Why do investors chase dividend paying strategies

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Why do investors chase dividend paying strategies

Postby larryswedroe » Mon Mar 25, 2013 10:02 am

http://www.cbsnews.com/8301-505123_162-57576075/theres-no-reason-to-chase-dividends/

There is a whole "cult" of investors that seem to believe that investing in either the stocks of high dividend payers or companies with rapidly growing dividends provides superior results.

Hope you find it of interest

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Re: Why do investors chase dividend paying strategies

Postby rustymutt » Mon Mar 25, 2013 10:20 am

Thank you Larry for another great article supporting the Boglehead philosophy. I've been taught for years that chasing dividends wasn't in my best interest for total return.
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Re: Why do investors chase dividend paying strategies

Postby Sidney » Mon Mar 25, 2013 10:22 am

I have seen theories proposed that dividend policies somehow "keep management honest." However, I have seen plenty of instances where dividend payments caused management to make some really bad decisions such as adding excessive debt, slashing R&D, cutting plant maintenance (and safety) in order to maintain dividends during economic downturns.
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Re: Why do investors chase dividend paying strategies

Postby plannerman » Mon Mar 25, 2013 10:34 am

Larry,

We all know that portfolio volatility is important, particularly when one is withdrawing from his or her portfolio.
I would expect a portfolio made up of dividend paying stocks would be less volatile than a portfolio with a similar asset allocation made up with non dividend paying stocks.
I have never seen this particular volatility issue expressly addressed in terms of portfolio withdrawals.

How about running those numbers through your Monte Carlo model and letting us know what the effect, if any, is on the SWR.

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Re: Why do investors chase dividend paying strategies

Postby Blues » Mon Mar 25, 2013 10:38 am

(withdrawn...probably a bit off the current topic)
Last edited by Blues on Mon Mar 25, 2013 2:20 pm, edited 1 time in total.
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Re: Why do investors chase dividend paying strategies

Postby Jfet » Mon Mar 25, 2013 10:47 am

Here is my theory on dividend paying companies.

What is the purpose of a company? Is it to grant stock options to key employees? Is it to grow revenue even if that means constant losses (see Salesforce for an example) to increase these options for awhile?

My theory is a good company is there to generate money, and pay that money out to people who own the company.

If you were in business for yourself...say you had a private practice as a doctor. Would it make good business sense to just concentrate on growing revenue even if that meant you could not pay yourself a salary?

Paying a dividend usually means you have a viable business model for the long term...a history of increasing dividends means you have a very good viable business model.

Coca Cola, Mcdonalds, J&J, ...

So maybe the question should be "Why do investors NOT insist on dividend paying companies?"
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Re: Why do investors chase dividend paying strategies

Postby rmelvey » Mon Mar 25, 2013 10:51 am

Jfet,

Dividend paying companies may be better companies, but that doesn't mean they are necessarily better stocks. You would have to make an argument that the value of dividend paying companies are consistently misjudged by the market. That seems unlikely because there are so many people obsessed with dividends.
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Re: Why do investors chase dividend paying strategies

Postby nisiprius » Mon Mar 25, 2013 11:02 am

Larry, I have a theory that quite a lot of "thinking" about investing is just many-decade-old legacies. In this case, the distinction between "growth stocks" and "dividend" or "income" stocks. ("Growth" here means the old usage, not the Fama-French factor.)

Before there were 401(k)'s; when mutual funds were not a particularly popular form of investment; when brokerages charged fixed commissions and the "normal" stock purchase or sale was a 100-share round-lot--for which the commission would have been around $100.

In those days, it was not possible to think in terms of small, incremental, arbitrary-dollar-amount purchases or sales. People were very excited about the stocks of companies that offered dividend reinvestment plans (DRIPs) because it was the only way for a small investor to do continuous reinvestment.

So, if you were accumulating, you selected growth stocks that did not pay dividends, and if you were in retirement, you selected dividend-paying stocks... and you cared a lot about how steady the dividends had been. People had to live directly off the dividends because it wasn't feasible to sell off in small increments. The only way to implement a 4% rule was to assemble a portfolio of stocks whose dividends were approximately 4%.

I believe that these categorizations, names, and ways of thinking have simply persisted. A tradition of paying attention to steadiness of dividends began because it related directly to ability to pay the light bill, and gradually evolved into a stock selection theory.

Your thoughts?
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Re: Why do investors chase dividend paying strategies

Postby edge » Mon Mar 25, 2013 11:05 am

I don't think that is valid. People didn't really worry about the 4% rule implicitly or explicitly. They had pensions. And the wealthy don't have to think in terms of SWRs anyway.
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Re: Why do investors chase dividend paying strategies

Postby Rick Ferri » Mon Mar 25, 2013 11:07 am

Good article and I completely agree. Buying dividend paying stocks is one of those "feel-good" strategies that offers no extra total return benefit. In fact, its a more expensive strategy to use in a mutual fund or ETF, and might lower after-tax total return due to higher taxes on dividends paid each year (thus the money is not available for reinvestment).

I was recently asked to be on local library endowment investment committee. The portfolio was invested in about 70 individual high-dividend yielding stocks. I convinced the committee to liquidate the stocks and buy the Vanguard Total Stock Market ETF (VTI). The committee agreed, but I had to include a slice of the higher cost Vanguard High Dividend Yield ETF (VYM) because a couple of committee members felt more comfortable with the higher cash-flow from high dividend payers. Go figure.

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Re: Why do investors chase dividend paying strategies

Postby nisiprius » Mon Mar 25, 2013 11:16 am

Jfet wrote:Here is my theory on dividend paying companies.... My theory is a good company is there to generate money, and pay that money out to people who own the company.
My take on that is that I believe the value of a stock is the present value of its future stream of dividends. I probably read that somewhere once and it's probably an act of cryptomnesia on my part, but my perception is that I just figured that out for myself because it seems patently obvious, and only learned later on about Irving Fisher, etc. I mean, what else can it possibly be? You do not own a share of the company's assets; you cannot drive into Fairfield with a GE stock certificate and say "OK, here's my certificate, I'm claiming what I own, please chip out and give me my bricks, #13 through 84, fifth course, building 26."

