Why do dividends still exist?

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
User avatar
bluquark
Posts: 1151
Joined: Mon Oct 22, 2018 2:30 pm

Re: Why do dividends still exist?

Post by bluquark »

Question: what happens when a stock in a market-cap-weighted index fund performs a buyback? Reasoning from first principles, this should cause the value of the existing stock to rise even as market cap doesn't change, so the fund is "forced" to sell the amount of the buyback and evenly buy every other stock in the index. In other words, very similar transactions to a dividend if dividend reinvestment is enabled, but with different tax implications. Is this actually what happens?

EDIT: I found an old thread about this: viewtopic.php?t=249450 . Looks like I was wrong in one sense: a buyback causes share price to hold steady and market cap to decline. However, the resulting transactions in the index fund are as I guessed.
Last edited by bluquark on Fri Aug 09, 2019 8:47 pm, edited 1 time in total.
70/30 portfolio | Equity: global market weight | Bonds: 20% long-term munis - 10% LEMB
bhsince87
Posts: 2683
Joined: Thu Oct 03, 2013 1:08 pm

Re: Why do dividends still exist?

Post by bhsince87 »

hungrywave wrote: Fri Aug 09, 2019 5:32 pm Why didn’t Apple Pay a dividend and instead did a buyback?
Apple does pay a dividend.
"If ye love wealth better than liberty, the tranquility of servitude better than the animating contest of freedom, go home from us in peace." Samuel Adams
Laika
Posts: 50
Joined: Sat Jul 14, 2018 1:49 pm

Re: Why do dividends still exist?

Post by Laika »

nisiprius wrote: Fri Aug 09, 2019 8:24 pm
fortyofforty wrote: Fri Aug 09, 2019 8:17 pm...Buffett and company absolutely love investing in companies that pay dividends, no matter what they claim...
A real question, not rhetorical. Do Buffett and company also love investing in companies that perform buybacks? If not, what do they think the difference is and why do they think it matters?
This amateur's take: The public position of Berkshire is that they are counting on investment payoffs from deep value and unexploited potential. To be deep value of the sort he looks for, the companies are likely under stress or under-performing and paying minimal or no dividends anyway. Berkshire itself believes it is still growing and should put off extensive dividends.

Buffetts advice for individuals, of course, is to ignore all that and simply buy the total market.
Laika
Posts: 50
Joined: Sat Jul 14, 2018 1:49 pm

Re: Why do dividends still exist?

Post by Laika »

bhsince87 wrote: Fri Aug 09, 2019 8:43 pm
hungrywave wrote: Fri Aug 09, 2019 5:32 pm Why didn’t Apple Pay a dividend and instead did a buyback?
Apple does pay a dividend.
They do both, partly to appease investors looking for dividends, and arguably partly to try to control its stock price.
Dead Man Walking
Posts: 1001
Joined: Wed Nov 07, 2007 6:51 pm

Re: Why do dividends still exist?

Post by Dead Man Walking »

rbaldini wrote: Fri Aug 09, 2019 6:43 pm Maybe the real question here is: why do we tax capital gains differently than income?
+1 :sharebeer

DMW
MotoTrojan
Posts: 10661
Joined: Wed Feb 01, 2017 8:39 pm

Re: Why do dividends still exist?

Post by MotoTrojan »

kosomoto wrote: Fri Aug 09, 2019 6:17 pm
hungrywave wrote: Fri Aug 09, 2019 6:13 pm
kosomoto wrote: Fri Aug 09, 2019 6:11 pm
hungrywave wrote: Fri Aug 09, 2019 6:05 pm
kosomoto wrote: Fri Aug 09, 2019 6:01 pm

If a company does buybacks consistently eventually the company will be private or the shares will become too expensive to buy.
Good thought but I’m not sure that is true. The stock could be split limitlessly. And stock held by the company would essentially be taken off the market. All these things are fluid and just require shareholder approval.
If the stock is being diluted at the same time they are buying shares back, they are not buying shares back.
Do you mean splits cause dilution? That isn’t true. All a split does is double everyone’s shares while cutting the price in half. It solves the high share price problem.
I’m confused as to why you brought up splits then. I didn’t mean prices get literally too high - I meant the value you get for each share would be lower if buybacks continue indefinitely regardless of valuation. Buybacks would be silly if the PE is 100 and growth is no better than other companies. Better to distribute the cash as a dividend.
Buybacks increase earnings per share, so PE won’t inflate and you’ll get more value (earnings) per share, quite literally.
User avatar
Phineas J. Whoopee
Posts: 9675
Joined: Sun Dec 18, 2011 6:18 pm

Re: Why do dividends still exist?

Post by Phineas J. Whoopee »

nisiprius wrote: Fri Aug 09, 2019 8:13 pm According to the dividend discount theory of stock value, dividends are the root of stock value. The value of the stock is the present value of the future stream of dividends it will pay. If you assume that the stock will never pay a dividend, then the calculation becomes indeterminate, like zero divided by zero, or infinity minus infinity. On a computer it usually displays as "NaN," not a number. Without dividends, a stock becomes something like bitcoin whose value is entirely psychological, based on circular reasoning--it's valuable because people think it's valuable because people think it's valuable. The value of stock is the present value of the future price of the stock, which in turn is the present value of the future price of the stock... and so on.

The reason why a non-dividend paying stock has a value is that it is expected that someday it will pay them. It has to pay them eventually in order to be worth owning. It's just a question of "pay me now or pay me later." Otherwise it's just speculation--like bitcoin, "I am buying it because I think it will go up."

The natural expectation is that the rate of growth of a young company is limited only by access to capital, and that it can use every dollar it gets. It shouldn't pay dividends, it should plow them back into the business. The rate of growth of an old company is limited by market saturation; no amount of capital is going to make it grow rapidly, that is not what is limiting its growth. Therefore, it should take whatever money it can't use, and use it to pay dividends. Therefore, you'd expect young companies not to pay dividends, and mature companies to pay them. This is exactly what we see with Microsoft, which began paying dividends in 2006.

