Are dividends really the same as capital gains?

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someinvestor
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Are dividends really the same as capital gains?

Post by someinvestor » Wed Jan 31, 2018 9:43 pm

i apologize for another dividend thread, i've read quite a few of them over the years. i get the notion that dividends and capital gains represent the same profit to the investor in the end. sort of. since the dividend amount is subtracted from the price of the stock when it's distributed its not actually different than selling a tiny amount of stock periodically.

so from a mechanical standpoint that makes quite a bit of sense. what i'm not quite getting is that the difference is that there is actual cash coming out of the company which seems like a good bit more direct than simply capital gains. so in some sense i get that if it's just a matter of owning a little bit more of a company that is worth a little bit less (dividends) or owning a little less of a company that is worth a little bit more (capital gains), but only if there's a direct correlation between a company's money in the bank vs stock price, which isn't actually the case. isn't there some kind of disconnect here?

RAchip
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Re: Are dividends really the same as capital gains?

Post by RAchip » Wed Jan 31, 2018 10:41 pm

The reality is that "the market" does not know how much cash is held by a company on a daily basis. That figure is disclosed quarterly. And nobody knows for sure how "the market" values cash held in a company at any particular time. So, in my view, you know exactly what a dollar dividended to you is worth but you really don't know what an extra dollar held in the company will be valued at by the market at any given time. I prefer to invest in companies who send their extra cash to me directly as a dividend.

gostars
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Re: Are dividends really the same as capital gains?

Post by gostars » Wed Jan 31, 2018 10:48 pm

Say you have company A and company B that are both making a profit. At the end of the quarter, Company A decides to put all of that profit back into the company to generate more money in the future through development of new products, entering new markets, better marketing, etc.. Company B doesn't have a better use for the money, so they just write a check to all the stockholders and continue on as they have been. Company A keeps a higher stock price because the idea is that investment in the company will come back in the future as more profit for stockholders. Some investors prefer to have the cash, while others prefer to ride the growth of a company up.

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Phineas J. Whoopee
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Re: Are dividends really the same as capital gains?

Post by Phineas J. Whoopee » Wed Jan 31, 2018 11:20 pm

Hi someinvestor, and welcome to the forum.

Total return is total return. You understand the mechanics correctly.

I think the place where the misunderstandings come in is the functions of money. It is a medium of exchange. Everybody gets that. It is a store of value. Most get that, but there's a contingent which claims it isn't because of long-term cumulative inflation. They're right in the sense it isn't perfect across all of time and space. It is also a unit of account, many people don't get that, and it's the sense in which total return is total return, whether or not somebody sends you a check without your needing or having asked them to.

Our socially-constructed tool money is all three things simultaneously.

To quote some unnamed sage, fish is fish.

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Sidney
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Re: Are dividends really the same as capital gains?

Post by Sidney » Wed Jan 31, 2018 11:26 pm

Economically there isn't a real difference but they are treated differently for taxes.
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Phineas J. Whoopee
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Re: Are dividends really the same as capital gains?

Post by Phineas J. Whoopee » Wed Jan 31, 2018 11:48 pm

Sidney wrote:
Wed Jan 31, 2018 11:26 pm
Economically there isn't a real difference but they are treated differently for taxes.
What you write is correct in terms of dividends paid out versus unrealized capital gains, but dividends and cap gains when realized are treated similarly for tax purposes, at least in the United States.

PJW

Bfwolf
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Re: Are dividends really the same as capital gains?

Post by Bfwolf » Wed Jan 31, 2018 11:57 pm

someinvestor wrote:
Wed Jan 31, 2018 9:43 pm
so in some sense i get that if it's just a matter of owning a little bit more of a company that is worth a little bit less (dividends) or owning a little less of a company that is worth a little bit more (capital gains), but only if there's a direct correlation between a company's money in the bank vs stock price, which isn't actually the case. isn't there some kind of disconnect here?
When a company pays out a dividend, you do not own a more of the company afterwards. You own the same amount of a company which is worth a little less (i.e. same % of a smaller pie). But you've got the cash.

When you sell stock, you own a little less of a company that's worth the same (i.e. smaller % of a pie that hasn't changed in size). But you've got the cash.

So you can see how they are 2 different ways of getting to the same thing. Your reduction in ownership of the stock comes from either the pie being reduced in size (dividends) or your slice being reduced in size (capital gains). But whatever you lose in stock ownership you pick up in cash.

And yes, there is a direct correlation between a company's money in the bank and its stock price. When the dividend is paid out and cash flows out of the company, the stock goes down in value by the equivalent amount of the dividend.

Companies DO need to return excess cash to shareholders. Dividends are one way of doing that. Share buybacks are another way. Some companies are in a growth phase and don't have excess cash to return and therefore don't participate in dividends or buybacks. Yet.

