Dividend irrelevance for individual securities

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OverseasBH
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Dividend irrelevance for individual securities

Post by OverseasBH »

As I understand it, the dividend irrelevance argument is that a fund’s NAV drops by the amount of the dividend, so you are no better off before tax if you receive dividends or do not. But is that always true when taken down to the individual security level? Here is an example to consider.

Say Acme Company has assets of $100m, debt of $40m, and equity of $60m. You are a 10% shareholder, so your interest is $6m of book equity. The market is willing to pay $3 for every $1 of Acme’s net book value, so has a P/B of 3:1 (VTI is 3.4:1). This is due to Acme’s perceived ability to generate future profits. The market therefore values your 10% equity stake at $18m and the whole company at $180m.

Acme then declares and pays a cash dividend of $10m, of which you receive $1m as a 10% shareholder. Paying this dividend reduces the book equity of Acme to $50m, your book equity to $5m, and your market equity to $15m. The whole company is now valued at $150m, reduced by 1/6 due to paying out 1/6 of the equity as a dividend.

You then own a $1m cash dividend plus $15m market equity in Acme, totaling $16m. You have lost $2m by this dividend being paid, because the market values the funds more highly inside the company than outside. Does this not impact dividend irrelevance?
jebmke
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Re: Dividend irrelevance for individual securities

Post by jebmke »

Wrapping a fund around securities doesn’t somehow change their properties.
When you discover that you are riding a dead horse, the best strategy is to dismount.
Artsypenguin
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Re: Dividend irrelevance for individual securities

Post by Artsypenguin »

Dividends are also tax negative.
Valuethinker
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Re: Dividend irrelevance for individual securities

Post by Valuethinker »

OverseasBH wrote: Sun Dec 04, 2022 6:32 am As I understand it, the dividend irrelevance argument is that a fund’s NAV drops by the amount of the dividend, so you are no better off before tax if you receive dividends or do not. But is that always true when taken down to the individual security level? Here is an example to consider.

Say Acme Company has assets of $100m, debt of $40m, and equity of $60m. You are a 10% shareholder, so your interest is $6m of book equity. The market is willing to pay $3 for every $1 of Acme’s net book value, so has a P/B of 3:1 (VTI is 3.4:1). This is due to Acme’s perceived ability to generate future profits. The market therefore values your 10% equity stake at $18m and the whole company at $180m.

Acme then declares and pays a cash dividend of $10m, of which you receive $1m as a 10% shareholder. Paying this dividend reduces the book equity of Acme to $50m, your book equity to $5m, and your market equity to $15m. The whole company is now valued at $150m, reduced by 1/6 due to paying out 1/6 of the equity as a dividend.

You then own a $1m cash dividend plus $15m market equity in Acme, totaling $16m. You have lost $2m by this dividend being paid, because the market values the funds more highly inside the company than outside. Does this not impact dividend irrelevance?
You have put leverage into your calculation. That 3x P/Book.

In the Modigliani & Miller model, which generalises, the price of the stock is equal to the cash in the company. And since you can also buy back shares at book value, the dividend is exactly equivalent to a share buyback *except* that the latter reduces the number of shares in issue.

If the market values the future prospects of a company highly enough, then paying dividends will lower the stock price by more than the dividend paid out. This is classically true of growth stocks. When a company starts paying a dividend it is a signal that the management do not see superior investing opportunities, at which they can apply their unique skills and corporate resources, to those available to the stock market as a whole. You do see the stock prices of companies go *down* on the announcement (ie not the payment of) a dividend policy - for a company that has hitherto not found it necessary to pay dividends.

If Berkshire Hathaway ever declared a dividend, I am sure the stock price reaction would be quite negative. It would be seen as a sign that Buffett was finally giving up.
Caduceus
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Re: Dividend irrelevance for individual securities

Post by Caduceus »

It's a very good question. But you haven't lost anything because you can simply re-purchase the company stock with your dividends, thereby increasing your stake in the company compared to where you were before. Also, payout of dividend is unlikely - using your example - to reduce the company's market capitalization by a direct P/B calculation.

You're asking a fundamental valuation question and the best way to think/learn about it is actually to follow a particular company's financial statements throughout, say, a decade, and analyze how its capital allocation decisions affected its book value, its intrinsic value, and ultimately, its market value. Pore through the numbers and ask yourself at every point: what would have been - retrospectively - the best use of the company's cash?

The book value of a company can have very little to do with its intrinsic/fair value (what it's really worth, economically). Apple is worth more than its book value. That will be true of many companies with strong brands and/or high returns on equity - the best companies don't need huge amounts of capital investments to generate profits. But, conversely, there are many companies that are worth less than their book value. Their "book" isn't even worth what they are being carried for on the balance sheet. Take a look at gold-mining companies over the last decade - pick one and read the financial statements and try to analyze their balance sheets.

Whether dividends or earnings retention or stock buybacks are better is a matter of capital allocation. In other words, whether dividends is a superior use of shareholder money depends on whether alternatives are available. If the company can buy back massive amounts of stock at a price less than its intrinsic value (and note that the intrinsic value can be much higher - or much lower - than its book value, so they are not the same things at all), then stock buybacks are the superior capital allocation decision. Take a look at what happened with Home Capital Group when new management came in - amazing capital allocation. Most boards are crap at stock buybacks. They will commit to buying back some fixed amount of stock over some time period regardless of the stock price. That's inane. But there are companies - Berkshire, Home Capital, etc. that will only buy back stock at a price below the fair value of the company's economic value, and that creates real shareholder windfalls.

But if the stock price is much higher than the fair value of a company, the firm should either reinvest its profits - if it can earn a decent return on equity on the reinvested capital - or release the cash to shareholders in the form of dividends. You can then decide whether to buy a greater share of the same company or re-invest elsewhere.
Ed 2
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Re: Dividend irrelevance for individual securities

Post by Ed 2 »

Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
So is your paycheck
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jebmke
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Re: Dividend irrelevance for individual securities

Post by jebmke »

Ed 2 wrote: Mon Dec 05, 2022 4:59 am
Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
So is your paycheck
But if you play your cards right, capital gains are not.
When you discover that you are riding a dead horse, the best strategy is to dismount.
exodusNH
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Re: Dividend irrelevance for individual securities

Post by exodusNH »

Ed 2 wrote: Mon Dec 05, 2022 4:59 am
Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
So is your paycheck
The difference, of course, is that a paycheck, assuming you aren't the sole business owner, actually increases your wealth.

A dividend merely changes the composition of it. A dividend is no different than taking $10 from your savings account, paying the government $1.50 and depositing the net $8.50 in your checking account.
dbr
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Re: Dividend irrelevance for individual securities

Post by dbr »

exodusNH wrote: Mon Dec 05, 2022 7:12 am
Ed 2 wrote: Mon Dec 05, 2022 4:59 am
Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
So is your paycheck
The difference, of course, is that a paycheck, assuming you aren't the sole business owner, actually increases your wealth.

A dividend merely changes the composition of it. A dividend is no different than taking $10 from your savings account, paying the government $1.50 and depositing the net $8.50 in your checking account.
It would seem that the concept that a dividend is not a paycheck might lie at the heart of all the discussion about this.