If a mature company is making money, but its stock is not rising in value, shareholders will insist on dividends and use their votes to force the company to pay them.

As for buybacks, there are various buyback-focussed indexes and ETFs that track them. Yet I cannot remember anybody in this forum ever showing any interest in them.
Which of course, and I'm including your whole post rather than cutting it down, and please forgive me nisi for pointing it out, is silly. It assumes things go on forever. It assumes dividends grow at a constant rate, without variation, and without end. Also, like many simplistic calculations, and many sophisticated ones, it is highly sensitive to assumed initial conditions. It's invalid if, as posted in a different thread earlier today, the company has low, or no, or negative earnings, even if it has a high and growing book value.

The Dividend Discount Model was better than valuation models that came before it. It was an advancement in the state of the art.
Herbert Stein wrote If something cannot go on forever, it will stop.
Models are useful, but they are not eternal verities.

PJW
Last edited by Phineas J. Whoopee on Fri Aug 09, 2019 9:29 pm, edited 1 time in total.
Northern Flicker
Posts: 6521
Joined: Fri Apr 10, 2015 12:29 am

Re: Why do dividends still exist?

Post by Northern Flicker »

When a company generates more net profit than they reasonably can or would want to reinvest in the development of new business or acquisitions, stockholders generally will not want the company to sit on the cash. It will either be distributed as dividends or used for share buybacks.

Companies with stable business models such as utilities may invest some in new infrastructure, but most of their profit is returned to stockholders. While this could be through share buybacks, investors in utility stocks have traditionally desired a stable income stream, hence dividends are used.

Tax implications for investors aside, I think it is true that a company declaring a dividend will tend to increase the liquidity of the outstanding shares slightly and share buybacks will tend to decrease the liquidity of the remaining outstanding shares slightly. But I suspect that companies with a long track record of declaring a dividend continue to distribute profit in that manner so as not to rock the boat— if they switched to buybacks the market might read all sorts of hidden intentions into it beyond the actual motivation.
fennewaldaj
Posts: 959
Joined: Sun Oct 22, 2017 11:30 pm

Re: Why do dividends still exist?

Post by fennewaldaj »

Phineas J. Whoopee wrote: Fri Aug 09, 2019 9:20 pm
Models are useful, but they are not eternal verities.

PJW
Sure but the point that shares of companies are not really worth anything (except in the same way bitcoin is worth something) if they never pay out to their shareholders ever remains.
User avatar
firebirdparts
Posts: 1801
Joined: Thu Jun 13, 2019 4:21 pm

Re: Why do dividends still exist?

Post by firebirdparts »

All I know about this I learned from this important historical documentary:

https://www.dailymotion.com/video/x6l2yq5
A fool and your money are soon partners
RAchip
Posts: 430
Joined: Sat May 07, 2016 7:31 pm

Re: Why do dividends still exist?

Post by RAchip »

hungrywave wrote: Fri Aug 09, 2019 6:36 pm
kosomoto wrote: Fri Aug 09, 2019 6:17 pm
hungrywave wrote: Fri Aug 09, 2019 6:13 pm
kosomoto wrote: Fri Aug 09, 2019 6:11 pm
hungrywave wrote: Fri Aug 09, 2019 6:05 pm

Good thought but I’m not sure that is true. The stock could be split limitlessly. And stock held by the company would essentially be taken off the market. All these things are fluid and just require shareholder approval.
If the stock is being diluted at the same time they are buying shares back, they are not buying shares back.
Do you mean splits cause dilution? That isn’t true. All a split does is double everyone’s shares while cutting the price in half. It solves the high share price problem.
I’m confused as to why you brought up splits then. I didn’t mean prices get literally too high - I meant the value you get for each share would be lower if buybacks continue indefinitely regardless of valuation. Buybacks would be silly if the PE is 100 and growth is no better than other companies. Better to distribute the cash as a dividend.
Buybacks keep share value constant, not decrease. Imagine a company is worth $2 and has 2 shares, each worth $1. The company has $1 in cash it wants to give back. It has the option of delivering a $0.5 dividend (decreasing the share price to $0.5). If it does that, the company decreases in value by $1 but the shareholders get $0.5. Thus, each shareholder now has $0.5 of stock and $0.5 of dividend.

Alternatively, it could buy a share for $1. If it does this, the company will newly be worth $1 because it spent its dollar on a share. The share seller has $1 capital gains. The remaining share holder has a share worth $1.

So, in both scenarios, the company transfers cash out. But the first is a tax inefficient dividend and the second is a tax efficient capital gain.

Since you say buybacks keep share value constant, how does a buyback benefit me as a non-selling stockholder?

If a company can repurchase shares for less than they a worth, that hurts the selling shareholders and benefits he non selling shareholders. But usually companies do buybacks during good times and pay more than their stock is worth which decreases the value of the remaining outstanding shares. Buybacks are nothing like dividends.
Dottie57
Posts: 9203
Joined: Thu May 19, 2016 5:43 pm
Location: Earth Northern Hemisphere

Re: Why do dividends still exist?

Post by Dottie57 »

yohac wrote: Fri Aug 09, 2019 5:49 pm Without dividends, there wouldn't be much incentive to buy stocks of slow-growth companies like utilities.
Bingo.
MathWizard
Posts: 4346
Joined: Tue Jul 26, 2011 1:35 pm

Re: Why do dividends still exist?

Post by MathWizard »

Companies pay a dividend because the board of directors declares a dividend. The shareholders are the owners of the company. They could change it at any time.

Capital gains have no advantage over dividends in a retirement account.

With increasing use of stock options in executive pay, a share buyback when stock options can be exercised is a transfer of value from shareholders to executives with stock options. I don't mind stock options to reward executives who increase the value of the company beyond what it would have otherwise been, but not just a stock buyback which adds no value to the company.

Stock buybacks should only happen when the shares are undervalued and the company can't use the money for anything else, like paying down debt or capital improvements which would boost profits.
Boglegrappler
Posts: 1292
Joined: Wed Aug 01, 2012 9:24 am

Re: Why do dividends still exist?