So, my theory is that there's a range of dividend payments at which the--just name-dropping a theorem name here, I don't know it--Modigliani-Miller theorem applies, and it doesn't matter if they pay a small dividend and grow the share price rapidly, or pay a large dividend and grow the share price slowly. It's just "pay me now or pay me later."

However, the smaller the dividend gets, the less "pay me now" and the more "pay me later" there is. And the riskier the proposition becomes, because more and more of the payback is farther and farther in the future. And if the dividend is zero and you expect it to remain zero, then the value becomes indeterminate, or explodes, or is 0/0 or something. Since you never actually get paid, the value becomes completely cut loose from anything real--you're trusting in the existence of a big stone wheel at the bottom of the sea. (Planet Money episode: Yap Islanders used big stone wheels as currency, and supposedly one of them fell out of a boat in transport and sank to the bottom of the sea, but since everyone knew who it belonged to and knew where it was, it still counted as the owner's money).

So I get quite queasy about the general shrinkage of dividends (and I do not accept the argument that a share buyback is the same thing).
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Re: Why do investors chase dividend paying strategies

Postby EDN » Mon Mar 25, 2013 11:25 am

nisiprius wrote:Larry, I have a theory that quite a lot of "thinking" about investing is just many-decade-old legacies. In this case, the distinction between "growth stocks" and "dividend" or "income" stocks. ("Growth" here means the old usage, not the Fama-French factor.)

Before there were 401(k)'s; when mutual funds were not a particularly popular form of investment; when brokerages charged fixed commissions and the "normal" stock purchase or sale was a 100-share round-lot--for which the commission would have been around $100.

In those days, it was not possible to think in terms of small, incremental, arbitrary-dollar-amount purchases or sales. People were very excited about the stocks of companies that offered dividend reinvestment plans (DRIPs) because it was the only way for a small investor to do continuous reinvestment.

So, if you were accumulating, you selected growth stocks that did not pay dividends, and if you were in retirement, you selected dividend-paying stocks... and you cared a lot about how steady the dividends had been. People had to live directly off the dividends because it wasn't feasible to sell off in small increments. The only way to implement a 4% rule was to assemble a portfolio of stocks whose dividends were approximately 4%.

I believe that these categorizations, names, and ways of thinking have simply persisted. A tradition of paying attention to steadiness of dividends began because it related directly to ability to pay the light bill, and gradually evolved into a stock selection theory.

Your thoughts?


Nisiprius,

I'm not Larry, but have a comment, and its an important distinction I think too few investors appreciate. The evolution of the investment management industry happened side by side with the brokerage industry. Investment banks hired salespeople to pump the companies they were underwriting in a competitive effort to earn more investment banking revenue.

We had no idea where returns came from, just that financial services firms earned a really high return for selling securities to investors in exchange for commissions as well as the investment banking revenues from underwriting.

Of course, in the 60s we started to embrace asset pricing models, the first (and now largely extinct in most circles) was the Capital Asset Pricing Model, which made a distinction between a cap weighted index ("the market") and the risk free rate. All portfolio returns were said to be a function of their exposure to the market, period. But even then, we knew there was a lot going on beyond just "market beta", so the financial services industry, always quick to jump on an opportunity, began crafting additional categories like "aggressive growth", "growth and income", "dividends", "capital appreciation", etc. And other arbitrary distinctions based on a security's features (whether it pays a dividend or not) instead of what really matters like the source of expected return and risk. The brokerage industry loved it, because more arbitrary categories meant greater likelihood that investors would hop back and forth between them, generating even greater commissions.

Well, by the late 70s and early 80s, the research coming out against the CAPM was just too overwhelming to ignore. It became quite clear, CAPM was a failure in ways that was fairly easy to quantify, and the investment implications were investors (active or "passive") had a richer set of opportunities with which to explore sources of expected return, which is of course a good thing--different people have different goals and risk tolerances and exposures, and should prefer different portfolios based on those circumstances.

Market capitalization and Price (relative to fundamentals like book value) were major contributions to the CAPM, and eventually the financial services industry had to fall in line with the evidence-based research from academia. Fast forward to today, and almost the entire investment world thinks in terms of "style boxes" or "exposure to size and price", or some derivation of the FF 3F model. Bond results are also sorted according to maturity and credit, another advancement FF didn't invent, just solidified.

But dividend based strategies crop up every so often for purely non-rational reasons (not unlike the Permanent Portfolio but for different reasons).
#1, investors have a preference for "bird in the hand" returns from bond coupons or stock dividends. Despite the evidence that dividend policy doesn't matter, it is a comfort thing for investors who don't understand how markets work.
#2, dividend stocks, like every other security "characteristic" there is, will do better than average from time to time in an almost completely random and unpredictable fashion. So after a few years of this, performance chasing investors will hop on dividend based strategies believing their outperformance will continue.

But unfortunately for investors, they don't realize there is no additional expected return from dividends relative to the market. Just a different form of those returns (more cash-flow, less appreciation). This has not stopped the financial services industry from rolling out countless high-dividend strategies with high expenses to exploit this investor naiveté.

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Re: Why do investors chase dividend paying strategies

Postby Jfet » Mon Mar 25, 2013 11:30 am

The problem with a company who earns money but does not pay a dividend is the company sometimes (usually) takes risk with the money that the stock owner (who would have received a dividend) would not normally take. Or worse, they use that money as a play account.

GENC (Gencor) is a good example. The company has about 15M more cash on hand than the current market cap and has no debt. They even have positive past and foward earnings. The management controls the company through class B shares, and refuses to pay a dividend. This type of behavior has scared off almost all investors and the stock trades at no volume and well below liquidation costs.

TC (Thompson Creek) is a good example of what happens when a company amasses a huge pile of cash and instead of paying out dividends, decides to go on a very risky venture that so far has failed misearably and cost investors over 80% of their investment.