As far as the performance of individual companies, if I were to invest in one the last thing I would want would be that the company forces me to take back part of the proceeds rather than investing in growing the enterprise. I would not have invested there if I did not think they could make better use of my money than I can. And, if for some reason I want to reduce how much of my assets are involved there, I would just sell some shares. But, I admit I don't invest in individual stocks and probably don't know much about it. It could be that dividend paying companies are bid up to higher prices than one's that don't pay dividends. It is true that failing companies that cut the dividend crash on the market.
exodusNH
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Re: Dividend irrelevance for individual securities

Post by exodusNH »

dbr wrote: Mon Dec 05, 2022 7:31 am
exodusNH wrote: Mon Dec 05, 2022 7:12 am
Ed 2 wrote: Mon Dec 05, 2022 4:59 am
Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
So is your paycheck
The difference, of course, is that a paycheck, assuming you aren't the sole business owner, actually increases your wealth.

A dividend merely changes the composition of it. A dividend is no different than taking $10 from your savings account, paying the government $1.50 and depositing the net $8.50 in your checking account.
It would seem that the concept that a dividend is not a paycheck might lie at the heart of all the discussion about this.

As far as the performance of individual companies, if I were to invest in one the last thing I would want would be that the company forces me to take back part of the proceeds rather than investing in growing the enterprise. I would not have invested there if I did not think they could make better use of my money than I can. And, if for some reason I want to reduce how much of my assets are involved there, I would just sell some shares. But, I admit I don't invest in individual stocks and probably don't know much about it. It could be that dividend paying companies are bid up to higher prices than one's that don't pay dividends. It is true that failing companies that cut the dividend crash on the market.
I was trying to avoid going down the well-worn rabbit hole discussion.

Yes, there is some good evidence that people who prefer dividends to wind up bidding up the price of the dividend stocks. I think Rational Reminder presented some of that data.

I really think part of the confusion is that until the advent of low-cost brokers, using your stock wealth involved huge transaction fees, especially if you were selling "odd lots". A dividend from the company was the only cost effective way to to convert stock wealth into money in your account. Dividends thus got cemented in our collective consciousness.

Even before I found this forum, I was "above average" in my knowledge of investing (which is a low bar), and I thought they were like bond coupon payments.
dbr
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Re: Dividend irrelevance for individual securities

Post by dbr »

exodusNH wrote: Mon Dec 05, 2022 9:09 am
dbr wrote: Mon Dec 05, 2022 7:31 am
exodusNH wrote: Mon Dec 05, 2022 7:12 am
Ed 2 wrote: Mon Dec 05, 2022 4:59 am
Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
So is your paycheck
The difference, of course, is that a paycheck, assuming you aren't the sole business owner, actually increases your wealth.

A dividend merely changes the composition of it. A dividend is no different than taking $10 from your savings account, paying the government $1.50 and depositing the net $8.50 in your checking account.
It would seem that the concept that a dividend is not a paycheck might lie at the heart of all the discussion about this.

As far as the performance of individual companies, if I were to invest in one the last thing I would want would be that the company forces me to take back part of the proceeds rather than investing in growing the enterprise. I would not have invested there if I did not think they could make better use of my money than I can. And, if for some reason I want to reduce how much of my assets are involved there, I would just sell some shares. But, I admit I don't invest in individual stocks and probably don't know much about it. It could be that dividend paying companies are bid up to higher prices than one's that don't pay dividends. It is true that failing companies that cut the dividend crash on the market.
I was trying to avoid going down the well-worn rabbit hole discussion.
Guilty as charged. I'll shut up now. What we really need is a bot that cancels any posting that talks about dividends.
Topic Author
OverseasBH
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Re: Dividend irrelevance for individual securities

Post by OverseasBH »

jebmke wrote: Sun Dec 04, 2022 6:37 am Wrapping a fund around securities doesn’t somehow change their properties.
Yes, that is why I am starting the example of a single company's stock, just like most of the bond fund discussions start with what happens with a single bond.
Topic Author
OverseasBH
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Re: Dividend irrelevance for individual securities

Post by OverseasBH »

Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
From whose perspective, company or shareholder and how does that impact the discussion?
cjking
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Re: Dividend irrelevance for individual securities

Post by cjking »

OverseasBH wrote: Sun Dec 04, 2022 6:32 am Say Acme Company has assets of $100m, debt of $40m, and equity of $60m. You are a 10% shareholder, so your interest is $6m of book equity. The market is willing to pay $3 for every $1 of Acme’s net book value, so has a P/B of 3:1 (VTI is 3.4:1). This is due to Acme’s perceived ability to generate future profits. The market therefore values your 10% equity stake at $18m and the whole company at $180m.

Acme then declares and pays a cash dividend of $10m, of which you receive $1m as a 10% shareholder. Paying this dividend reduces the book equity of Acme to $50m, your book equity to $5m, and your market equity to $15m. The whole company is now valued at $150m, reduced by 1/6 due to paying out 1/6 of the equity as a dividend.

You then own a $1m cash dividend plus $15m market equity in Acme, totaling $16m. You have lost $2m by this dividend being paid, because the market values the funds more highly inside the company than outside. Does this not impact dividend irrelevance?
I think the theory says if a $180 million capitalisation company pays a $10 million dividend, the capitalisation falls to $170 million, not $150 million as you have theorised. (Edit: actually I'm not sure what the theory says, but I think what I say in this paragraph is what actually happens.)

I suppose in your example that must mean the price to book increases. Thinking about a company that pays fixed regular dividends, presumably cash is restored from earnings by the time of the subsequent dividend, so the price to book will gradually return to its original level.
Last edited by cjking on Mon Dec 05, 2022 9:36 am, edited 1 time in total.
Topic Author
OverseasBH
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Re: Dividend irrelevance for individual securities

Post by OverseasBH »

OverseasBH wrote: Sun Dec 04, 2022 6:32 am As I understand it, the dividend irrelevance argument is that a fund’s NAV drops by the amount of the dividend, so you are no better off before tax if you receive dividends or do not. But is that always true when taken down to the individual security level? Here is an example to consider.

Say Acme Company has assets of $100m, debt of $40m, and equity of $60m. You are a 10% shareholder, so your interest is $6m of book equity. The market is willing to pay $3 for every $1 of Acme’s net book value, so has a P/B of 3:1 (VTI is 3.4:1). This is due to Acme’s perceived ability to generate future profits. The market therefore values your 10% equity stake at $18m and the whole company at $180m.

Acme then declares and pays a cash dividend of $10m, of which you receive $1m as a 10% shareholder. Paying this dividend reduces the book equity of Acme to $50m, your book equity to $5m, and your market equity to $15m. The whole company is now valued at $150m, reduced by 1/6 due to paying out 1/6 of the equity as a dividend.