Post by Boglegrappler »

For information from the horse's mouth, see:

https://www.berkshirehathaway.com/letters/2012ltr.pdf

Pages 19-21, regarding Buffets views on dividends. It addresses some of the issues raised here.
MathIsMyWayr
Posts: 2284
Joined: Mon Mar 27, 2017 10:47 pm
Location: CA

Re: Why do dividends still exist?

Post by MathIsMyWayr »

nisiprius wrote: Fri Aug 09, 2019 8:13 pm According to the dividend discount theory of stock value, dividends are the root of stock value. The value of the stock is the present value of the future stream of dividends it will pay. If you assume that the stock will never pay a dividend, then the calculation becomes indeterminate, like zero divided by zero, or infinity minus infinity. On a computer it usually displays as "NaN," not a number. Without dividends, a stock becomes something like bitcoin whose value is entirely psychological, based on circular reasoning--it's valuable because people think it's valuable because people think it's valuable. The value of stock is the present value of the future price of the stock, which in turn is the present value of the future price of the stock... and so on.

The reason why a non-dividend paying stock has a value is that it is expected that someday it will pay them. It has to pay them eventually in order to be worth owning. It's just a question of "pay me now or pay me later." Otherwise it's just speculation--like bitcoin, "I am buying it because I think it will go up."
If no companies pay dividend ever, it will be a giant Ponzi game: a stock has a value only as long as there is another greater fool to sell to. It is like a piece of non-producing desert land the price of which is appreciating. "Dividend is an evil" is a myopic, me-only, immature view.
User avatar
Dale_G
Posts: 3384
Joined: Tue Feb 20, 2007 5:43 pm
Location: Central Florida - on the grown up side of 83

Re: Why do dividends still exist?

Post by Dale_G »

And I am willing to bet that if buybacks become much more significant that dividends, those with taxing power will figure out they are losing revenue - and add a special tax on the buybacks themselves. 30% seems to be a nice round number.

Dale
Volatility is my friend
Topic Author
hungrywave
Posts: 231
Joined: Tue Apr 09, 2019 7:48 pm

Re: Why do dividends still exist?

Post by hungrywave »

Boglegrappler wrote: Fri Aug 09, 2019 10:23 pm For information from the horse's mouth, see:

https://www.berkshirehathaway.com/letters/2012ltr.pdf

Pages 19-21, regarding Buffets views on dividends. It addresses some of the issues raised here.
Yes! Thank you! :)

“Of course, a shareholder in our dividend-paying scenario could turn around and use his dividends to purchase more shares. But he would take a beating in doing so: He would both incur taxes and also pay a 25% premium to get his dividend reinvested. (Keep remembering, open-market purchases of the stock take place at 125% of book value.)

The second disadvantage of the dividend approach is of equal importance: The tax consequences for all taxpaying shareholders are inferior – usually far inferior – to those under the sell-off program. Under the dividend program, all of the cash received by shareholders each year is taxed whereas the sell-off program results in tax on only the gain portion of the cash receipts.”

Interestingly, he says stock buyback only makes sense when it is a good deal. He puts that at 120% book. Maybe that is why most tech companies don’t do buybacks: They are too expensive.
The world is largely random so don't sweat the small stuff.
User avatar
ThereAreNoGurus
Posts: 524
Joined: Fri Jan 24, 2014 11:41 pm

Re: Why do dividends still exist?

Post by ThereAreNoGurus »

MathIsMyWayr wrote: Fri Aug 09, 2019 10:37 pm
nisiprius wrote: Fri Aug 09, 2019 8:13 pm According to the dividend discount theory of stock value, dividends are the root of stock value. The value of the stock is the present value of the future stream of dividends it will pay. If you assume that the stock will never pay a dividend, then the calculation becomes indeterminate, like zero divided by zero, or infinity minus infinity. On a computer it usually displays as "NaN," not a number. Without dividends, a stock becomes something like bitcoin whose value is entirely psychological, based on circular reasoning--it's valuable because people think it's valuable because people think it's valuable. The value of stock is the present value of the future price of the stock, which in turn is the present value of the future price of the stock... and so on.

The reason why a non-dividend paying stock has a value is that it is expected that someday it will pay them. It has to pay them eventually in order to be worth owning. It's just a question of "pay me now or pay me later." Otherwise it's just speculation--like bitcoin, "I am buying it because I think it will go up."
If no companies pay dividend ever, it will be a giant Ponzi game: a stock has a value only as long as there is another greater fool to sell to. It is like a piece of non-producing desert land the price of which is appreciating. "Dividend is an evil" is a myopic, me-only, immature view.
"If no companies pay dividend ever, it will be a giant Ponzi game..."

Wrong. Stocks represent ownership in companies. If a company were to never pay a dividend but held assets worth millions, the stock definitely has value. When a company is purchased, the resulting payout is normally not a dividend.
Trade the news and you will lose.
Topic Author
hungrywave
Posts: 231
Joined: Tue Apr 09, 2019 7:48 pm

Re: Why do dividends still exist?

Post by hungrywave »

This seems a reasonable summary of what stock buybacks do. It confirms that they are a tax efficient alternative to dividends. It does not explain Buffet's consideration of what to do if the company seems overvalued in the market.

It also says that, when the buyback is done on the open market, it increases share price. On one hand, this makes sense because it puts buying pressure on the price. On the other hand, however, the company is just transferring cash to the selling shareholders so maybe an increase in price is irrational. :confused
The world is largely random so don't sweat the small stuff.
Wakefield1
Posts: 1059
Joined: Mon Nov 14, 2016 10:10 pm

Re: Why do dividends still exist?