Give me a company who can make a steady or increasing dividend year after year for decades over a company who *might* be the next big thing.
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Re: Why do investors chase dividend paying strategies

Postby dbr » Mon Mar 25, 2013 11:33 am

EDN wrote:But dividend based strategies crop up every so often for purely non-rational reasons (not unlike the Permanent Portfolio but for different reasons).
#1, investors have a preference for "bird in the hand" returns from bond coupons or stock dividends. Despite the evidence that dividend policy doesn't matter, it is a comfort thing for investors who don't understand how markets work.
Eric


I believe from reading posts here, among other places, that there is a mental accounting separation between principal (ie shares) that must be preserved and income (ie dividends) that are like wages from investments "working" for an investor. Investors want to believe that the investment is secure and that there is an income stream. To be placed in the position that the income stream might be obtained by selling shares is a very uncomfortable proposition. One can ponder this by saying that not reinvesting the dividends is the same as selling shares. That should be a rational picture because an investment is the principal together with the return, including dividends, and a withdrawal is a withdrawal, no matter the mechanics by which it is obtained.
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Re: Why do investors chase dividend paying strategies

Postby Sidney » Mon Mar 25, 2013 11:35 am

dbr wrote:
EDN wrote:But dividend based strategies crop up every so often for purely non-rational reasons (not unlike the Permanent Portfolio but for different reasons).
#1, investors have a preference for "bird in the hand" returns from bond coupons or stock dividends. Despite the evidence that dividend policy doesn't matter, it is a comfort thing for investors who don't understand how markets work.
Eric


I believe from reading posts here, among other places, that there is a mental accounting separation between principal (ie shares) that must be preserved and income (ie dividends) that are like wages from investments "working" for an investor. Investors want to believe that the investment is secure and that there is an income stream. To be placed in the position that the income stream might be obtained by selling shares is a very uncomfortable proposition. One can ponder this by saying that not reinvesting the dividends is the same as selling shares. That should be a rational picture because an investment is the principal together with the return, including dividends, and a withdrawal is a withdrawal, no matter the mechanics by which it is obtained.

I tend to agree. With dividends, the firm decides when equity value is turned to cash. Without dividends, the investor decides. Obviously you can reinvest dividends but you cannot avoid the tax consequences of the forced distribution.
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Re: Why do investors chase dividend paying strategies

Postby dbr » Mon Mar 25, 2013 11:42 am

Jfet wrote:The problem with a company who earns money but does not pay a dividend is the company sometimes (usually) takes risk with the money that the stock owner (who would have received a dividend) would not normally take. Or worse, they use that money as a play account.

GENC (Gencor) is a good example. The company has about 15M more cash on hand than the current market cap and has no debt. They even have positive past and foward earnings. The management controls the company through class B shares, and refuses to pay a dividend. This type of behavior has scared off almost all investors and the stock trades at no volume and well below liquidation costs.

TC (Thompson Creek) is a good example of what happens when a company amasses a huge pile of cash and instead of paying out dividends, decides to go on a very risky venture that so far has failed misearably and cost investors over 80% of their investment.

Give me a company who can make a steady or increasing dividend year after year for decades over a company who *might* be the next big thing.


Larry has pointed out in his article that dividend stocks are a little lower returning at a little less risk. The risk adjusted return is a wash. That probably reflects the point you are making. There is, however, little carryover from attempting to pick individual stocks and understanding the properties of asset classes. The property that does seem to be predictive regarding dividend payers is that this is a partial proxy for the value factor. Thus there is nothing wrong with concentrating in dividend payers other than it is a concentration, but there are probably more rewarding ways to tilt a portfolio, including a small value tilt combined with reducing the stock allocation.
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Re: Why do investors chase dividend paying strategies

Postby Aptenodytes » Mon Mar 25, 2013 11:44 am

Jfet wrote:Give me a company who can make a steady or increasing dividend year after year for decades over a company who *might* be the next big thing.

Thanks to the empirical research, you now know how much this choice costs you in terms of reduced wealth. I don't quite get how someone could willingly make such a choice, though I suppose your cherry-picked two-company comparison offers some clue about the reasoning involved.

There is a LOT of research that shows that we have a tendency to over-generalize from isolated examples and to inflate our ability to make judgments about what will work out best.

The boglehead philosophy is meant as an antidote to those kinds of tendencies.
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Re: Why do investors chase dividend paying strategies

Postby Beagler » Mon Mar 25, 2013 12:03 pm

I'm sure once the Wellington Management team catches on to the error of their ways, they'll immediately shift the focus of Wellington Fund and Wellesley Income Fund away from dividend stocks. :D
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Re: Why do investors chase dividend paying strategies

Postby Jfet » Mon Mar 25, 2013 12:04 pm

Aptenodytes wrote:
Jfet wrote:Give me a company who can make a steady or increasing dividend year after year for decades over a company who *might* be the next big thing.

Thanks to the empirical research, you now know how much this choice costs you in terms of reduced wealth. I don't quite get how someone could willingly make such a choice, though I suppose your cherry-picked two-company comparison offers some clue about the reasoning involved.

There is a LOT of research that shows that we have a tendency to over-generalize from isolated examples and to inflate our ability to make judgments about what will work out best.

The boglehead philosophy is meant as an antidote to those kinds of tendencies.


I guess it is ok to cherry pick a 20 year section out of the market to point out how dividend paying strategies are poor compared others.

I follow more of a total stock market index approach now, but I still have this gut feeling that if I own a company I should get a share of the income without having to sell out my shares.
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Re: Why do investors chase dividend paying strategies

Postby Default User BR » Mon Mar 25, 2013 12:11 pm

nisiprius wrote:My take on that is that I believe the value of a stock is the present value of its future stream of dividends.

The value of a stock is the collective market's valuation of it. Whether that's the present value of future dividends, or value of future capital appreciation, estimation of "soundness", or any other criteria that investors might use.

Berkshire Hathaway went along for the fifty years of Buffet's tenure basically without distributing dividends (Wikipedia says once) to stock-holders. Did that make the stock worthless? Is it now worth more that BH is putting together a dividend plan? I dunno. I don't try to value stocks.


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Re: Why do investors chase dividend paying strategies

Postby Beagler » Mon Mar 25, 2013 12:16 pm

Benjamin Graham and David Dodd: " The prime purpose of a business corporation is to pay dividends to its owners," ...

But what did they know? :D
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Re: Why do investors chase dividend paying strategies

Postby TJSI » Mon Mar 25, 2013 12:22 pm

Has there been a study performed comparing the return of non-dividend paying value stocks to dividend paying value stocks? If not, I think it would be interesting to see how much of the "value premium" is due to dividend payouts.
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Re: Why do investors chase dividend paying strategies

Postby larryswedroe » Mon Mar 25, 2013 2:05 pm

TJSI
Don't know that but we do know that the value premium is much larger in small than large. And that's due small growth being the black hole of investing. And SG stocks typically don't pay dividends.