You then own a $1m cash dividend plus $15m market equity in Acme, totaling $16m. You have lost $2m by this dividend being paid, because the market values the funds more highly inside the company than outside. Does this not impact dividend irrelevance?
Valuethinker wrote: Mon Dec 05, 2022 3:39 am You have put leverage into your calculation. That 3x P/Book.
This is just market cap over book value. What does leverage have to do with it?
Valuethinker wrote: Mon Dec 05, 2022 3:39 am And since you can also buy back shares at book value
Are not shares bought back at market value, not book value?
Artsypenguin
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Re: Dividend irrelevance for individual securities

Post by Artsypenguin »

OverseasBH wrote: Mon Dec 05, 2022 9:18 am
Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
From whose perspective, company or shareholder and how does that impact the discussion?
The shareholders. Every time I'm paid dividends in my taxable account a portion is withheld for state and federal taxes. I'll get this back eventually, but it's money that can't be in the market right now. If you own dividend stocks in a tax deferred account it is a different consideration in my understanding.
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burritoLover
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Re: Dividend irrelevance for individual securities

Post by burritoLover »

Dividend irrelevance applies to individual stocks as an an extension to funds - not the other way around. The price of an individual stock drops by the amount of the dividend due to market action in an efficient market. If it didn't, then any brain-dead investor could capitalize on what would be a free lunch. Everything else (whether the market as a whole thinks mgmt should pay a dividend, etc) acts "separately" on the price. End of story.
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OverseasBH
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Re: Dividend irrelevance for individual securities

Post by OverseasBH »

cjking wrote: Mon Dec 05, 2022 9:25 am
OverseasBH wrote: Sun Dec 04, 2022 6:32 am Say Acme Company has assets of $100m, debt of $40m, and equity of $60m. You are a 10% shareholder, so your interest is $6m of book equity. The market is willing to pay $3 for every $1 of Acme’s net book value, so has a P/B of 3:1 (VTI is 3.4:1). This is due to Acme’s perceived ability to generate future profits. The market therefore values your 10% equity stake at $18m and the whole company at $180m.

Acme then declares and pays a cash dividend of $10m, of which you receive $1m as a 10% shareholder. Paying this dividend reduces the book equity of Acme to $50m, your book equity to $5m, and your market equity to $15m. The whole company is now valued at $150m, reduced by 1/6 due to paying out 1/6 of the equity as a dividend.

You then own a $1m cash dividend plus $15m market equity in Acme, totaling $16m. You have lost $2m by this dividend being paid, because the market values the funds more highly inside the company than outside. Does this not impact dividend irrelevance?
I think the theory says if a $180 million capitalisation company pays a $10 million dividend, the capitalisation falls to $170 million, not $150 million as you have theorised.

I suppose in your example that must mean the price to book increases. Thinking about a company that pays fixed regular dividends, presumably cash is restored from earnings by the time of the subsequent dividend, so the price to book will gradually return to its original level.
Why would be price to book change as the market was prepared to pay $3 for $1 of equity/earning. You are implying that there is some other factor driving what is behind market valuations besides an evaluation of what I as an investor would pay for each dollar of earnings of a company. Is that not the most atomic level of fundamental analysis?
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Re: Dividend irrelevance for individual securities

Post by alex_686 »

OverseasBH wrote: Sun Dec 04, 2022 6:32 am As I understand it, the dividend irrelevance argument is that a fund’s NAV drops by the amount of the dividend, so you are no better off before tax if you receive dividends or do not. But is that always true when taken down to the individual security level? Here is an example to consider.

Say Acme Company has assets of $100m, debt of $40m, and equity of $60m. You are a 10% shareholder, so your interest is $6m of book equity. The market is willing to pay $3 for every $1 of Acme’s net book value, so has a P/B of 3:1 (VTI is 3.4:1). This is due to Acme’s perceived ability to generate future profits. The market therefore values your 10% equity stake at $18m and the whole company at $180m.

Acme then declares and pays a cash dividend of $10m, of which you receive $1m as a 10% shareholder. Paying this dividend reduces the book equity of Acme to $50m, your book equity to $5m, and your market equity to $15m. The whole company is now valued at $150m, reduced by 1/6 due to paying out 1/6 of the equity as a dividend.

You then own a $1m cash dividend plus $15m market equity in Acme, totaling $16m. You have lost $2m by this dividend being paid, because the market values the funds more highly inside the company than outside. Does this not impact dividend irrelevance?
You are kind of on the right track. However the point you have wrong is the bit about cash and book value. Book value does a poor job of describing a company's value as it is only tied to plant, property, etc. Cash is not part of book value.

The concept you want to focus on is Enterprise Value, or the economic value of the company.

https://www.investopedia.com/terms/e/en ... evalue.asp

Let us say the economic value of the company, the bits that produce earnings & profits is worth 100m. And the company has cash of 20m. It then sends out a dividend of 10m. How does this change the Enterprise Value of the company? i.e., how will it effect the core economic productivity of the company? Well, it doesn't, does it.

Which takes us to the core investment concept, Modigliani-Miller Capital Structure Theorem. a.k.a. Dividend Irrelevance Theory.

Let say we have a company whose EV is 100m. You can chose to finance that company many different ways. You could finance it with 70m equity / 30m bonds. Or 30m equity and 70m bonds. Let say you are at 70/30. You could borrow 10m and issue a 10m cash dividend, moving you to 40/70.

Or lets say you are at 30/70 plus you have 10m in cash. You could pay a 10m cash dividend. Or you could pay down your debt - you are fairly highly leveraged.

I mean, what is the difference between paying 2.5m a quarter verse 10m a year? Yes, there is a little computing interest but let us gloss over this. Paying off debt today so you can generate more and higher earnings tomorrow for a bigger cash dividend in the future? Or instead of paying out a cash dividend reinvesting back into the company?

From a first order perspective the dividend irreverence theory is airtight. If it where not then I, as a CFO, could magic money out of thin air by manipulating the books. You can't do that.

Things get more interesting when you look at second order movements.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
exodusNH
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Re: Dividend irrelevance for individual securities

Post by exodusNH »

OverseasBH wrote: Mon Dec 05, 2022 9:18 am
Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
From whose perspective, company or shareholder and how does that impact the discussion?
Due to taxation, a dividend payment results in you having less wealth now, since somewhere between 0-40% of the dividend was paid to the government as tax.

A stock buyback has no tax consequences for you now, but potentially 0-15% when you sell in the future.

In a tax-advantaged account, it doesn't matter.

Note when you hear, "dividend irrelevance", it doesn't mean that dividends aren't important, but rather that, absent taxes and transaction fees, one shouldn't care about the source of return. At the end of the day, you have the same wealth.

"Irrelevance" like "rational" are unfortunately "loaded" terms in the vernacular. They have very specific meanings within certain fields, but the general public ascribes meaning on top of the technical meaning.

It's just like "theory." EVERYONE uses "theory" when they really mean "hypothesis", but if you try to correct people when they use the term, you will stop getting invited to parties.
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OverseasBH
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Re: Dividend irrelevance for individual securities

Post by OverseasBH »

burritoLover wrote: Mon Dec 05, 2022 9:36 am Dividend irrelevance applies to individual stocks as an an extension to funds - not the other way around. The price of an individual stock drops by the amount of the dividend due to market action in an efficient market. If it didn't, then any brain-dead investor could capitalize on what would be a free lunch. Everything else (whether the market as a whole thinks mgmt should pay a dividend, etc) acts "separately" on the price. End of story.
That is the high level view but I am looking at this from a detailed perspective. When one looks at this at a much lower level without the usual canards, perhaps it does not seem so obvious. I cannot see where in my example above this falls apart. Welcome a detailed look.
exodusNH
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Re: Dividend irrelevance for individual securities

Post by exodusNH »