Post by Wakefield1 »

nisiprius wrote: Fri Aug 09, 2019 8:13 pm According to the dividend discount theory of stock value, dividends are the root of stock value. The value of the stock is the present value of the future stream of dividends it will pay. If you assume that the stock will never pay a dividend, then the calculation becomes indeterminate, like zero divided by zero, or infinity minus infinity. On a computer it usually displays as "NaN," not a number. Without dividends, a stock becomes something like bitcoin whose value is entirely psychological, based on circular reasoning--it's valuable because people think it's valuable because people think it's valuable. The value of stock is the present value of the future price of the stock, which in turn is the present value of the future price of the stock... and so on.

The reason why a non-dividend paying stock has a value is that it is expected that someday it will pay them. It has to pay them eventually in order to be worth owning. It's just a question of "pay me now or pay me later." Otherwise it's just speculation--like bitcoin, "I am buying it because I think it will go up."

I believe that Mr. Bogle believed something like that.
Perhaps if you use a "DRIP" and always reinvest your dividend into more shares of the same thing you are sort of turning the dividend into something more like a company share buyback. Not so good. Also not taking advantage of the opportunity to diversify.

Perhaps that is why (as I think I remember) Mr. Bogle encouraged me to get my individual stocks out of the DRIPs that I had and use the dividends to buy other investments. Such as the mutual fund that he pioneered. At least as short of the radical solution to just sell the stocks and buy mutual fund shares with the proceeds.
Ari
Posts: 640
Joined: Sat May 23, 2015 6:59 am

Re: Why do dividends still exist?

Post by Ari »

I’m not sure where people think the money used in a buyback goes if they don’t think it’s distributed to the shareholders? It’s just not distributed evenly, but it’s still paid out to shareholders. Over the history of the company until failure, it will have paid out massive amounts of money to shareholders, just as if it had been paying dividends. I don’t see any difference in amount of money paid out to shareholders between a company that pays regular dividends and one who does regular buybacks.

Everyone who doesn’t participate gets a larger percentage share of the company instead.

Seems to me that participating in a buyback = getting a dividend and not participating = reinvesting your dividend, tax implications aside.
All in, all the time.
usagi
Posts: 272
Joined: Wed Jun 05, 2019 1:08 am

Re: Why do dividends still exist?

Post by usagi »

nisiprius wrote: Fri Aug 09, 2019 8:13 pm According to the dividend discount theory of stock value, dividends are the root of stock value...

...If a mature company is making money, but its stock is not rising in value, shareholders will insist on dividends and use their votes to force the company to pay them.
Finally... +++1

Another great post.
usagi
Posts: 272
Joined: Wed Jun 05, 2019 1:08 am

Re: Why do dividends still exist?

Post by usagi »

totallystudly wrote: Fri Aug 09, 2019 8:15 pm IBM is a shining example of how buybacks don't increase share value and dividends would have been better for everyone
Bingo...and buybacks were used as a way for the C-Suite to raid the company coffers.
User avatar
nedsaid
Posts: 13851
Joined: Fri Nov 23, 2012 12:33 pm

Re: Why do dividends still exist?

Post by nedsaid »

JBTX wrote: Fri Aug 09, 2019 5:44 pm I recall reading, many years ago, that paying dividends tends to instill some financial discipline in management, in that it prevents you from throwing everything away in ill advised acquisitions, investments and bonuses. They have to prioritize.

How applicable that may still be I don't know.
Still applicable. KraftHeinz is the perfect example of value being destroyed through a merger. The shareholders of Kraft and the shareholders of Heinz would have been far better off getting a dividend here instead of capital gains that never came from a bad merger. Somehow folks think that merging and then firing employees always creates Value, it doesn't. What a disaster. Corporate mergers don't always work out.
A fool and his money are good for business.
minimalistmarc
Posts: 1057
Joined: Fri Jul 24, 2015 4:38 pm

Re: Why do dividends still exist?

Post by minimalistmarc »

yohac wrote: Fri Aug 09, 2019 5:49 pm Without dividends, there wouldn't be much incentive to buy stocks of slow-growth companies like utilities.
Their total return would be the same because the dividend would be used for a buy back or something else to add value
usagi
Posts: 272
Joined: Wed Jun 05, 2019 1:08 am

Re: Why do dividends still exist?

Post by usagi »

rbaldini wrote: Fri Aug 09, 2019 6:43 pm Maybe the real question here is: why do we tax capital gains differently than income?
Take it to its logical conclusion. One of the greatest impediments to building wealth are taxes.
One of the greatest tax shelters is a small business(talk to any small business owner about it, or look at the difference between the book value of a small business and its actual asking price, the difference is usually explained by owner's benefit). If capital gains were taxed as ordinary income you would see far more people leaving large corporate America to strike out on their own and grow their own business. There is an old saying: you will never be rich, you pay too much in taxes. And that is part of the message of our mentor, Jack Bogle. Take away the tax advantage of capital gains and capital will migrate where it can find tax efficiency to the detriment of large corporate America.
MathIsMyWayr
Posts: 2284
Joined: Mon Mar 27, 2017 10:47 pm
Location: CA

Re: Why do dividends still exist?

Post by MathIsMyWayr »

ThereAreNoGurus wrote: Fri Aug 09, 2019 11:40 pm
MathIsMyWayr wrote: Fri Aug 09, 2019 10:37 pm
nisiprius wrote: Fri Aug 09, 2019 8:13 pm According to the dividend discount theory of stock value, dividends are the root of stock value. The value of the stock is the present value of the future stream of dividends it will pay. If you assume that the stock will never pay a dividend, then the calculation becomes indeterminate, like zero divided by zero, or infinity minus infinity. On a computer it usually displays as "NaN," not a number. Without dividends, a stock becomes something like bitcoin whose value is entirely psychological, based on circular reasoning--it's valuable because people think it's valuable because people think it's valuable. The value of stock is the present value of the future price of the stock, which in turn is the present value of the future price of the stock... and so on.