Few other thoughts

first, yes companies tend to "piss away" cash in bad acquisitions. So paying dividends probably a good thing. They are also signals to the market that management expects things to be good because no one likes to cut dividends. But that confuses the great company with high returning stock argument. The market knows these things and incorporates it into prices.

Yes I agree that it's a behavioral thing with most investors, certainly no logic to it.

Best wishes
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Re: Why do investors chase dividend paying strategies

Postby scone » Mon Mar 25, 2013 2:41 pm

It seems to me, if you have enough, such that you can live on dividiends and interest, you could "automatically" discipline yourself to stay within your withdrawal "safe zone," which is a good thing in itself. And you might well be less likely to have to sell stocks when the market is crashing, to meet your expenses. (Alternatively, you might be able to buy stocks to rebalance.)

The only other ways I can think of, to keep your income up in a crashing market, is through an annuity (provided the insurer doesn't go bankrupt!) or by having enough cash in reserve to outlast a crash. And even having cash on the side might not be enough in a "lost decade" Japan scenario. At any rate, selling into a crashed market has got to affect the "sequence of returns" problem pretty drastically. If it were me, I'd far rather use dividends and interest, than capitulate and see the total value of my nest egg drop massively, particularly in the first few years of retirement.

These ideas derive from something Sheepdog said, BTW, who was in the unfortunate position described above. I gather selling for income during the recent crash was very painful for him. (Thank you for the advice, Sheepdog!) It may be only a "behavioral story," but personally I would not want to be in that situation, and I'm willing to sacrifice some theoretical return to avoid that pain. If there's some better way to do that, I'm all ears.
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Re: Why do investors chase dividend paying strategies

Postby statsguy » Mon Mar 25, 2013 2:52 pm

I am one of those investors who buys dividend stocks. We are most interested in buying common shares that have a history of dividend growth.

Larry, I agree with 90% of what your write, but maybe a little less in this short article. I agree that the main argument against buying dividend stocks is that your portfolio will be less diversified. On the other hand, I think the argument that dividend investors are chasing higher returns is a straw man argument. I know in my case, I am happy if our dividend stock return matches the broader index. Why would I think a lower volatility approach would have more returns? That stands in direct opposition to Fama-French. We own dividend stocks because they have a lower volatility and are willing to sacrifice some return for that safety. During the great recession when the equity market was dropping 50% we were able to sleep well at night with our 30% drop because we were seeing a growing dividend (growing income) each year despite having a few dividend cuts.

In our case, about half of our equity portfolio are mutual funds chosen to help diversify us (typically a Total stock market, total international, and midcap index). We own 30 companies, mostly bluechips, but some REITs and some MLPs. We stay away from very high yield and when buying a stock. Our experience has been very positive. Last year, our total return fell below the index (the third time since 2005 that has happened) but the dividend growth (our income) grew was well above inflation. In fact, our dividend growth has beaten inflation every year since we began buying dividend stocks in 2004.

The first paragraph of your article says that "... new research from Dimensional Fund Advisors shows that investors who expect dividends to protect them in tough times might be in for a rude awakening." I would really be interested in a link to the research if possible, but if you cannot provide a link, could you provide a synopsis of the new research?

Best of luck
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Re: Why do investors chase dividend paying strategies

Postby EDN » Mon Mar 25, 2013 3:26 pm

statsguy wrote:I am one of those investors who buys dividend stocks. We are most interested in buying common shares that have a history of dividend growth.

Larry, I agree with 90% of what your write, but maybe a little less in this short article. I agree that the main argument against buying dividend stocks is that your portfolio will be less diversified. On the other hand, I think the argument that dividend investors are chasing higher returns is a straw man argument. I know in my case, I am happy if our dividend stock return matches the broader index. Why would I think a lower volatility approach would have more returns? That stands in direct opposition to Fama-French. We own dividend stocks because they have a lower volatility and are willing to sacrifice some return for that safety. During the great recession when the equity market was dropping 50% we were able to sleep well at night with our 30% drop because we were seeing a growing dividend (growing income) each year despite having a few dividend cuts.

In our case, about half of our equity portfolio are mutual funds chosen to help diversify us (typically a Total stock market, total international, and midcap index). We own 30 companies, mostly bluechips, but some REITs and some MLPs. We stay away from very high yield and when buying a stock. Our experience has been very positive. Last year, our total return fell below the index (the third time since 2005 that has happened) but the dividend growth (our income) grew was well above inflation. In fact, our dividend growth has beaten inflation every year since we began buying dividend stocks in 2004.

The first paragraph of your article says that "... new research from Dimensional Fund Advisors shows that investors who expect dividends to protect them in tough times might be in for a rude awakening." I would really be interested in a link to the research if possible, but if you cannot provide a link, could you provide a synopsis of the new research?

Best of luck
Stats


Stats,

If you are willing to hold a portfolio that is (slightly) less diversified than the market as measured by # of holdings (in that it holds less than 100% of the stocks), but more diversified by unique sources of expected return, and are looking for market returns with lower risk, you are better apt to combine large and small value indexes and high-quality 5YR bonds.

Since 1993, a portfolio of 30% each in the MSCI 750 value and 1750 value indexes, with 40% in 5YR t-notes returned +8.8% compared to +8.3% for the Russell 3000. The 60/40 mix had 47% less annual volatility than the market.

Since 1995, a portfolio of 30% each in the MSCI World exUS large and small value indexes, with 40% in 5YR t-notes returned + 7.6% vs. +5.4% for the MSCI World ex US index. The 60/40 mix had 42% less annual volatility than the market.

Since 1997, a portfolio of 60% in the MSCI Emerging Market Value index, with 40% in 5YR t-notes returned +9.5% vs. +7.8% for the MSCI Emerging Markets index. The 60/40 mix had 45% less annual volatility than the market.

These all-value mixes work best for retirees, because they are less sensitive to business cycle risks (compared to working investors), but are more exposed to inflation and purchasing power risk (which value stocks help to offset) and liquidity risks (which high-quality bonds help to hedge).