OverseasBH wrote: Mon Dec 05, 2022 9:47 am
burritoLover wrote: Mon Dec 05, 2022 9:36 am Dividend irrelevance applies to individual stocks as an an extension to funds - not the other way around. The price of an individual stock drops by the amount of the dividend due to market action in an efficient market. If it didn't, then any brain-dead investor could capitalize on what would be a free lunch. Everything else (whether the market as a whole thinks mgmt should pay a dividend, etc) acts "separately" on the price. End of story.
That is the high level view but I am looking at this from a detailed perspective. When one looks at this at a much lower level without the usual canards, perhaps it does not seem so obvious. I cannot see where in my example above this falls apart. Welcome a detailed look.
Read alex_686's post. He's been in the industry for a long time and has detailed knowledge of the inner workings. Funds are merely collections of the underlying stocks. There is no difference in analyzing a single stock vs the collective behavior.
petulant
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Re: Dividend irrelevance for individual securities

Post by petulant »

OverseasBH wrote: Mon Dec 05, 2022 9:39 am
cjking wrote: Mon Dec 05, 2022 9:25 am
OverseasBH wrote: Sun Dec 04, 2022 6:32 am Say Acme Company has assets of $100m, debt of $40m, and equity of $60m. You are a 10% shareholder, so your interest is $6m of book equity. The market is willing to pay $3 for every $1 of Acme’s net book value, so has a P/B of 3:1 (VTI is 3.4:1). This is due to Acme’s perceived ability to generate future profits. The market therefore values your 10% equity stake at $18m and the whole company at $180m.

Acme then declares and pays a cash dividend of $10m, of which you receive $1m as a 10% shareholder. Paying this dividend reduces the book equity of Acme to $50m, your book equity to $5m, and your market equity to $15m. The whole company is now valued at $150m, reduced by 1/6 due to paying out 1/6 of the equity as a dividend.

You then own a $1m cash dividend plus $15m market equity in Acme, totaling $16m. You have lost $2m by this dividend being paid, because the market values the funds more highly inside the company than outside. Does this not impact dividend irrelevance?
I think the theory says if a $180 million capitalisation company pays a $10 million dividend, the capitalisation falls to $170 million, not $150 million as you have theorised.

I suppose in your example that must mean the price to book increases. Thinking about a company that pays fixed regular dividends, presumably cash is restored from earnings by the time of the subsequent dividend, so the price to book will gradually return to its original level.
Why would be price to book change as the market was prepared to pay $3 for $1 of equity/earning. You are implying that there is some other factor driving what is behind market valuations besides an evaluation of what I as an investor would pay for each dollar of earnings of a company. Is that not the most atomic level of fundamental analysis?
Imagine I have a unique, irreplaceable magical machine that I purchased on January 1 for $100. The magical machine prints $30 per year, and the machine never depreciates or wears out. I bought the machine inside a company with no debt on its balance sheet. At the end of the year, I still have the machine, but I also have $30 in cash that was printed during the year. Since financial accounting uses historical cost, my balance sheet would say $130 in assets (and equity), composed of the magical machine and the $30 in cash. If my corporation was publicly traded, a fundamentals investor would rationally place a high p/b multiple on the part of my balance sheet related to the magical machine, while the cash would be treated 1:1 for valuation. Thus, if the risk-adjusted market cost of capital was about 10%, then I would expect the fair market value of my magical machine would be about $300 instead of its book value of $100, and my corporation would be worth $330, for an overall p/b of 2.53. However, imagine I instead pay out a dividend of $30 using my cash printed during the year. After that payment, the fundamental investor would only see the magical machine; it would be valued at $300; and my p/b ratio would be 3. Assuming no other market volatility, the market value of my corporation would tend to stay around $300 except that it would slowly grow over the year until it reached $330, just before the dividend payment, and then it would crash back to $300 on the date of the payment. Further, the p/b would fluctuate from 3 down to 2.53 and back up to 3. Of course, there would be other quibbles and variations and tweaks, but you get the point.
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Re: Dividend irrelevance for individual securities

Post by burritoLover »

OverseasBH wrote: Mon Dec 05, 2022 9:47 am
burritoLover wrote: Mon Dec 05, 2022 9:36 am Dividend irrelevance applies to individual stocks as an an extension to funds - not the other way around. The price of an individual stock drops by the amount of the dividend due to market action in an efficient market. If it didn't, then any brain-dead investor could capitalize on what would be a free lunch. Everything else (whether the market as a whole thinks mgmt should pay a dividend, etc) acts "separately" on the price. End of story.
That is the high level view but I am looking at this from a detailed perspective. When one looks at this at a much lower level without the usual canards, perhaps it does not seem so obvious. I cannot see where in my example above this falls apart. Welcome a detailed look.
It is that simple. You want to force the assumption that price/book is a constant which is not the case.
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Re: Dividend irrelevance for individual securities

Post by alex_686 »

exodusNH wrote: Mon Dec 05, 2022 9:53 am
OverseasBH wrote: Mon Dec 05, 2022 9:47 am
burritoLover wrote: Mon Dec 05, 2022 9:36 am Dividend irrelevance applies to individual stocks as an an extension to funds - not the other way around. The price of an individual stock drops by the amount of the dividend due to market action in an efficient market. If it didn't, then any brain-dead investor could capitalize on what would be a free lunch. Everything else (whether the market as a whole thinks mgmt should pay a dividend, etc) acts "separately" on the price. End of story.
That is the high level view but I am looking at this from a detailed perspective. When one looks at this at a much lower level without the usual canards, perhaps it does not seem so obvious. I cannot see where in my example above this falls apart. Welcome a detailed look.
Read alex_686's post. He's been in the industry for a long time and has detailed knowledge of the inner workings. Funds are merely collections of the underlying stocks. There is no difference in analyzing a single stock vs the collective behavior.
To extend a bit,

I strongly favor Dividend Irrelevance Theory for individual stocks. I have worked with enough accounting, financial reporting, and investment theory to know how statements, dividends, and values work. How they can be manipulated and how they can't. That being said, M&M is the starting point, not the ending point. There is a fair amount of nuance and complexity when it comes to real life. This is my opinion.

When it comes to mutual funds Dividend Irrelevance is a cold hard fact. The sole purpose of dividends is to generate "reportable transactions" to generate a 1099 for tax reporting. There is a very low linkage between tax reporting and economic returns. When a mutual fund declares a dividend that triggers a set of accounting ledger transactions. Nothing economic happens.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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Re: Dividend irrelevance for individual securities

Post by exodusNH »

alex_686 wrote: Mon Dec 05, 2022 10:31 am
exodusNH wrote: Mon Dec 05, 2022 9:53 am
OverseasBH wrote: Mon Dec 05, 2022 9:47 am
burritoLover wrote: Mon Dec 05, 2022 9:36 am Dividend irrelevance applies to individual stocks as an an extension to funds - not the other way around. The price of an individual stock drops by the amount of the dividend due to market action in an efficient market. If it didn't, then any brain-dead investor could capitalize on what would be a free lunch. Everything else (whether the market as a whole thinks mgmt should pay a dividend, etc) acts "separately" on the price. End of story.
That is the high level view but I am looking at this from a detailed perspective. When one looks at this at a much lower level without the usual canards, perhaps it does not seem so obvious. I cannot see where in my example above this falls apart. Welcome a detailed look.
Read alex_686's post. He's been in the industry for a long time and has detailed knowledge of the inner workings. Funds are merely collections of the underlying stocks. There is no difference in analyzing a single stock vs the collective behavior.
To extend a bit,

I strongly favor Dividend Irrelevance Theory for individual stocks. I have worked with enough accounting, financial reporting, and investment theory to know how statements, dividends, and values work. How they can be manipulated and how they can't. That being said, M&M is the starting point, not the ending point. There is a fair amount of nuance and complexity when it comes to real life. This is my opinion.