The reason why a non-dividend paying stock has a value is that it is expected that someday it will pay them. It has to pay them eventually in order to be worth owning. It's just a question of "pay me now or pay me later." Otherwise it's just speculation--like bitcoin, "I am buying it because I think it will go up."
If no companies pay dividend ever, it will be a giant Ponzi game: a stock has a value only as long as there is another greater fool to sell to. It is like a piece of non-producing desert land the price of which is appreciating. "Dividend is an evil" is a myopic, me-only, immature view.
"If no companies pay dividend ever, it will be a giant Ponzi game..."

Wrong. Stocks represent ownership in companies. If a company were to never pay a dividend but held assets worth millions, the stock definitely has value. When a company is purchased, the resulting payout is normally not a dividend.
Companies have assets. True and false. They also have liabilities. An ownership of something worthless is again worthless. Enron shares went from $90.75 to $0.26. GM also went bankrupt. Didn't other companies go bankrupt? As someone noted earlier, companies eventually become worthless and die. When you receive dividend, you are taking a small piece off its value as an owner and you have money in the bank. The ultimate source of the value of a company is its perceived ability to produce profit as dividend.
MathIsMyWayr
Posts: 2284
Joined: Mon Mar 27, 2017 10:47 pm
Location: CA

Re: Why do dividends still exist?

Post by MathIsMyWayr »

hungrywave wrote: Sat Aug 10, 2019 1:10 am It also says that, when the buyback is done on the open market, it increases share price. On one hand, this makes sense because it puts buying pressure on the price. On the other hand, however, the company is just transferring cash to the selling shareholders so maybe an increase in price is irrational. :confused
Paying dividend or share buybacks do not create wealth by itself. It is a financial engineering. A company can refund money to all the share holders as dividend or spend the same amount to buy off some share holders.
rossington
Posts: 774
Joined: Fri Jun 07, 2019 2:00 am
Location: Florida

Re: Why do dividends still exist?

Post by rossington »

minimalistmarc wrote: Sat Aug 10, 2019 2:46 am
yohac wrote: Fri Aug 09, 2019 5:49 pm Without dividends, there wouldn't be much incentive to buy stocks of slow-growth companies like utilities.
Their total return would be the same because the dividend would be used for a buy back or something else to add value
This is not true with respect to utilities. They are completely regulated by the states they provide services to. Their growth is determined by each state's regulatory commission. They do not have the freedom to operate the same as other independently traded public companies. But given the fact that they are allowed to pay a % of their regulated earnings as a dividend makes them attractive to income oriented investors. No share buy backs here.
"Success is going from failure to failure without loss of enthusiasm." Winston Churchill.
Herekittykitty
Posts: 736
Joined: Wed Apr 16, 2014 8:11 pm
Location: Flyover Country

Re: Why do dividends still exist?

Post by Herekittykitty »

nisiprius wrote: Fri Aug 09, 2019 8:13 pm According to the dividend discount theory of stock value, dividends are the root of stock value. The value of the stock is the present value of the future stream of dividends it will pay. If you assume that the stock will never pay a dividend, then the calculation becomes indeterminate, like zero divided by zero, or infinity minus infinity. On a computer it usually displays as "NaN," not a number. Without dividends, a stock becomes something like bitcoin whose value is entirely psychological, based on circular reasoning--it's valuable because people think it's valuable because people think it's valuable. The value of stock is the present value of the future price of the stock, which in turn is the present value of the future price of the stock... and so on.

The reason why a non-dividend paying stock has a value is that it is expected that someday it will pay them. It has to pay them eventually in order to be worth owning. It's just a question of "pay me now or pay me later." Otherwise it's just speculation--like bitcoin, "I am buying it because I think it will go up."

The natural expectation is that the rate of growth of a young company is limited only by access to capital, and that it can use every dollar it gets. It shouldn't pay dividends, it should plow them back into the business. The rate of growth of an old company is limited by market saturation; no amount of capital is going to make it grow rapidly, that is not what is limiting its growth. Therefore, it should take whatever money it can't use, and use it to pay dividends. Therefore, you'd expect young companies not to pay dividends, and mature companies to pay them. This is exactly what we see with Microsoft, which began paying dividends in 2006.

If a mature company is making money, but its stock is not rising in value, shareholders will insist on dividends and use their votes to force the company to pay them.

As for buybacks, there are various buyback-focussed indexes and ETFs that track them. Yet I cannot remember anybody in this forum ever showing any interest in them.
This is the first time I have thought I understood the matter. Thanks!
I don't know anything.
Seasonal
Posts: 2103
Joined: Sun May 21, 2017 1:49 pm

Re: Why do dividends still exist?

Post by Seasonal »

rbaldini wrote: Fri Aug 09, 2019 6:43 pm Maybe the real question here is: why do we tax capital gains differently than income?
The answer would require delving into politics.
Seasonal
Posts: 2103
Joined: Sun May 21, 2017 1:49 pm

Re: Why do dividends still exist?

Post by Seasonal »

nisiprius wrote: Fri Aug 09, 2019 8:13 pm According to the dividend discount theory of stock value, dividends are the root of stock value.
Distributions of cash are the root of stock value under this theory. It doesn't really matter if cash is distributed as a dividend or a buyback.
Seasonal
Posts: 2103
Joined: Sun May 21, 2017 1:49 pm

Re: Why do dividends still exist?

Post by Seasonal »

Note that qualified dividends are taxed the same as capital gains.
bberris
Posts: 1547
Joined: Sun Feb 20, 2011 9:44 am

Re: Why do dividends still exist?

Post by bberris »

Trader Joe wrote: Fri Aug 09, 2019 7:58 pm
hungrywave wrote: Fri Aug 09, 2019 5:32 pm Capital gains are more tax efficient than dividends in the US. Presumably, that is why Berkshire Hathaway doesn’t generate dividends.

So, why do any US companies still provide shareholders with dividends? Is it some sort of tax-inefficient budgeting tool for investors?