Eric

PS -- this is not a recent phenomenon. Using FF indexes from 1928-1992 (prior to my MSCI example above), a US 60/40 all-value mix earned +10.3% vs. +9.7% for the CRSP 1-10 Index and had 15% less volatility. In the 5 decades (28-39, 40-49, 50-59, etc.), the 60/40 only trailed 100% total stock once. So while 5 data points aren't conclusive, you like to be on the right side of history with out-of-sample confirmation to boot.
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Re: Why do investors chase dividend paying strategies

Postby Rick Ferri » Mon Mar 25, 2013 3:43 pm

Using FF indexes from 1928-1992 (prior to my MSCI example above), a US 60/40 all-value mix earned +10.3% vs. +9.7% for the CRSP 1-10 Index and had 15% less volatility. In the 5 decades (28-39, 40-49, 50-59, etc.), the 60/40 only trailed 100% total stock once. So while 5 data points aren't conclusive, you like to be on the right side of history with out-of-sample confirmation to boot.


As Eric wrote, on average there is one decade in every three on average where go-go growth stock mania takes hold the TSM outperforms a small-value tilted portfolio. No doubt this will occur again in the future. That's why an investor who does a small-value tilt should understand the strategy thoroughly. It will help them stay the course during one of the go-go periods.

Another way to stay the course is to have a reduced small-value tilt because this strategy will reduce tracking error against the TSM during go-go years. It also reduces expected portfolio return, but that's the trade-off. It's better to stay the course with a lesser tilt than risk jumping ship during the go-go years.

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Re: Why do investors chase dividend paying strategies

Postby Rick Ferri » Mon Mar 25, 2013 3:44 pm

Using FF indexes from 1928-1992 (prior to my MSCI example above), a US 60/40 all-value mix earned +10.3% vs. +9.7% for the CRSP 1-10 Index and had 15% less volatility. In the 5 decades (28-39, 40-49, 50-59, etc.), the 60/40 only trailed 100% total stock once. So while 5 data points aren't conclusive, you like to be on the right side of history with out-of-sample confirmation to boot.


As Eric wrote, on average there is one decade in every three where go-go growth stocks takes hold and the TSM outperforms a small-value tilted portfolio. No doubt this will occur again in the future. That's why an investor who does a small-value tilt should understand the strategy thoroughly. It will help them stay the course during one of the go-go periods.

Another way to stay the course is to have a reduced small-value tilt because this strategy will reduce tracking error against the TSM during go-go years. It also reduces expected portfolio return, but that's the trade-off. It's better to stay the course with a lesser tilt than risk jumping ship during the go-go years.

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Last edited by Rick Ferri on Mon Mar 25, 2013 3:50 pm, edited 1 time in total.
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Re: Why do investors chase dividend paying strategies

Postby larryswedroe » Mon Mar 25, 2013 3:46 pm

stats guy

As I have noted in many other blog posts on dividend paying strategies--there is no logic to investing in them, nor any data to show they perform better. As you note it might provide some psychological benefit --purely a mental accounting one. But the problem is even then it's an illusion of safety as evidenced by the number of companies that cut dividends. The biggest issue is clearly a less diversified portfolio which means you are taking lots of uncompensated risks--holding 30 stocks IMO is not a good idea. Our typical client owns about 10-12k of them and much more diversified against economic and geopolitical risks and across factors that determine returns.

As to the rude awakening, just look at what happened to dividend strategies in 2008, like SDY and VIG (S&P High Yield Dividend Aristocrats Index and Vanguard Dividend Appreciation ETF). Now if you substitute these for safe fixed income (to get higher yields or returns) now your portfolio really crashes in 2008, cannot get rebalancing benefit because no winners to sell, and if in withdrawal phase now have much bigger problem as likelihood of portfolio running out of money went up

Good luck to you

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Re: Why do investors chase dividend paying strategies

Postby EDN » Mon Mar 25, 2013 4:25 pm

Rick Ferri wrote:
Using FF indexes from 1928-1992 (prior to my MSCI example above), a US 60/40 all-value mix earned +10.3% vs. +9.7% for the CRSP 1-10 Index and had 15% less volatility. In the 5 decades (28-39, 40-49, 50-59, etc.), the 60/40 only trailed 100% total stock once. So while 5 data points aren't conclusive, you like to be on the right side of history with out-of-sample confirmation to boot.


As Eric wrote, on average there is one decade in every three on average where go-go growth stock mania takes hold the TSM outperforms a small-value tilted portfolio. No doubt this will occur again in the future. That's why an investor who does a small-value tilt should understand the strategy thoroughly. It will help them stay the course during one of the go-go periods.

Another way to stay the course is to have a reduced small-value tilt because this strategy will reduce tracking error against the TSM during go-go years. It also reduces expected portfolio return, but that's the trade-off. It's better to stay the course with a lesser tilt than risk jumping ship during the go-go years.

Rick Ferri


I agree all-value portfolio's aren't a free lunch, and market "tracking error" is no joke. One reason why I'm not a fan of the 100% small value allocations -- like someone with hands covered in Crisco trying to juggle a chainsaw. I wouldn't even recommend all-value (half large, half small) to DIY investors, only brought it up because the poster already seemed comfortable with a non-market portfolio, so I assumed something like a balanced value-index approach would be a safer and easier way to do what he was attempting and vastly superior to buying dividiend stocks.

I'm not sure what the expected "market underperformance" of all-value balanced (60/40) portfolios are relative to the market, probably 1 in 4 or so if history is any guide. In the US, back to 1928, we have the 1990s and the 1950s, in the UK (with data back to 1950s), we have only the 1990s, or 1 in 5. But it's important to point out when the 60/40 all-value has "lagged", it hasn't tanked. In the 1950s, the all-value US 60/40 did +12.8% vs. a whopping +18.2% for the CRSP 1-10 Index. In the 1990s, it was +13.2% vs. +18.0%.

And because of 40% to 5YR T-Notes, there were no decades where the 60/40 had greater volatility than TSM. So pretty reliable risk reduction (especially when applied globally).

But yes, a more watered down version is likely much more palatable and still maintains some of the benefits relative to TSM. I'll use 30% S&P 500 with 30% large value and 40% small value for those who want a balanced mix of large/small and growth/value, think that would work better for most here. Vanguard value index and small value index hold a fair slug of "blend" stocks, too, so that also helps reduce extreme results.