When it comes to mutual funds Dividend Irrelevance is a cold hard fact. The sole purpose of dividends is to generate "reportable transactions" to generate a 1099 for tax reporting. There is a very low linkage between tax reporting and economic returns. When a mutual fund declares a dividend that triggers a set of accounting ledger transactions. Nothing economic happens.
My favorite quote from you was that the only people at your firm that loved dividends were the sales and marketing folks. All the technical people subscribed to M&M.
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Re: Dividend irrelevance for individual securities

Post by Valuethinker »

OverseasBH wrote: Mon Dec 05, 2022 9:29 am
Valuethinker wrote: Mon Dec 05, 2022 3:39 am You have put leverage into your calculation. That 3x P/Book.
This is just market cap over book value. What does leverage have to do with it?
The portfolio is now geared. You are holding the stock at a multiple of its intrinsic value. The M&M theorems assume the stock is worth the cash in it (and it has no other operations).

The practical implication of that should be that if you pay out a dividend, the stock should drop by more in value than the dividend - because someone was willing to pay $3 for $1 of cash in the shares. That's the gearing effect (leverage in American parlance).

In actual practice what dividends convey is a signal about the quality of the underlying profits (the Board knows the company really can pay out those earnings). But it's a weak signal. It also lowers the agency costs (the agents, ie the management, have less money to misspend if it is in the shareholder bank account rather than the company bank account - the costs for investors of someone else looking after their money are lower).
Valuethinker wrote: Mon Dec 05, 2022 3:39 am And since you can also buy back shares at book value
Are not shares bought back at market value, not book value?
[/quote]

In the M&M proof, dividends are paid out or shares bought back at the same valuation.

So if the stock has $10 per share of cash, and you pay out $1 it drops by $1 in price.

Alternatively you buy back 1/10th of 1 share (x num shares in issue). ie buy back at book value (cash per share).
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Re: Dividend irrelevance for individual securities

Post by alex_686 »

Valuethinker wrote: Mon Dec 05, 2022 11:11 am The portfolio is now geared. You are holding the stock at a multiple of its intrinsic value. The M&M theorems assume the stock is worth the cash in it (and it has no other operations).

The practical implication of that should be that if you pay out a dividend, the stock should drop by more in value than the dividend - because someone was willing to pay $3 for $1 of cash in the shares. That's the gearing effect (leverage in American parlance).
Lots of minor quibbles but I will point at this one specifically. M&M makes this assumption about Enterprise Value, not specifically cash. But maybe this is what you mean.

Next, M&M says that the market capitalization should fall by the amount of cash paid out, be it either dividends or stock buybacks. In practice this holds, and it is due to leverage - but maybe not the way you think.

When you pay out cash you are, by definition, increasing leverage. Increasing leverage increases volatility and risk. This increases the stock’s Beta, thus affecting the stock’s price. In theory you should wind up a price exactly the same as where you started. Ignoring taxes, investor’s preferences, etc.
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Re: Dividend irrelevance for individual securities

Post by Apathizer »

exodusNH wrote: Mon Dec 05, 2022 10:40 am
alex_686 wrote: Mon Dec 05, 2022 10:31 am
exodusNH wrote: Mon Dec 05, 2022 9:53 am
OverseasBH wrote: Mon Dec 05, 2022 9:47 am
burritoLover wrote: Mon Dec 05, 2022 9:36 am Dividend irrelevance applies to individual stocks as an an extension to funds - not the other way around. The price of an individual stock drops by the amount of the dividend due to market action in an efficient market. If it didn't, then any brain-dead investor could capitalize on what would be a free lunch. Everything else (whether the market as a whole thinks mgmt should pay a dividend, etc) acts "separately" on the price. End of story.
That is the high level view but I am looking at this from a detailed perspective. When one looks at this at a much lower level without the usual canards, perhaps it does not seem so obvious. I cannot see where in my example above this falls apart. Welcome a detailed look.
Read alex_686's post. He's been in the industry for a long time and has detailed knowledge of the inner workings. Funds are merely collections of the underlying stocks. There is no difference in analyzing a single stock vs the collective behavior.
To extend a bit,

I strongly favor Dividend Irrelevance Theory for individual stocks. I have worked with enough accounting, financial reporting, and investment theory to know how statements, dividends, and values work. How they can be manipulated and how they can't. That being said, M&M is the starting point, not the ending point. There is a fair amount of nuance and complexity when it comes to real life. This is my opinion.

When it comes to mutual funds Dividend Irrelevance is a cold hard fact. The sole purpose of dividends is to generate "reportable transactions" to generate a 1099 for tax reporting. There is a very low linkage between tax reporting and economic returns. When a mutual fund declares a dividend that triggers a set of accounting ledger transactions. Nothing economic happens.
My favorite quote from you was that the only people at your firm that loved dividends were the sales and marketing folks. All the technical people subscribed to M&M.
Exactly. I speculate that sales/marketing people favor them since common cognitive shortcomings lead many investors to think they're free money.

To be redundant, much like this topic, we really do need a function on this site that automatically deletes new dividend threads. It's been discussed ad nauseum.
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Re: Dividend irrelevance for individual securities

Post by exodusNH »

Apathizer wrote: Mon Dec 05, 2022 12:31 pm Exactly. I speculate that sales/marketing people favor them since common cognitive shortcomings lead many investors to think they're free money.

To be redundant, much like this topic, we really do need a function on this site that automatically deletes new dividend threads. It's been discussed ad nauseum.
I would be a little more generous and avoid the term "shortcomings", with its negative connotation.

It's confusing, since a) they're marketed in this way, b) the same term is used for bond coupons, c) Monopoly gives you free money from dividends, d) lots of financial sites present them as free money, e) until the advent of low-cost brokers, it was the only cost-effective way to realize money in your pocket from your holdings and felt like "income", even though it wasn't.
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Re: Dividend irrelevance for individual securities

Post by burritoLover »

Apathizer wrote: Mon Dec 05, 2022 12:31 pm To be redundant, much like this topic, we really do need a function on this site that automatically deletes new dividend threads. It's been discussed ad nauseum.
Dividend irrelevance is not mentioned anywhere in the BH wiki that I can find, including on the main dividend page (it talks about mutual fund NAV dropping which is not the same thing):
https://www.bogleheads.org/wiki/Dividend

Many podcasts/etc like to dance around the topic (except Rational Reminder) - seems like they don't want to alienate a large portion of their listeners who believe in dividend magic. So, it isn't surprising that many come to this conclusion, even when excluding brokerages' marketing.
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Re: Dividend irrelevance for individual securities

Post by dbr »

burritoLover wrote: Mon Dec 05, 2022 12:56 pm
Apathizer wrote: Mon Dec 05, 2022 12:31 pm To be redundant, much like this topic, we really do need a function on this site that automatically deletes new dividend threads. It's been discussed ad nauseum.
Dividend irrelevance is not mentioned anywhere in the BH wiki that I can find, including on the main dividend page (it talks about mutual fund NAV dropping which is not the same thing):
https://www.bogleheads.org/wiki/Dividend

Many podcasts/etc like to dance around the topic (except Rational Reminder) - seems like they don't want to alienate a large portion of their listeners who believe in dividend magic. So, it isn't surprising that many come to this conclusion, even when excluding brokerages' marketing.
They bounce you out to a five page thread which is probably one of the earliest of the many, many non-productive discussions that have run on the forum over the years. I say non-productive because neither that discussion nor any others seem to leave all participants in agreement on the topic. It will never go away, so whoever one is, you can decide for yourself and choose your investments accordingly and wait for the next resurrection of the discussion.