EDIT: I guess my follow up question is: Wouldn’t a regular stock buyback be a more tax efficient version of a dividend? This gets around the problem of a company not having good investment opportunities for its cash. Why didn’t Apple Pay a dividend and instead did a buyback?
Because stock holders (owners) love them.
Ok, but why do they love them? I know people like getting money but as said above stock buybacks do the same thing and don't trigger unwanted tax liablilities. In my mind, dividends are an anachronism, like real estate agents.
grayfox
Posts: 5569
Joined: Sat Sep 15, 2007 4:30 am

Re: Why do dividends still exist?

Post by grayfox »

fortyofforty wrote: Fri Aug 09, 2019 8:17 pm
Keep in mind that much of Berkshire's cash comes from dividends paid to it by the companies it owns. Buffett and company absolutely love investing in companies that pay dividends, no matter what they claim. If you look at their top holdings, most of them are dividend paying companies. Perhaps they are able to recognize the value of dividends to Berkshire's bottom line.
That's right. Warren Buffet doesn't like paying dividends but he loves getting dividends. I read a book about WB. In addition to buying dividend-paying companies, when he buys a company outright, he likes to keep the current managers. However, 100% of the profits from the acquired company come back to Berkshire-Hathaway. Then he and Charlie Munger decide how to deploy the money. He does not let the managers decide what to do with the profits their company produced.

This started when he bought Berkshire-Hathaway itself, which was a textile manufacturing company. At the time, it was producing great profits. The managers of the textile manufacturing business wanted to use the profits to invest back in the factories, buying new machinery, expanding etc. But WB had different ideas. He believed that the textile industry in the U.S. was doomed, so he used the textile company as a cash cow and redeployed all its cash profits into other businesses, like GEICO and the Wahington Post. Eventually, the textiles factories all closed, and just the name Berkshire-Hahaway was left, which owned many companies. That is the BK we all know today. But when WB first bought it, it was only a textile manufacturer.

Buffet and Munger basically take 100% of the profit as a dividend from the BK companies, and then allocates the cash in the best way possible. As the owners, WB and CM, not the managers, decide what to do with the profits.

:arrow: Warren Buffet loves getting that CASH. :moneybag
alex_686
Posts: 6864
Joined: Mon Feb 09, 2015 2:39 pm

Re: Why do dividends still exist?

Post by alex_686 »

patrick013 wrote: Fri Aug 09, 2019 7:48 pm
alex_686 wrote: Fri Aug 09, 2019 6:55 pm
It is interesting to compare and contract how the average company's dividend is treated verse a REITs dividend - which is obviously much more erratic.

What happens to EPS ?

operating reserve
dividends
research and tech dvelopment
expansion of profit centers
repairs and replacement
debt service

If a company pays an above average dividend it apparently has more money for that
and needs less for other categories. Perhaps even some buybacks.
I am not sure what you point is. All of the items you mention - with the exception of dividends - are "above the line" stuff. i.e. operation stuff. We are talking about "below the line", or financing stuff.

The question at hand is: What does it matter if a dollar is distributed to shareholders via dividends or by stock buy-back? With the OP making the argument that stock buy backs are more efficient from a tax perspective.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
alex_686
Posts: 6864
Joined: Mon Feb 09, 2015 2:39 pm

Re: Why do dividends still exist?

Post by alex_686 »

grayfox wrote: Sat Aug 10, 2019 5:24 am That's right. Warren Buffet doesn't like paying dividends but he loves getting dividends. I read a book about WB.
I have not only read a book about Warren Buffet, but I have read books, his stockholder letters, and academic articles.

He does not love getting dividends.

What he loves is companies with high quality earnings and a low-beta under-priced stock. Now, while these companies tend to have dividends, he has bought quite a few of the companies he buys does not. Also, and critically, while low-beta quality-earnings companies tend to pay dividends the inverse is not true. That is, there are lots of dividend paying companies that are not low-beta quality earnings companies that WB would not touch with a 10 foot pole.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
fortyofforty
Posts: 2083
Joined: Wed Mar 31, 2010 12:33 pm

Re: Why do dividends still exist?

Post by fortyofforty »

nisiprius wrote: Fri Aug 09, 2019 8:24 pm
fortyofforty wrote: Fri Aug 09, 2019 8:17 pm...Buffett and company absolutely love investing in companies that pay dividends, no matter what they claim...
A real question, not rhetorical. Do Buffett and company also love investing in companies that perform buybacks? If not, what do they think the difference is and why do they think it matters?
In my opinion, they select companies they believe present a great value. Often, such companies are out of favor, but continue to generate tons of excess cash. They are later in their life-cycles, so are not buying new plants or investing in new product lines or dumping money into expensive product launches. It's a confluence of several factors. To answer your question directly, it certainly seems that Buffett, Munger, and the rest of Berkshire do not pressure companies to do stock buybacks, but actually favor receiving dividend payments that they, in turn, can redeploy in other investment ideas. Of course, tax consequences are different for Berkshire than for individual investors, as has been endlessly pointed out here.

As for buybacks, they force an investor to "purchase" shares of a company at whatever price exists at the time of the buyback. I've heard many times of companies buying back shares at prices that do not present a good value for shareholders. Dividends allow investors to buy more shares, or buy shares of something else, or buy a new refrigerator, or pay college tuition. As for selling shares to generate income, that forces investors to decide which shares to sell and at what moment in time. The popularity of target-date funds these days indicates that many investors do not wish to have to make such decisions.
fortyofforty
Posts: 2083
Joined: Wed Mar 31, 2010 12:33 pm

Re: Why do dividends still exist?

Post by fortyofforty »

alex_686 wrote: Sat Aug 10, 2019 6:03 am
grayfox wrote: Sat Aug 10, 2019 5:24 am That's right. Warren Buffet doesn't like paying dividends but he loves getting dividends. I read a book about WB.
I have not only read a book about Warren Buffet, but I have read books, his stockholder letters, and academic articles.

He does not love getting dividends.

