unfold. And I'm not really sure what your point is. The earth could fall into the sun tomorrow. Not likely for another 2 billion years, but it COULD happen. A lot of things you cite...get a larger perspective, please. And get off the 'global warming' trend. Katrina was bad due to government reaction (slow) and gutting the ACoE and National Guard for the follies of 'paygo' and the fun of throwing a war. Not much else. President as businessman or businessman as president...hah! Croneyism is as croneyism does. That's your bigger risk to stocks--stupidity and shear humanity of management, nothing else.

    @superdrol I hope you meant 67 cents, not the ".67 cents per share gain." A fractional penny is a horrible return, even if you're you're dealing in 3K shares. What was the tax hit for such a short-term holding?

    @greyhound44. You and Paris and the rest of the trust-fund babies. Warren's decision to dump most of his money at his death somewhere else besides his kids is one of the few reasons I respect him. 'You didn't earn it, why should you benefit from just holding onto it?' is one of the greater constructive destructions ever invented. Or, as was observed by the sage Riddick at the end of the little-seen 'Chronicles of Riddick,' "You keep what you kill."

    Okay, that movie wasn't a paradigm parody of Wall Street, but it might as well have been with the ethereal Judy Dench playing the roll of Analyst (impotent, a watcher, and vaguely useful to somehow move events along), Riddick being the up and coming outsider that rises to the throne of insider (sort of like the revolving door between GS and the Treasury Department), and the whole concept of a race of Necromongers that do nothing but eat the vital worlds and strut and prance and make bloody sport of the lesser beings they consume for food and life. But the more I think of it, it's a good analogy, a very good analogy.

    What does all this have to do with dividends?

    At 2-3%, and the rule of 72, in about 40 years you'll double your money. Other than an indicator of some predictability, the average investor (most reading this board, with the few exceptional aforementioned extremely Special olympians.) I'd say 30 years to double your money, but markets go up and down, and lean years always eat up the fat ones quicker than we think, don't they?

    Otherwise, the money is being made by those on the inside (Hank Paulson's wisdom to become SecOTres to shield half a billion tax free), those connected to the inside (BOb' Obama, 'if elected I will not serve, if nominated hell yes I'll load up at the gravy train...my wife would kill me if I missed this primo opportunity to grab hold of the speaking-tour guaranteed income teat') Whitacre (hey, I'm worth a couple of billion for not making any egregious mistakes recombining AT&T...why shouldn't I run GM?). The other money is made by being a shill like Cramer or, a broker making money if the stocks go up or down, or writing a newsletter, and selling it to a bunch of fools.

    As a buying member of some of that last service, I'm still reserving judgment, but I think the money isn't made in the gold rush, but by being a storekeeper and selling supplies. If Tom & David ever publish their net worth, and break out exactly how much more money they make in their portfolios VS how much they make from the website, that'd be real data. But like seeing the Wizard at the end of the movie, I think it might be a let down, and I like some of my illusions.

    My story with dividends is mixed; I bought MOT stock in a DRP, and had about 40-something shares at one point by the early 2002 time frame. I think my cost was about $750, average cost was ~$25-$30/share. Over time, it grew to 50 shares, which I still own. Amount the stock is worth: $300-400, depending.

    As Kenny Rogers observed, 'know when to hold 'em, know when to fold 'em,' which is often cited.

    The true wisdom with any gambling, and anyone who buys a stock in an exchange-traded vehicle is a gambler, never an investor, is the closing portion of that verse: "'cause every hand's a loser, and every hand's a winner, and the best that you can hope for is to die in your sleep."

    That's the best. If you're a little fish. I'm fairly certain there are many, many worse fates.

  • Report this Comment On March 01, 2010, at 4:58 PM, rednekkin wrote:

    As you note, the primary reason for dividends is as a discipline for management -- assuming the appropriate stage of life for the company and a reasonable payout ratio.

    As John Bogle points out, we live in an era of manager-controlled, rather than shareholder-controlled, corporations. If there's a pile of cash on the table, you can be darn sure that a good chunk of it will find its way into increasingly opaque and self-awarded management compensation mechanisms with no real relation to management performance.