A full Google search of the topic is here:

https://www.google.com/search?q=dividen ... nt=gws-wiz

I suppose a person can scan through that and decide if there is any more enlightenment to be found. The results are primarily academic discussions.

If you change the search terms to try to get away from "dividend irrelevance theory" and try "dividend as a fund criterion"

https://www.google.com/search?q=dividen ... 2&dpr=1.25

then you get a different set of articles that seem to be dominated by advisors and mutual fund companies pushing dividend funds, but a person can see for themselves what might turn up.
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Re: Dividend irrelevance for individual securities

Post by firebirdparts »

exodusNH wrote: Mon Dec 05, 2022 9:09 am
I was trying to avoid going down the well-worn rabbit hole discussion.

Yes, there is some good evidence that people who prefer dividends to wind up bidding up the price of the dividend stocks. I think Rational Reminder presented some of that data.

I really think part of the confusion is that until the advent of low-cost brokers, using your stock wealth involved huge transaction fees, especially if you were selling "odd lots". A dividend from the company was the only cost effective way to to convert stock wealth into money in your account. Dividends thus got cemented in our collective consciousness.

Even before I found this forum, I was "above average" in my knowledge of investing (which is a low bar), and I thought they were like bond coupon payments.
These threads never turn out well. There's no way the people motivated to post in these threads over and over ever thought they were irrelevant to begin with. To your original question, if P/B is 3 due to growth, then the company could make use of the money. Lots of companies can't. If you think these boards are paying dividends out of extreme stupidity, there has to be another explanation. You can't really just stop there and expect to be right. When forced to get rid of money, where organic growth is not really possible, the board will destroy it with value-killing M&A's, and if they don't, the company becomes a takeover target.

Here's a more important consideration, and it's critical to your question: it's a lie that dividends "come right out of" company value. The opposite is true. The company value "comes right out of" people arguing over price when buying and selling the stock. The people, actual humans, have to arbitrage the cash out of the stock price. They're motivated. That is why the 3:1 P/B doesn't make the stock go down $3 when it pays a $1 dividend. If it did, people would know ahead of time to short it. See? Humans set the price, and they're very good at arbitrage. The price isn't really controlled by platitudes.

If you can find a way to break with that one big lie, you'll be a lot less confused.
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Re: Dividend irrelevance for individual securities

Post by exodusNH »

firebirdparts wrote: Mon Dec 05, 2022 1:16 pm
exodusNH wrote: Mon Dec 05, 2022 9:09 am
I was trying to avoid going down the well-worn rabbit hole discussion.

Yes, there is some good evidence that people who prefer dividends to wind up bidding up the price of the dividend stocks. I think Rational Reminder presented some of that data.

I really think part of the confusion is that until the advent of low-cost brokers, using your stock wealth involved huge transaction fees, especially if you were selling "odd lots". A dividend from the company was the only cost effective way to to convert stock wealth into money in your account. Dividends thus got cemented in our collective consciousness.

Even before I found this forum, I was "above average" in my knowledge of investing (which is a low bar), and I thought they were like bond coupon payments.
These threads never turn out well. There's no way the people motivated to post in these threads over and over ever thought they were irrelevant to begin with. To your original question, if P/B is 3 due to growth, then the company could make use of the money. Lots of companies can't. If you think these boards are paying dividends out of extreme stupidity, there has to be another explanation. You can't really just stop there and expect to be right. When forced to get rid of money, where organic growth is not really possible, the board will destroy it with value-killing M&A's, and if they don't, the company becomes a takeover target.

Here's a more important consideration, and it's critical to your question: it's a lie that dividends "come right out of" company value. The opposite is true. The company value "comes right out of" people arguing over price when buying and selling the stock. The people, actual humans, have to arbitrage the cash out of the stock price. They're motivated. That is why the 3:1 P/B doesn't make the stock go down $3 when it pays a $1 dividend. If it did, people would know ahead of time to short it. See? Humans set the price, and they're very good at arbitrage. The price isn't really controlled by platitudes.

If you can find a way to break with that one big lie, you'll be a lot less confused.
I'm not sure to whom you're directing this comment.

As noted by alex_686, who has been involved in all of this (and more), (viewtopic.php?p=6993395&sid=55a8109aaaa ... 8#p6993395), P/B doesn't include cash.

But since this is going to devolve into another pointless "dividend relevance" vs "dividend irrelevance", I'll stop here: it's probably best to say it's "dividend indifference" but dividends absolutely lower the value of the company, either directly because they hold less cash or because they took on debt to pay them, which adds a liability which has the same numerical effect.
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Re: Dividend irrelevance for individual securities

Post by psteinx »

While I didn't closely read every response to the OP, I think most responders miss the OP's point.

If a stock (or the market) is at 3.0 mkt/book value (in OP's example, though I think in real life it's a bit lower), then it seems it would be bad for companies to return capital to shareholders, as that $1 on the company's books would be worth (maybe) $3 in the marketplace.

To respond to this head on:

There are many companies that trade at a mkt/book of 3. And some that trade much higher. But, that doesn't mean that if you add every dollar of cash you add to (subtract from) the company's balance sheet/equity will be valued in the marketplace at 3 (or whatever the mkt/book ratio is).

i.e. The market is not pricing the stock by simplicity observing the company's equity value and slapping a 3.0 multiplier on it. Rather, the market is examining the full picture of the company - earnings power, growth potential, ability to profitably invest more capital, and yes, cash and investments versus liabilities on the balance sheet.

A company with a mkt/book of 3 is generally seen as having strong prospects by the market. Such companies can usually easily raise further capital by issuing stock. Depending on underwriting costs, they might be able to get $98 of equity onto the books for a $100 stock issuance (the $2 being underwriting costs). If the market uniformly valued equity at 3x, this would be, effectively, a license for companies to print money (or at least, print market cap). But companies don't generally do this - more often the reverse - buying back stock, even when their mkt/book is noticeably above 1. Cash on the books that isn't needed is not very efficient. It earns modest interest, and companies pay tax on that interest (then, when companies pay dividends, (some) investors pay tax again - double taxation).

Sure, if a company can deploy new/extra cash productively, it should. But even profitable companies can't easily do that. Google can't likely build another version of its core money-making franchise(s) for the book value they're carried at. Maybe they can spend huge sums and achieve other successes, or maybe those huge sums will be ~writeoffs.