What he loves is companies with high quality earnings and a low-beta under-priced stock. Now, while these companies tend to have dividends, he has bought quite a few of the companies he buys does not. Also, and critically, while low-beta quality-earnings companies tend to pay dividends the inverse is not true. That is, there are lots of dividend paying companies that are not low-beta quality earnings companies that WB would not touch with a 10 foot pole.
A real question, not rhetorical: does Buffett speak with and pressure management to stop paying dividends, or reduce dividend payments, or use excess cash for stock buybacks, or do something else with excess cash rather than pay Berkshire a hefty quarterly cash payout? You've read much more than I on Buffett, so maybe you've heard he has done so.
grayfox
Posts: 5569
Joined: Sat Sep 15, 2007 4:30 am

Re: Why do dividends still exist?

Post by grayfox »

alex_686 wrote: Sat Aug 10, 2019 6:03 am
grayfox wrote: Sat Aug 10, 2019 5:24 am That's right. Warren Buffet doesn't like paying dividends but he loves getting dividends. I read a book about WB.
I have not only read a book about Warren Buffet, but I have read books, his stockholder letters, and academic articles.

He does not love getting dividends.

What he loves is companies with high quality earnings and a low-beta under-priced stock. Now, while these companies tend to have dividends, he has bought quite a few of the companies he buys does not. Also, and critically, while low-beta quality-earnings companies tend to pay dividends the inverse is not true. That is, there are lots of dividend paying companies that are not low-beta quality earnings companies that WB would not touch with a 10 foot pole.
You are missing the point. I am not talking about how he selects companies to acquire. I'm talking about how he operates once the companies are under the BK umbrella. He takes 100% of the profits of all the companies back to BK, and then deploys the cash in the best way he knows how. This is like a 100% dividend payout ratio, if it were a dividend. His company managers don't get to decide what to do with the profits they create. They have to hand over the cash to WB and CM.
fortyofforty
Posts: 2083
Joined: Wed Mar 31, 2010 12:33 pm

Re: Why do dividends still exist?

Post by fortyofforty »

grayfox wrote: Sat Aug 10, 2019 6:26 am
alex_686 wrote: Sat Aug 10, 2019 6:03 am
grayfox wrote: Sat Aug 10, 2019 5:24 am That's right. Warren Buffet doesn't like paying dividends but he loves getting dividends. I read a book about WB.
I have not only read a book about Warren Buffet, but I have read books, his stockholder letters, and academic articles.

He does not love getting dividends.

What he loves is companies with high quality earnings and a low-beta under-priced stock. Now, while these companies tend to have dividends, he has bought quite a few of the companies he buys does not. Also, and critically, while low-beta quality-earnings companies tend to pay dividends the inverse is not true. That is, there are lots of dividend paying companies that are not low-beta quality earnings companies that WB would not touch with a 10 foot pole.
You are missing the point completely. I am not talking about how he selects companies to acquire. I'm talking about how he operates once the companies are under the BK umbrella. He takes 100% of the profits of all the companies back to BK, and then deploys the cash in the best way he knows how. This is like a 100% dividend payout ratio, if it were a dividend. His company managers don't get to decide what to do with the profits they create.
A quick seat-of-the-pants look shows that about thirteen out of Berkshire's forty-six or so holdings do not pay dividends to Berkshire.
grayfox
Posts: 5569
Joined: Sat Sep 15, 2007 4:30 am

Re: Why do dividends still exist?

Post by grayfox »

fortyofforty wrote: Sat Aug 10, 2019 6:34 am
A quick seat-of-the-pants look shows that about thirteen out of Berkshire's forty-six or so holdings do not pay dividends to Berkshire.
You must be talking about the public shares owned by B-H.

List of assets owned by Berkshire Hathaway

Some companies were acquired and owned 100%. Like See's Candies, Borsheim's Jewelery, Nebraska Furniture, GEICO, General Re. There are about 65 or so owned outright. Other companies, B-H just owns public shares, like Wells Fargo, and is a minority shareholder. It looks like about 46 of those?

What I read in the book was that the wholly owned subsidiaries like GEICO sent all their profits to back to Omaha for Warren and Charlie to deploy.
alex_686
Posts: 6864
Joined: Mon Feb 09, 2015 2:39 pm

Re: Why do dividends still exist?

Post by alex_686 »

fortyofforty wrote: Sat Aug 10, 2019 6:23 am A real question, not rhetorical: does Buffett speak with and pressure management to stop paying dividends, or reduce dividend payments, or use excess cash for stock buybacks, or do something else with excess cash rather than pay Berkshire a hefty quarterly cash payout? You've read much more than I on Buffett, so maybe you've heard he has done so.
Buffett tends to leave management in place, letting them do what they do. After all, management built the company that he is buying, so he is buying them and their skills as well.

And when things go south, Buffett tends to leave management in place, and let them have a chance of doing a turn around. Lots of examples of this. If this fails, he tends to sell his holdings. As a last resort he just cleans out management and hires a new team. This is rare.

Look at his interactions with the Berkshire management, the cloth manufacture. He finds confrontation distressing. He has also said that one of his worst investments was buying Berkshire. He says he spend too much time and energy extracting value from that company.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
grayfox
Posts: 5569
Joined: Sat Sep 15, 2007 4:30 am

Re: Why do dividends still exist?

Post by grayfox »

alex_686 wrote: Sat Aug 10, 2019 6:54 am
fortyofforty wrote: Sat Aug 10, 2019 6:23 am A real question, not rhetorical: does Buffett speak with and pressure management to stop paying dividends, or reduce dividend payments, or use excess cash for stock buybacks, or do something else with excess cash rather than pay Berkshire a hefty quarterly cash payout? You've read much more than I on Buffett, so maybe you've heard he has done so.
Buffett tends to leave management in place, letting them do what they do. After all, management built the company that he is buying, so he is buying them and their skills as well.

And when things go south, Buffett tends to leave management in place, and let them have a chance of doing a turn around. Lots of examples of this. If this fails, he tends to sell his holdings. As a last resort he just cleans out management and hires a new team. This is rare.

Look at his interactions with the Berkshire management, the cloth manufacture. He finds confrontation distressing. He has also said that one of his worst investments was buying Berkshire. He says he spend too much time and energy extracting value from that company.
I think you are each talking about two different things here. B-H has two kinds of holdings.