    There are other management quality metrics, but they can be jiggled as easily as net earnings can.

    Dividends are a public covenant between managers and shareholders that is easily understood and easily measured. A history of dividend increases requires constant attention to the knitting and brooks no excuses.

  • Report this Comment On March 02, 2010, at 6:40 PM, TMFEditorsDesk wrote:

    @ fgraham65, topsecret10, dumberthanafool, and sevenofseven,

    Re: fgraham65’s question…generally agreeing with the answers topsecret10, dumberthanafool, and sevenofseven.

    @busterbuddy,

    Generally agreeing that derivatives and options are risky.

    @gporter1008,

    Many of those scenarios involve ends in which virtually no investment is a good one. Hence, I diversify across the globe and hope for the best.

    -Anand (TMFBomb)

  • Report this Comment On March 02, 2010, at 7:01 PM, TMFEditorsDesk wrote:

    @marc5477,

    I too love hamburgers and dividends...in that order per my waistline and bank account.

    @mountain8,

    I was wondering if someone would point out that the shares most of us own didn't put money directly in a comany's coffers (if we bought in the secondary market). I didn't clarify for brevity's sake, but the point still remains since we're part owners of a business.

    @jomueller,

    Agreeing that it's sometimes wise to lower dividends in bad times (I railed against the banks that were slow to do so in the financial crisis), but the market does often react with fear when a dividend is lowered.

    @memoandstitch,

    Fair distinction...I phrased the line conversationally for effect ("Buffett actually loves dividends…when they’re paid to him.")...however, I still disagree with your earlier point (Buffett doesn't like dividends (Berkshire doesn't pay dividends)) for the reasons I stated above.

    @daveandrae,

    As you mention, the key point is assessing future earnings.

    @rednekkin,

    Good points.

    -Anand (TMFBomb)

  • Report this Comment On March 03, 2010, at 8:45 PM, craigdelt wrote:

    Finance generally accepted academic theory holds that dividends rationally provide the ONLY long-run benefit in owning a stock. Your stream of income over the long run from an investment is the only reason you (or any buyer you try to sell to will) own it. Now, I am not saying that in the short run, companies (and their shareholders) aren't better off with the company holding on the money and re-investing it in the business. BUT, that is only the case because investors collectively eventually expect that such reinvestment will eventually lead to BIGGER dividends. Because there is no intrinsic value to a stock certificate (they are not rare objects or collectibles, whose scarcity may provide some arguable value, though still typically not intrinsic value--think baseball cards), any other capital appreciation that may occur on the shares (other than appreciation due to investors' expectations of higher future returns due to growth of the company) is only due to investors' collective willingness to accept LOWER returns in the future on those shares.

    To give another example to fgraham above, think of the counter-example of your scenario--the company that previously did pay dividends suddenly stops doing so. If investors actually didn't care about dividends, why do such stocks get so pummeled in the market immediately?

  • Report this Comment On March 04, 2010, at 1:05 PM, TMFEditorsDesk wrote:

    @craigdelt,

    Put another way, you expect returns on any investment you make...for stocks as an asset class, that return is ultimately dividends.

    -Anand

  • Report this Comment On March 05, 2010, at 12:02 PM, cgscouten wrote:

    "Ultimately, it's because we think that company can grow our money by using that money to invest in its growth."

    Not me. I invest because I think the firm can create more value for me than I could in some other investment. The role of management is to achieve a balance of growth and dividend that maximizes value added. Whether the payout is dividend or stock price appreciation is immaterial. Management too often sells that "growth at any price" argument to the stockholders who almost invariable get shafted while management lines their pockets. OK, Buffett is an exception, but for every buffett there are dozens of Lucents, AT&Ts, and the like. Please deliver me from growth stocks like these.