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Re: Why do investors chase dividend paying strategies

Postby nisiprius » Mon Mar 25, 2013 4:38 pm

larryswedroe wrote:As to the rude awakening, just look at what happened to dividend strategies in 2008, like SDY and VIG (S&P High Yield Dividend Aristocrats Index and Vanguard Dividend Appreciation ETF). Now if you substitute these for safe fixed income (to get higher yields or returns) now your portfolio really crashes in 2008, cannot get rebalancing benefit because no winners to sell, and if in withdrawal phase now have much bigger problem as likelihood of portfolio running out of money went up
:?: OK, I just looked at what happened to dividend-focussed funds in 2008-2009, and it looks pretty good to me.

If someone thought of dividend stocks as a substitute for bonds, I think they were... unwise. But if someone thought of dividend stocks as a substitute for stocks in general, 2008-2009 seems to support that point of view.

SPDR S&P DIvidend (SDY), VIG (Vanguard DIvidend Appreciation Index ETF), and the other one with "dividend" in the name, Vanguard DIvidend Growth Fund (VDIGX), dropped meaningfully less than Total Stock during the plunge. VTSMX dropped 48%; SDY, 42%; VIG, 40%; VDIGX, 36%. And then after the drop, they recovered just about the same amount as Total Stock did.

Image

Another way to put it: to my eyeball, from start of 2008 to today, you'd actually have been better off with 100% Vanguard Dividend Growth Fund than with Vanguard Target Retirement 2020, which was probably over 25% bonds then.
Image
I don't belong to the cult of dividend stocks myself and I am sure it is a flawed strategy, but I don't think 2008-2009 is the time period that illustrates the flaw. Dropped like 75/25 stocks/bonds, then climbed like 100% stocks. I'd call that nice.
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Re: Why do investors chase dividend paying strategies

Postby cheapskate » Mon Mar 25, 2013 5:06 pm

Investing in broad dividend tilted funds/ETFs is not a terrible mistake. Confusing dividend paying equities as a replacement for safe fixed income is.

While the argument that dividend paying companies are shrinking making dividend strategies less diversified is a good one, I have worked in (large and well known technology) companies which did not pay dividends, never planned on paying one, where share buybacks were massively abused. In these companies, share buybacks were used primarily as an executive compensation tool. Stock dropping ? Never mind, let's issue more shares to the execs to make up for their underwater options and buy back stock. This is theft of shareholder money - there is no other way to describe this. This sort of corporate mis-governance is rampant in the tech sector. This was a good enough reason for me to Value tilt :), and invest in dividend paying ETFs/funds.

True. Berkshire Hathaway has never paid a dividend in its history. But very few companies are as good as BRK in terms of corporate governance. Buffet has long been against stock options as a compensation tool and has long been a proponent of accounting for options based compensation correctly.
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Re: Why do investors chase dividend paying strategies

Postby dbc47 » Mon Mar 25, 2013 5:13 pm

My dear 'ol Dad gets over $60K a year from one of his dividend paying stocks, and has for many many years (probably around 40). He's gotten back his initial investment a long time ago and is quite happy. Wish I could get $60K per year for doing nothing................ :greedy. Could he have done better someplace else? Perhaps, perhaps not.
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Re: Why do investors chase dividend paying strategies

Postby larryswedroe » Mon Mar 25, 2013 5:16 pm

nisiprius

Here's the way to look at these two dividend strategy funds, as I explained in various blog posts. An investment in the S&P High Yield Dividend Aristocrats Index (SDY) was similar to investing in a Russell 1000 value fund. A three-factor regression found that the fund had a beta (market risk) “loading” (exposure to beta risk) of 0.66 percent (versus 0.94) and a value loading of 0.60 (0.33), and a slightly lower expected return relative to the market (0.41 versus 0.58).

An investment in a fast-growing dividend strategy, via the Vanguard Dividend Appreciation ETF (VIG), is similar to investing in the S&P 500 Index. A three-factor regression found that the ETF had a beta loading of 0.78 (versus 0.95), and the exact same exposures to the size (-0.12) and value (0.05) risk factors. With the same loadings on size and value, and a lower beta loading, VIG has a lower expected return relative to the market (and relatively less risk).

As you can see the dividend strategies have lower betas, so obviously in down years they should before better, but not as good in up years. Note that one reason might be that because of their dividends their durations are shorter.

As I explained in my blog: With this knowledge, we can now show how switching from safe fixed income impacts an investor’s asset allocation. Consider an investor that begins with $200,000 in assets. Based on his ability, willingness and need to take risk, our investor decides that the appropriate asset allocation is 50 percent stocks and 50 percent bonds. Therefore, he holds $100,000 in stocks and $100,000 in bonds. Having been tempted by the allure of high dividends, he sells his bonds and buys $100,000 of SDY. Given SDY’s beta loading of 0.66, we can calculate that the $100,000 investment is the equivalent in terms of risk of owning $66,000 of stocks and $34,000 of bonds. And with the 0.9 loading on the value factor, he also has a high degree of exposure to the risks of value stocks. In terms of risk, we see that his allocation has shifted from $100,000/$100,000 (50/50) to $166,000/$34,000 (83/17). And he has likely exceeded his ability, willingness and need to take risk. Similar analysis on an investment in VIG would show a shift to an allocation of 89 percent stocks/11 percent bonds.

In other words if you use a dividend strategy you have a different asset allocation ---exposure to different risks and it should be accounted for, something very few investors I am sure have even thought about, let alone understand. In other words, often you trade one risk for another.

Not having done it it might be worthwhile doing a five factor analysis on dividend strategies to see if you happen to pick up some term risk, which is what you do when you buy low volatility stocks

I hope that is helpful

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Re: Why do investors chase dividend paying strategies

Postby statsguy » Mon Mar 25, 2013 5:44 pm

Thanks nisiprius. I am on vacation and only have my iPad today and was having a hard time posting those links.

In Larry's defense he might have been referring to the growing income that did not grow in 2009 (both ETFs he listed had a drop but have recovered). My own experience was that the income (growth of dividend) from our dividend portfolio has increased every year. Last year the income growth was 19%, in 2009 the growth was only about 1% (that was our worst year).