Meta/Facebook has one great money making franchise, and is sinking tons of cash into trying to build another (the metaverse). But so far, the financial results for the metaverse are disappointing, and Meta/Facebook's market value is much lower now than it was ~a year ago. Meta investors would have been happier (so far, anyways), if that excess cash had gone to dividends or buybacks.
Last edited by psteinx on Mon Dec 05, 2022 4:32 pm, edited 1 time in total.
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Re: Dividend irrelevance for individual securities

Post by burritoLover »

psteinx wrote: Mon Dec 05, 2022 2:42 pm Meta/Facebook has one great money making franchise, and is sinking tons of cash into trying to build another (the metaverse). But so far, the financial results for the metaverse are disappointing, and Meta/Facebook's market value is much lower now than it was ~a year ago ago. Meta investors would have been happier (so far, anyways), if that excess cash had gone to dividends or buybacks.
So why would these theoretical investors continue to hold META through the downturn if they felt the company was being mismanaged?
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Re: Dividend irrelevance for individual securities

Post by Riprap »

Dividends are a good thing. It's the board of directors sending money to the corporations owners.

Sure, the board could hoard cash but there is no guarantee there will be a liquidation event someday sending all that cash to the shareholders. In fact, has there ever been a non distress liquidation? Corporations die in bankruptcy or get swallowed in an acquistion.

No amount of dividend irrelevance mathematics lessons here on BHs will change the fact that boards and corporate management do dumb things with cash and even with a tax drag, shareholders sometimes, but not all the time, are better off receiving a dividend.

Just the way it is.
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Re: Dividend irrelevance for individual securities

Post by psteinx »

burritoLover wrote: Mon Dec 05, 2022 3:00 pm
psteinx wrote: Mon Dec 05, 2022 2:42 pm Meta/Facebook has one great money making franchise, and is sinking tons of cash into trying to build another (the metaverse). But so far, the financial results for the metaverse are disappointing, and Meta/Facebook's market value is much lower now than it was ~a year ago ago. Meta investors would have been happier (so far, anyways), if that excess cash had gone to dividends or buybacks.
So why would these theoretical investors continue to hold META through the downturn if they felt the company was being mismanaged?
Meta has seen a massive selloff/downward valuation.

~12 months ago, the market had more positive views on Meta & Zuckerberg, as evidenced by the relatively higher price. Events of the last ~year have caused investors to reevaluate, so the market-clearing price for Meta is now MUCH lower.

(You don't get the opportunity to sell your holding now, for the price that it was valued at 12 months ago, of course.)
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Re: Dividend irrelevance for individual securities

Post by Riprap »

psteinx wrote: Mon Dec 05, 2022 2:42 pmMeta/Facebook has one great money making franchise, and is sinking tons of cash into trying to build another (the metaverse). But so far, the financial results for the metaverse are disappointing, and Meta/Facebook's market value is much lower now than it was ~a year ago ago. Meta investors would have been happier (so far, anyways), if that excess cash had gone to dividends or buybacks.
Agreed.

Don't expect many others here to agree with you though.

I wouldn't be surprised if Meta makes a business school case study someday in corporate blunders. The reports I've read in WSJ is that the metaverse is basically a product/service searching for a demand.
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Re: Dividend irrelevance for individual securities

Post by Logan Roy »

psteinx wrote: Mon Dec 05, 2022 2:42 pm Meta/Facebook has one great money making franchise, and is sinking tons of cash into trying to build another (the metaverse). But so far, the financial results for the metaverse are disappointing, and Meta/Facebook's market value is much lower now than it was ~a year ago ago. Meta investors would have been happier (so far, anyways), if that excess cash had gone to dividends or buybacks.
burritoLover wrote: Mon Dec 05, 2022 3:00 pm So why would these theoretical investors continue to hold META through the downturn if they felt the company was being mismanaged?
I think it may be a repeat of the phenomena we saw in the 90s, with people investing in ideas, rather than businesses. And not really doing their due diligence on these ideas. I know fund managers who still hold large positions in Meta, because they believe in the idea. But I think it may be a case where they'd do better speaking to teenagers.

This is hard for me to get my head around. But Meta have invested nearly $10bn in this so far. And apparently all they've got to show for it is an app called Horizon Worlds, which is a bit of a laughing stock among Gen Z. It looks like they've rebuilt an old-ish app called VR Chat – which they could've easily acquired. How they burn through this much cash, and only come up with a 2 star VR chat app, is baffling for me. I don't think markets have been particularly efficient in assessing Meta's growth prospects on this. Perhaps a look at how much superfluous staff they've been able to axe at Twitter gives a clue as to what's been going wrong with Big Tech hiring, and how they could burn through $10bn developing this.

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Re: Dividend irrelevance for individual securities

Post by Charles Joseph »

jebmke wrote: Mon Dec 05, 2022 5:35 am
Ed 2 wrote: Mon Dec 05, 2022 4:59 am
Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
So is your paycheck
But if you play your cards right, capital gains are not.
Same with qualified dividends.
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Re: Dividend irrelevance for individual securities

Post by psteinx »

Charles Joseph wrote: Mon Dec 05, 2022 6:02 pm
jebmke wrote: Mon Dec 05, 2022 5:35 am
Ed 2 wrote: Mon Dec 05, 2022 4:59 am
Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
So is your paycheck
But if you play your cards right, capital gains are not.
Same with qualified dividends.
Capital gains are generally better, from a tax perspective, than qualified dividends, because you can defer CG (i.e. don't sell the stock and realize the gain until far down the line). There are other alternatives with CG, too...
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Re: Dividend irrelevance for individual securities

Post by Apathizer »

psteinx wrote: Mon Dec 05, 2022 6:38 pm
Charles Joseph wrote: Mon Dec 05, 2022 6:02 pm
jebmke wrote: Mon Dec 05, 2022 5:35 am
Ed 2 wrote: Mon Dec 05, 2022 4:59 am
Artsypenguin wrote: Sun Dec 04, 2022 7:01 am Dividends are also tax negative.
So is your paycheck
But if you play your cards right, capital gains are not.
Same with qualified dividends.
Capital gains are generally better, from a tax perspective, than qualified dividends, because you can defer CG (i.e. don't sell the stock and realize the gain until far down the line). There are other alternatives with CG, too...
And of course not all dividends are qualified.
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Re: Dividend irrelevance for individual securities

Post by DaBombCat »

OverseasBH wrote: Sun Dec 04, 2022 6:32 am As I understand it, the dividend irrelevance argument is that a fund’s NAV drops by the amount of the dividend, so you are no better off before tax if you receive dividends or do not. But is that always true when taken down to the individual security level?
As a caveman-type stock investor who didn’t get a PhD from Chicago, the arguments against dividends are all so technical and theoretical that long term investors wouldn’t even consider them to calculate value. They tend to be things that short-term traders might use to justify minute daily movements—surprising, considering that BH are mostly long-term focused. Or, the arguments relate to mutual fund mechanics, as the OP discovered.

Stock funds are valued by design on a snapshot of the market price and cash balance (NAV). In my 15 yr experience, long-term, individual stocks (of profitable companies) are pretty consistently priced based on their stream of profit—regardless of any dividend payouts, and not on how much cash is sitting in their account.
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Re: Dividend irrelevance for individual securities

Post by DaBombCat »

Riprap wrote: Mon Dec 05, 2022 4:03 pm Dividends are a good thing. It's the board of directors sending money to the corporations owners.

Sure, the board could hoard cash but there is no guarantee there will be a liquidation event someday sending all that cash to the shareholders. In fact, has there ever been a non distress liquidation? Corporations die in bankruptcy or get swallowed in an acquistion.

No amount of dividend irrelevance mathematics lessons here on BHs will change the fact that boards and corporate management do dumb things with cash and even with a tax drag, shareholders sometimes, but not all the time, are better off receiving a dividend.