AlohaJoe
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Re: Are dividends really the same as capital gains?

Post by AlohaJoe » Thu Feb 01, 2018 12:45 am

someinvestor wrote:
Wed Jan 31, 2018 9:43 pm
but only if there's a direct correlation between a company's money in the bank vs stock price, which isn't actually the case.
I am generally suspicious of simplified Economics 101 reasoning but in this case I think it might be a useful place to start:

Let's imagine that a company pays a dividend and it's stock price doesn't drop by a commensurate amount. You own $10,000 of Apple and they pay you $500 in a dividend. So you now have $10,500. If that's how things worked then -- let's ignore small-fry investors like you and me -- why wouldn't massive institutional investors and hedge funds spend hundreds of millions of dollars buying Apple the day before the dividend is declared to get this easy "free money"? (And then sell the Apple stock a few hours/days later once they have on record as owning the dividend.)

This is starting to sound like a classic arbitrage it away scenario. Soon some other hedge fund would buy Apple 2 days before, to get 90% of the dividend. And then someone else buys it 3 days before to get 80% of the dividend. And....eventually there's no free dividend money around because it has all been arbitraged away.

With the simplistic analysis, our initial reaction should be that dividends aren't some special anomalous source of return relative to capital gains. Or, if they are, the amount of that anomalous return should be quite small, maybe a few dollars for every million invested? It would need to a number small enough that all of those institutional investors with billions of dollars to throw around don't find it worth the effort to have their computers do the trades. (After all, their computers are doing all of the work across thousands of stocks, it isn't like they need to spend any actual human effort on this.)

There are reasons the simplistic analysis could be wrong -- or at least off. In the real world there are things like taxes, hedging costs (holding the stock for a day or two to get the dividends isn't totally risk-free), interest on margin (if the strategy works, why wouldn't you borrow $500,000 right before dividends come out?), trading costs (buying and selling isn't free, though it is very very cheap), human weirdness (maybe buying dividends like this isn't seen as "cool" so hedge funds don't do it because it is all about Machine Learning right now?), and a number of other things. But I think the default position needs to be that anyone thinking that dividends are special in some way have the burden of proof laying squarely at their feet. And not "I proved it in some theoretical hand wavy way in a two paragraph post on an internet forum with not a single number anywhere in sight". Burden of proof like actual empirical data of how things work in the real world for real investors. What's the real actual dollar amount that your theory about dividends results in?

Hank Moody
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Re: Are dividends really the same as capital gains?

Post by Hank Moody » Thu Feb 01, 2018 1:02 am

But the tiny piece of stock that's sold in lieu of the forgone dividend also contains a small element of basis, so not all of the current proceeds are subject to tax. If the dividend were paid instead, 100% of that amount would be taxed.
Phineas J. Whoopee wrote:
Wed Jan 31, 2018 11:48 pm
Sidney wrote:
Wed Jan 31, 2018 11:26 pm
Economically there isn't a real difference but they are treated differently for taxes.
What you write is correct in terms of dividends paid out versus unrealized capital gains, but dividends and cap gains when realized are treated similarly for tax purposes, at least in the United States.

PJW
-HM

jebmke
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Re: Are dividends really the same as capital gains?

Post by jebmke » Thu Feb 01, 2018 9:07 am

Phineas J. Whoopee wrote:
Wed Jan 31, 2018 11:48 pm
Sidney wrote:
Wed Jan 31, 2018 11:26 pm
Economically there isn't a real difference but they are treated differently for taxes.
What you write is correct in terms of dividends paid out versus unrealized capital gains, but dividends and cap gains when realized are treated similarly for tax purposes, at least in the United States.

PJW
Not exactly. The tax rate applied is the same. However, if one has capital losses (current or carryover) the capital gain can be offset by the loss whereas the dividend cannot (except to the extent of the $3,000 taken to the 1040 in cases where the total Schedule D shows a net loss).
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Phineas J. Whoopee
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Re: Are dividends really the same as capital gains?

Post by Phineas J. Whoopee » Thu Feb 01, 2018 7:37 pm

Hank Moody wrote:
Thu Feb 01, 2018 1:02 am
But the tiny piece of stock that's sold in lieu of the forgone dividend also contains a small element of basis, so not all of the current proceeds are subject to tax. If the dividend were paid instead, 100% of that amount would be taxed.
...
In your scenario everybody else knows that too, understands their own tax situation, and adjusts their bid and ask prices to account for it.

PJW

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Phineas J. Whoopee
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Re: Are dividends really the same as capital gains?

Post by Phineas J. Whoopee » Thu Feb 01, 2018 7:38 pm

jebmke wrote:
Thu Feb 01, 2018 9:07 am
...
Not exactly. The tax rate applied is the same. However, if one has capital losses (current or carryover) the capital gain can be offset by the loss whereas the dividend cannot (except to the extent of the $3,000 taken to the 1040 in cases where the total Schedule D shows a net loss).
In your scenario everybody else knows that too, in their own situations, and applies the changes to their own tax conditions, which are very much different between taxable and nontaxable entities.