I also added up the stocks in our portfolio (well M* did). We own 4123 somewhat less than the 12,000 for the average Larry client. Of course, the 30 stocks we own make up more than market weight. Our biggest holding is VTR (Ventas) a REIT at 2.2% of portfolio. It is rather large due to doing so well rather than us buying so much. Our original purchase would have made it about 1% of portfolio (our typical purchase amount).

Also, Larry you did not respond to the new DFA research question.

Best of luck
Stats

Sorry did not see Larry 's post prior to posting this one
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Re: Why do investors chase dividend paying strategies

Postby statsguy » Mon Mar 25, 2013 5:50 pm

Larry, I find it hard to believe that investors substitute SDY for bonds, probably because I have not met anyone who would do that. Of course that is a crazy strategy. When I talk of owning dividend stocks, they come for the equity side of the equation.

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Re: Why do investors chase dividend paying strategies

Postby gwrvmd » Mon Mar 25, 2013 5:53 pm

Nisiprius
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Re: Why do investors chase dividend paying strategies

Postby larryswedroe » Mon Mar 25, 2013 6:03 pm

statsguy
If I had the proverbial nickel for every investor who did that.....

DBC
Your dad just got lucky. There were plenty of other similar companies that paid divs for long time and then disappeared. Don't confuse strategy and outcome
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Re: Why do investors chase dividend paying strategies

Postby jdilla1107 » Mon Mar 25, 2013 6:26 pm

So many people confuse great companies with great investments. I have long thought that this is because the prices used for trading stocks don't really mean anything by themselves and this violates our natural sense of things.

Say you go to the store and are looking for cookies. You can choose the best cookies or average cookies. Which would you choose?

...
...

The first question that crossed your mind should have been, "what's the price?" You do this almost automatically at the store. If the best cookies cost $1000 per box, would you still buy them? No. But with stocks people will say, "buy the best", "buy quality", "buy great companies" without thinking about the price.

The fact of the matter is that great companies are expensive and bad companies are cheap. It's just hard to see this in a really obvious/intuitive way.
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Re: Why do investors chase dividend paying strategies

Postby nedsaid » Mon Mar 25, 2013 8:58 pm

Oh man, you have hit the hot button on this one.

Dividend paying strategies a cult? Come on now. It is one of the time honored styles of investing. Value investors do this all the time. It is called getting paid while you wait. What about the successful equity income and growth and income funds?
Successful balanced funds use this strategy as well. If you are a value investor, you are employing some version of this strategy. Anyone practicing a "slice and dice" strategy is unknowingly using a dividend strategy.

This discussion reminds me of the "Bladder Theory" as explained by Peter Lynch. When companies build up vast cash hoards they are tempted to piss it away on acquisitions that don't work out. I would prefer that companies pay a dividend unless they can better reinvest the proceeds in growing their business. Too often, companies take the excess cash to "diworseify" into unrelated businesses they know nothing about. I would rather own a company that pays a dividend than one that does not. (I have owned both, invidually and through funds).

Of course you don't overpay for a good company. Of course you don't buy or keep companies in a portfolio that can't sustain its dividend. Smart investors know that high dividends that are much above the market averages or for their industry is a sign of trouble. Dividend paying strategies are a lot more than buying the highest yielding dividends. And of course you don't pile into dividend payers because everyone else is. This strategy shouldn't be chased any more than the tech stocks in the late 1990's.

As I have said time and time again on this forum, you need to pay attention to valuations to be a successful investor. If all this means to you as a Boglehead is that you don't pile into hot asset classes, this will save you lots of money and heartache.

If dividend paying strategies don't work, then value investing doesn't either.
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Re: Why do investors chase dividend paying strategies

Postby larryswedroe » Mon Mar 25, 2013 9:03 pm

nedsaid
You missed the point or misinterpreted it. As I showed a high dividend strategy is nothing more than a value strategy and a poor one at that. It's a cult IMO because people who believe in that strategy cannot accept that fact, ignore the data, and so on. There is a reason for a value strategy based on the data, and either a risk or behavioral story. There is none for a dividend strategy, at least IMO.
The same is true of a high growth of dividend strategy. There is just nothing special about it
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Re: Why do investors chase dividend paying strategies

Postby nedsaid » Mon Mar 25, 2013 9:32 pm

Wow Larry that was fast.

I would never advocate a high dividend strategy. I have warned a family member that chasing yields on the stock side can be as bad as chasing yields on the bond side. Eight percent of zero is still zero. You are right that a high dividend strategy is a poor value strategy. In fact, too high dividends can be a sign of trouble. And often big trouble.

I would argue that dividends are an important part of value investing and central to the strategy. Dividends give you incentive to wait things out. Sometimes it takes a while for a value story to play out. Dividends help you stay patient.

If a good portion of your return from a stock is from the dividend, the management of the company is less dependent on doing crazy things to pump up the stock price. I have seen crazy things. Make an acquistion, realize that it didn't cause the stock to go up 20% a year, then spin the silly thing off again again hoping for 20% growth rate. Or the Coke strategy of spinning everything off but the logo and the syrup. Outsource, insource, and then outsourch again. Pure craziness that accomplishes nothing. Flashy and cool often crashes and burns. Consistent and steady wins the race. Sustainable dividends are relentless, quarter by quarter adding to your account.

I would argue that companies paying out less and less of their earnings in dividends is a bad thing. We have seen too much of management managing the numbers and the stock price and not so much the business they are in!! Too much short term thinking.

Thanks for your clarification. I don't disagree too much with what you are saying. I am glad you are not arguing against value strategies. Sorry for the misunderstanding.
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Re: Why do investors chase dividend paying strategies

Postby larryswedroe » Tue Mar 26, 2013 7:53 am

nedsaid
You certainly can argue it but it is not supported by the data.

If you rank stocks by p/b, p/c, p/s, p/e or P/D the lowest return is P/D. That I believe clearly shows that dividends are not an important part of a value strategy.

Here's another thought. DFA runs a tax managed fund. When the dividend taxes were higher than K gain taxes they would screen out the highest div payers to make the fund more tax efficient without sacrificing returns ---but not cut so many that you would lose diversification benefits---so obviously they found that dividends were not an important part

I do agree that paying dividends does create better corporate behavior. I don't think that is even a debatable point. The mistake I believe you are making is that you believe the market doesn't know that and thus doesn't incorporate that into prices. It appears that it does or dividend payers would have higher returns and they don't. And don't once you control for size and value factors because if they did you would need a dividend factor to explain returns. That's the difference between great companies and high returning stocks--the most common of errors investors make.