Just the way it is.
+1

Sometimes acquisitions happen to profitable companies with strong balance sheets. But, that’s me nit-picking your words. As you pointed out, cash usually only affects individual stock valuation in a liquidation scenario.

Maybe that’s why it makes sense that cash IS part of mutual fund value. Mutual fund value is basically their nightly liquidation value.
Logan Roy
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Re: Dividend irrelevance for individual securities

Post by Logan Roy »

Riprap wrote: Mon Dec 05, 2022 4:03 pm Dividends are a good thing. It's the board of directors sending money to the corporations owners.

Sure, the board could hoard cash but there is no guarantee there will be a liquidation event someday sending all that cash to the shareholders. In fact, has there ever been a non distress liquidation? Corporations die in bankruptcy or get swallowed in an acquistion.

No amount of dividend irrelevance mathematics lessons here on BHs will change the fact that boards and corporate management do dumb things with cash and even with a tax drag, shareholders sometimes, but not all the time, are better off receiving a dividend.

Just the way it is.
I think the argument is that dividends do have an effect on investor behaviour, when logically they shouldn't. And in the UK, a dividend culture is blamed for a lack of growth, investment and innovation in UK businesses, leading to a lagging market full of ex-growth 'bond proxies'.

Less experienced investors tend to think of dividends as a guarantee or safety net. They think of stocks as if they were bonds – rather than part ownership of a business. They don't appreciate that the dividend is paid out by the slice of the business you own – it's a payment to yourself. Some argue that boards and CEOs can't be trusted to deploy capital effectively. Well that's an argument against investing stocks altogether. Without effective capital allocation, stocks, as a whole, would probably struggle to outperform T-bills. So if you invest in stocks, you really want to be there for the effective employment of capital. Not just to sit tight and take the income.
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Riprap
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Re: Dividend irrelevance for individual securities

Post by Riprap »

Logan Roy wrote: Tue Dec 06, 2022 2:01 amSo if you invest in stocks, you really want to be there for the effective employment of capital. Not just to sit tight and take the income.
It's not as binary as you make it seem.

This site's namesake most certainly advocated sitting tight and taking income.
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Re: Dividend irrelevance for individual securities

Post by vineviz »

Riprap wrote: Tue Dec 06, 2022 9:32 am
Logan Roy wrote: Tue Dec 06, 2022 2:01 amSo if you invest in stocks, you really want to be there for the effective employment of capital. Not just to sit tight and take the income.
It's not as binary as you make it seem.

This site's namesake most certainly advocated sitting tight and taking income.
I don't think that binary thinking was implied by Logan Roy. I don't read it that way, at least.

Sometimes dividends and/or share repurchases ARE the most effective use of capital for a business. When it is, investors should cheer that.

What is dangerous, IMHO, is for investors to encourage (directly, or merely through irrational preference for income over growth) companies to pay dividends EVEN WHEN that is not the most effective use of capital. Likewise, it would be dangerous for investors to exhibit an irrational preference for growth over income.

Of course, both types of irrationality do exist. Which, thankfully, nets out the effect to some degree. And some investors will have fully rational reasons for preferring growth over income, or vice-versa, for tax or other reasons.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
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OverseasBH
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Re: Dividend irrelevance for individual securities

Post by OverseasBH »

Wow, so many answers and so much theory. I will try to wend my way through all of it and answer what people have posted.

I do completely understand that there is no magic and how any advantage would be arbitraged away. It is just that I am trying to understand that this outside of general bromides and certainties by using a simple example. In the simplest of investment analysis, while a buyer and seller have to arrive at a price, I am starting from the idea that the price to book (the net equity of the firm) ratio is not going to adjust much based on paying a cash dividend to the shareholders. If that starting premise is true (and why would it not be), then I would think my example holds.

So can someone please explain why, in the example I provided, why in this short time period of the dividend declaration and payment, would the P/B change?
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OverseasBH
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Re: Dividend irrelevance for individual securities

Post by OverseasBH »

alex_686 wrote: Mon Dec 05, 2022 9:42 am
OverseasBH wrote: Sun Dec 04, 2022 6:32 am As I understand it, the dividend irrelevance argument is that a fund’s NAV drops by the amount of the dividend, so you are no better off before tax if you receive dividends or do not. But is that always true when taken down to the individual security level? Here is an example to consider.

Say Acme Company has assets of $100m, debt of $40m, and equity of $60m. You are a 10% shareholder, so your interest is $6m of book equity. The market is willing to pay $3 for every $1 of Acme’s net book value, so has a P/B of 3:1 (VTI is 3.4:1). This is due to Acme’s perceived ability to generate future profits. The market therefore values your 10% equity stake at $18m and the whole company at $180m.

Acme then declares and pays a cash dividend of $10m, of which you receive $1m as a 10% shareholder. Paying this dividend reduces the book equity of Acme to $50m, your book equity to $5m, and your market equity to $15m. The whole company is now valued at $150m, reduced by 1/6 due to paying out 1/6 of the equity as a dividend.

You then own a $1m cash dividend plus $15m market equity in Acme, totaling $16m. You have lost $2m by this dividend being paid, because the market values the funds more highly inside the company than outside. Does this not impact dividend irrelevance?
You are kind of on the right track. However the point you have wrong is the bit about cash and book value. Book value does a poor job of describing a company's value as it is only tied to plant, property, etc. Cash is not part of book value.

The concept you want to focus on is Enterprise Value, or the economic value of the company.

https://www.investopedia.com/terms/e/en ... evalue.asp

Let us say the economic value of the company, the bits that produce earnings & profits is worth 100m. And the company has cash of 20m. It then sends out a dividend of 10m. How does this change the Enterprise Value of the company? i.e., how will it effect the core economic productivity of the company? Well, it doesn't, does it.

Which takes us to the core investment concept, Modigliani-Miller Capital Structure Theorem. a.k.a. Dividend Irrelevance Theory.

Let say we have a company whose EV is 100m. You can chose to finance that company many different ways. You could finance it with 70m equity / 30m bonds. Or 30m equity and 70m bonds. Let say you are at 70/30. You could borrow 10m and issue a 10m cash dividend, moving you to 40/70.

Or lets say you are at 30/70 plus you have 10m in cash. You could pay a 10m cash dividend. Or you could pay down your debt - you are fairly highly leveraged.

I mean, what is the difference between paying 2.5m a quarter verse 10m a year? Yes, there is a little computing interest but let us gloss over this. Paying off debt today so you can generate more and higher earnings tomorrow for a bigger cash dividend in the future? Or instead of paying out a cash dividend reinvesting back into the company?

From a first order perspective the dividend irreverence theory is airtight. If it where not then I, as a CFO, could magic money out of thin air by manipulating the books. You can't do that.

Things get more interesting when you look at second order movements.
Thanks, it will take me awhile to read up enough to understand your reply. But I do not understand your initial stamement:
Cash is not part of book value.
A reference to the same source you used states clearly that it is: https://www.investopedia.com/terms/p/pr ... kratio.asp
book value per share is calculated as follows: (total assets - total liabilities) / number of shares outstanding)... The book value of equity is an accounting measure based on the historic cost principle and reflects past issuances of equity, augmented by any profits or losses, and reduced by dividends and share buybacks... In other words, if a company liquidated all of its assets and paid off all its debt, the value remaining would be the company's book value.
Can you explain?
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