The fact that everybody knows the same public information does not mean their conclusions with respect to their own portfolios will be the same.

PJW

Hank Moody
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Re: Are dividends really the same as capital gains?

Post by Hank Moody » Thu Feb 01, 2018 11:58 pm

I disagree. We're considering someone who compares self-created dividends to dividend paying stock. I think it's fair to say that these types of investors are an extreme minority -- far too little to affect price in any meaningful way. People who care about cash flow buy dividend paying stocks.
Phineas J. Whoopee wrote:
Thu Feb 01, 2018 7:37 pm
Hank Moody wrote:
Thu Feb 01, 2018 1:02 am
But the tiny piece of stock that's sold in lieu of the forgone dividend also contains a small element of basis, so not all of the current proceeds are subject to tax. If the dividend were paid instead, 100% of that amount would be taxed.
...
In your scenario everybody else knows that too, understands their own tax situation, and adjusts their bid and ask prices to account for it.

PJW
-HM

1nv35t
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Re: Are dividends really the same as capital gains?

Post by 1nv35t » Fri Feb 02, 2018 9:02 am

Hank Moody wrote:
Thu Feb 01, 2018 11:58 pm
I disagree. We're considering someone who compares self-created dividends to dividend paying stock. I think it's fair to say that these types of investors are an extreme minority -- far too little to affect price in any meaningful way. People who care about cash flow buy dividend paying stocks.
I wish more stocks were like Berkshire Hathaway and redeployed what might otherwise have been paid out in dividends (that leaves me with a taxable event and having to decide where to redeploy those dividends myself). Even if those dividends were just being redeployed into a index tracker fund. I can see how tens of thousands of individuals each paying their broker perhaps $10 to reinvest their dividends (after paying the tax man a slice) is economically productive, but I'd rather pass on that activity myself (minimize costs).

If I want cash-flow, selling some shares to the value of cash required, at a time of my own choosing is more fitting than having that cash flow amount and timing being depicted by someone else.

1nv35t
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Re: Are dividends really the same as capital gains?

Post by 1nv35t » Fri Feb 02, 2018 9:11 am

Some might like a cash deposit account that posted them the interest every quarter, and charged a fee for each deposit made. Others might prefer that interest to just automatically be added to their accounts balance and draw money from that as and when needed.

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rustymutt
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Re: Are dividends really the same as capital gains?

Post by rustymutt » Fri Feb 02, 2018 9:19 am

Kinda, sorta. It's a corporate balancing act in my humble, and oft times wrong opinion. Growth, vs payout.
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dbr
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Re: Are dividends really the same as capital gains?

Post by dbr » Fri Feb 02, 2018 6:47 pm

The starting point is return. Return is the sum of dividends and capital gains. The first interest of the investor is the wealth held. This is given by the wealth you held at the start plus the return. All of that is the definition of return and first grade arithmetic.

The first question is whether not investments can be picked based on dividends in order to get higher return. That is, is it known that stocks on the whole that pay higher dividends also deliver greater return than stocks paying lesser dividends. If this is true, then a portfolio of higher dividend stocks will grow to greater values of wealth than a portfolio of more average paying stocks. The exercise for the reader is to answer the question whether or not picking portfolio for greater dividends results in a portfolio that delivers greater returns. Otherwise one is simply taking more of the return in dividends and less in capital gains.

The second question for the reader, if the answer to the above question is yes, is whether or not the portfolio of higher dividend higher returning stocks is riskier than a more average portfolio.

A third question for the reader is to find out if might be true that a portfolio of dividend stocks while offering or not offering superior return, might be less risky.

NB For purposes of comparison the baseline portfolio could well be the total stock market.

denovo
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Re: Are dividends really the same as capital gains?

Post by denovo » Fri Feb 02, 2018 6:58 pm

Sidney wrote:
Wed Jan 31, 2018 11:26 pm
Economically there isn't a real difference but they are treated differently for taxes.
IMO, in terms of economics and finance there is a huge difference between the two.

Dividends is income coming from the corporate balance sheet to investors.

Capital gains are proceeds from the sale of shares that can be between strangers that have nothing to do with the company. If I am holding a stock certificate for Apple and sell it to my friend directly for $50 or $5,000 a share it has nothing to do with the company's income or finances.
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jalbert
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Re: Are dividends really the same as capital gains?

Post by jalbert » Sat Feb 03, 2018 1:09 am

From a taxability standpoint there is a big difference: if you sell shares or withdraw from a mutual fund to realize cash generating a capital gain, some of the realized cash will be return of capital, which is not income.
Risk is not a guarantor of return.

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