I hope you find the above helpful.
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Re: Why do investors chase dividend paying strategies

Postby nisiprius » Tue Mar 26, 2013 8:14 am

It would be interesting to know what percentage of investors in dividend stocks believe that dividends are an extra added free lunch--that dividend stocks are superstocks with the same capital appreciation as others plus dividends on top of that. They hear about nothing but price movements, believe that investing is about nothing but share price movements (and prediction thereof), and the discovery that some stocks also pay dividends too comes as a revelation.

Have you seen this, Larry, or have your clients learned better long before they reach your firm?
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Re: Why do investors chase dividend paying strategies

Postby larryswedroe » Tue Mar 26, 2013 8:50 am

nisiprius

First, we certainly get more questions from prospective clients than from existing ones. Though we do get questions from existing ones when they read some article about dividend strategies or hear from some friend. That is why I have written so many pieces on them

Second, what's really interesting when you look at these strategies is that they have different loadings on the FIVE factors, so you trade one risk for another (no alpha though). High div for example does have lower beta, and notably it has negative exposure to default risks (which helps explain 2008 relatively better performance) but it also loads heavily on value and has bit of term exposure (again helped in 2008)

I might get around to writing up another post explaining the factor exposures

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Re: Why do investors chase dividend paying strategies

Postby Harold » Tue Mar 26, 2013 9:28 am

nisiprius wrote:
Jfet wrote:Here is my theory on dividend paying companies.... My theory is a good company is there to generate money, and pay that money out to people who own the company.
My take on that is that I believe the value of a stock is the present value of its future stream of dividends. I probably read that somewhere once and it's probably an act of cryptomnesia on my part, but my perception is that I just figured that out for myself because it seems patently obvious, and only learned later on about Irving Fisher, etc. I mean, what else can it possibly be? You do not own a share of the company's assets; you cannot drive into Fairfield with a GE stock certificate and say "OK, here's my certificate, I'm claiming what I own, please chip out and give me my bricks, #13 through 84, fifth course, building 26."

So, my theory is that there's a range of dividend payments at which the--just name-dropping a theorem name here, I don't know it--Modigliani-Miller theorem applies, and it doesn't matter if they pay a small dividend and grow the share price rapidly, or pay a large dividend and grow the share price slowly. It's just "pay me now or pay me later."

However, the smaller the dividend gets, the less "pay me now" and the more "pay me later" there is. And the riskier the proposition becomes, because more and more of the payback is farther and farther in the future. And if the dividend is zero and you expect it to remain zero, then the value becomes indeterminate, or explodes, or is 0/0 or something. Since you never actually get paid, the value becomes completely cut loose from anything real--you're trusting in the existence of a big stone wheel at the bottom of the sea. (Planet Money episode: Yap Islanders used big stone wheels as currency, and supposedly one of them fell out of a boat in transport and sank to the bottom of the sea, but since everyone knew who it belonged to and knew where it was, it still counted as the owner's money).

So I get quite queasy about the general shrinkage of dividends (and I do not accept the argument that a share buyback is the same thing).

It is patently obvious -- and it goes to the core of what investing really is.

An investor hands over money to a firm with the expectation that a sufficiently greater amount of money will be returned to him by the firm in the future. Investors generally aren't in the gift-giving business, and stocks aren't magical creators of shareholder value.

I generally think of an example such as if I had a booming $60M enterprise, and I was looking for $40M more capital. With that capital I could guarantee that the $100M enterprise would grow to $10B in five years (or some similarly spectacular growth). So for $40M, an investor could own 40% of a $10B company. But I was upfront and honest (within the constraints of law), saying that I was never going to pay a dividend, was going to put all earnings into the company, when I ran out of profitable things to do I was going to give it to employees, fund my wife's charities, pay for the best executive retreats the world has ever seen, run the company into the ground once the profitable idea runs dry, have an agreement with my heirs that they follow my wishes, etc. In short, to the best of my ability, I'm taking $40M and never giving it back.

Hard to see how that investment would have much value (which would lie mainly in the chance of some future person not following my wishes). It's an extreme example, but there certainly are companies who have many interests that come before returning money to shareholders. Dividends are a way of keeping the companies honest.

Sure there's a tax-preference for selling shares rather than receiving dividends, and sure there are companies such as Microsoft who don't pay dividends for a decade or more because they can very profitably plow the money back into the firm -- and investors recognize that, so the companies have value without paying dividends (and that value can be captured by selling stocks to get the money back from the investment). But ultimately, at some point, dividends in some form must be expected to be paid.

This seems to be a different question than the original post though. There does seem to be a class of investors who view dividend-paying stocks as a sort of free money, resulting in a superior investing strategy. There's no fundamental basis for that.
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Re: Why do investors chase dividend paying strategies

Postby dumbmoney » Tue Mar 26, 2013 10:04 am

nisiprius wrote:And if the dividend is zero and you expect it to remain zero, then the value becomes indeterminate, or explodes, or is 0/0 or something.


If a stock can never pay dividends, then its value is well defined (it's zero). Also if a stock can pay dividends, its value is well defined, even if it never actually pays dividends. Berkshire is the perfect example. It's been a money machine for decades, has never paid a dividend, and no dividend is expected. There is no problem with valuing it on the basis of dividends that could be paid (but won't be).
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Re: Why do investors chase dividend paying strategies

Postby larryswedroe » Tue Mar 26, 2013 10:26 am

dumb money
Think of all the companies that never paid a dividend and where acquired at which point the investors received capital back.


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Re: Why do investors chase dividend paying strategies

Postby JamesSFO » Tue Mar 26, 2013 10:50 am

So I generally agree with Larry's and Rick's comments from a portfolio perspective, I think one appealing aspect of dividends is that if for some reason you are investing in individual stocks, they provide a sanity check on the finances of the company.
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Re: Why do investors chase dividend paying strategies

Postby larryswedroe » Tue Mar 26, 2013 12:15 pm

fwiw
IMO it's all mental accounting and failure to differentiate between companies that pay dividends or grow them might be better companies but so what? That doesn't mean you should get higher returns because what you know market knows.
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