1. One kind of holding is public shares of companies, they may or may not pay dividends. B-H is only a minority shareholder. E.g. B-H owns 5.4% of Apple and 9.4% of Coca-Cola Company. Buffet does not have the power to keep or replace Apple or CocaCola management, or control dividend payout. Maybe he can make suggestions.

2. The other kind of holding is 100% owned subsidiaries. Those were acquired and are not public companies anymore. They don't pay dividends. Buffet has the power to keep or replace their management. e.g. GEICO and See's Candies.

fortyofforty is asking about dividends, so he must be talking about 1.
alex_686 is talking about keeping or replacing management, so that must be 2.

List of assets owned by Berkshire Hathaway
alex_686
Posts: 6864
Joined: Mon Feb 09, 2015 2:39 pm

Re: Why do dividends still exist?

Post by alex_686 »

grayfox wrote: Sat Aug 10, 2019 7:12 am fortyofforty is asking about dividends, so he must be talking about 1.
alex_686 is talking about keeping or replacing management, so that must be 2.
I will disagree. WB tends to buy the same type of company. Under-priced, Low-Beta, High quality earnings. Wide moats and good cash flow.

The difference between directly held companies and indirect companies is size. If they company is small he just buys them whole. If they are large and public, he just buys a slice, because that is all he can afford or without running up the price.

It restate my position relative to WB, dividends is a pretty poor signal. P/E, P/B, etc. will give you greater insight into how WB thinks.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
grayfox
Posts: 5569
Joined: Sat Sep 15, 2007 4:30 am

Re: Why do dividends still exist?

Post by grayfox »

alex_686 wrote: Sat Aug 10, 2019 7:36 am
grayfox wrote: Sat Aug 10, 2019 7:12 am fortyofforty is asking about dividends, so he must be talking about 1.
alex_686 is talking about keeping or replacing management, so that must be 2.
I will disagree. WB tends to buy the same type of company. Under-priced, Low-Beta, High quality earnings. Wide moats and good cash flow.

The difference between directly held companies and indirect companies is size. If they company is small he just buys them whole. If they are large and public, he just buys a slice, because that is all he can afford or without running up the price.

It restate my position relative to WB, dividends is a pretty poor signal. P/E, P/B, etc. will give you greater insight into how WB thinks.
No disagreement from me. I'm was talking about what happens to the cash profits from wholy-owned subsidiaries once they are part of B-H.
alex_686
Posts: 6864
Joined: Mon Feb 09, 2015 2:39 pm

Re: Why do dividends still exist?

Post by alex_686 »

grayfox wrote: Sat Aug 10, 2019 7:37 am No disagreement from me. I'm was talking about what happens to the cash profits from wholy-owned subsidiaries once they are part of B-H.
You should read up what WB was doing back in the 80s. There was a sweet spot that if you owned a large minority stake in a company you could just move the minorities earnings directly onto your balance sheet. So much more powerful than getting your hands on the minorities company's cash flow (i.e., dividends.)
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
User avatar
firebirdparts
Posts: 1801
Joined: Thu Jun 13, 2019 4:21 pm

Re: Why do dividends still exist?

Post by firebirdparts »

MathIsMyWayr wrote: Fri Aug 09, 2019 10:37 pm If no companies pay dividend ever, it will be a giant Ponzi game: a stock has a value only as long as there is another greater fool to sell to. It is like a piece of non-producing desert land the price of which is appreciating. "Dividend is an evil" is a myopic, me-only, immature view.
Of course, obviously. The greater fool concept is always going to be limited by fool size. I have learned, though, that there is not much point in discussing this with people.
A fool and your money are soon partners
Dandy
Posts: 6357
Joined: Sun Apr 25, 2010 7:42 pm

Re: Why do dividends still exist?

Post by Dandy »

I don't own individual stocks but if I did I would prefer dividends for several reasons.

1. I think many buy backs are likely not to reduce total shares outstanding. They will be used to pay incentives to management so the potential additional stock value from the buy backs will not materialize. They should get the bulk of their incentives in other ways.
2. If I have tax concerns with dividends I can hold the stock in a tax advantaged account or buy stocks that don't pay dividends.
3. If I want income I don't want the hassle and potential trade cost of selling "a few shares" on an ongoing basis.
4. Don't some qualified stock dividends currently have a lower rate than ordinary income?
5. As noted, dividends are a bird in hand vs 2 in the bush. Any long term Sears stock holders wish they had only buy backs?
6. Dividends are usually regularly paid vs buy backs that usually are not.

New, growing companies most likely can't afford to pay dividends-- mature well run companies can. If I invested in a mature well run company I would except growth and dividends.
User avatar
House Blend
Posts: 4761
Joined: Fri May 04, 2007 1:02 pm

Re: Why do dividends still exist?

Post by House Blend »

MathWizard wrote: Fri Aug 09, 2019 9:54 pm With increasing use of stock options in executive pay, a share buyback when stock options can be exercised is a transfer of value from shareholders to executives with stock options.
Bingo.

There's an interesting recent article in the Atlantic arguing that share buybacks have become the go-to strategy for executives seeking to increase profits from their stock options.

The fact that they are more tax-efficient for shareholders is an afterthought.

The Stock-Buyback Swindle

American corporations are spending trillions of dollars to repurchase their own stock. The practice is enriching CEOs—at the expense of everyone else.
One class of shareholder, however, has benefited greatly from the temporary price jumps: the managers who initiate buybacks and are privy to their exact scope and timing. Last year, SEC Commissioner Robert Jackson Jr. instructed his staff to “take a look at how buybacks affect how much skin executives keep in the game.” This analysis revealed that in the eight days following a buyback announcement, executives on average sold five times as much stock as they had on an ordinary day. “Thus,” Jackson said, “executives personally capture the benefit of the short-term stock-price pop created by the buyback announcement.”
https://www.theatlantic.com/magazine/ar ... le/592774/
Post Reply