  • Report this Comment On March 05, 2010, at 3:05 PM, mayach wrote:

    Equity market is the safest bet in the present market

    http://bit.ly/EquityMarket

  • Report this Comment On March 05, 2010, at 3:30 PM, klchien wrote:

    It's difficult to take a premise seriously that begins with a list of '100 to 1' odds, i.e. "Ask the Super Bowl bettors who took the so-called suckers' bet of the Giants over an 18-0 Patriots team."

    What is that even supposed to mean? Prove that sometimes a bet pays off? Big deal - more often it DOES NOT pay off.

    Sorry, dumb article.

  • Report this Comment On March 05, 2010, at 4:55 PM, Jess60 wrote:

    I used to buy the no-dividend argument. But I've been around long enough to remember a technology company (Digital Equipment) that never payed dividends. Just prior to Black Friday in 1987, its stock price was about $200. It fell drastically that day and never ever got close to that number again. Those who bought it on the way up were SOL.

    These days I better see dividends or I'm not going to buy for the long term.

  • Report this Comment On March 06, 2010, at 11:49 AM, TMFEditorsDesk wrote:

    @kichien,

    The three examples were used to illustrate that sometimes conventional wisdom is violently wrong.

    -Anand (TMFBomb)

  • Report this Comment On March 06, 2010, at 11:18 PM, sulpolitixmdp wrote:

    Dividends are a good thing as noted in this article. Stock buybacks are, however, fraught with risks. And besides, stock buybacks are like plastic bananas--they look good but you can't eat them.

    sulpolitix

  • Report this Comment On March 07, 2010, at 6:40 PM, Lordrobot wrote:

    The only problem with dividends is the GOV. In 1913, the US gov decided to make dividends a product of double taxation. Every new innovation that gets around it like the Unit trusts or tax shelters get hit. So ultimately the key to dividends is your tax bracket.

    But I would also state that the abuse of corps to fail to pay the owners back with sharevalue or dividends is a theft. Apple works only because it returns sharevalue. Microsoft stock div have been great.

    In times of flat markets and low interest, Div yields can be superlative.

    So while the gov continues to work against American business, people with money are still smarter than politicians. Shareholders are owners of the company and they have an absolute right to get paid from the profits.

  • Report this Comment On March 11, 2010, at 12:06 PM, SirBubbalicious wrote:

    Let's be dialectical.

    1. You own no shares of a company. You expect no income from it.

    2. You own all the shares of the company, you expect income from it, not just some future payoff in 10 years.

    In America, shareholders are second in line for income behind CEO's and upper level executives. This would never happen in a private company. Employees having more control than the owner is some absurd result of poor regulation and late 20th century American captialism being hijacked. Because of laws governing public companies, somehow American capitalism has given huge power to the noncapitalist employees and proxy voting has become a joke.

    If companies were run more to the liking of it's true owners, executive pay would be lower across America and the savings would be dividends. That would not hurt capital reinvestment at all.

    All the talk above of capital reinvestment belies the fact that upper level management at many companies are robbing us blind. They are using stock options and other magical waving of hands to say it doesn't come out of your pocket, but it always does. Those options could as easily be used to benefit the companies bottom line. Oh, and don't forget how many pay-for-performance systems just don't work.

    Take the CEO, CFO etc. total compensation and divide by outstanding shares. For the most part, that's the dividends that have been stolen from you by over paid executives. It's absurd that anything over a million/year is necessary to obtain a good CEO.

    Dividends are a shareholders right and for the most part they've been stolen, not necessarily reinvested.

  • Report this Comment On June 02, 2010, at 2:22 AM, kungfucious wrote:

    SirBubbalicious...

    wow. a litle extream but i follow your logic. further... i agree with what youve written ...in theory. sadly... what you wrote fails b/c in the real world, emotion + momentum combine to defeat rational investor behaviour... thus the opportunity for speculators to exist (and thrive on those not paying attention).

  • Report this Comment On April 11, 2011, at 6:10 PM, Matt84 wrote:

    "But then what? If there aren't any compelling internal opportunities, a company has four choices:

    * Sit on the cash.

    * Buy back shares.

    * Make acquisitions.

    * Pay dividends."

    They can also reinvest it back into the company itself.

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