Dividend investing vs. index investing

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Momus
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Dividend investing vs. index investing

Post by Momus » Tue Nov 05, 2019 2:56 am

Which one is better? in Youtube, it looks like dividend investing is all in the rage. I know that every dividend payout results in lowering stock price of equal amount. How are people bragging about getting a force selling event every month on their shares in the form of dividend? Enlighten me :?

Which one is a better strategy over the long term?

fwellimort
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Re: Dividend investing vs. index investing

Post by fwellimort » Tue Nov 05, 2019 3:41 am

If I knew the future, I would tell you but I don't so that's my response.

Like most people here, I say : No one really knows.

Also, ignore a lot of videos related to finance and all.
It might be possible dividend investing might just be much better on tax advantaged accounts. Who knows.

There are indexes catered towards high dividends and all. Indexing is just a collection of investments grouped together at end of day.

So we are technically not even comparing the right products. Anyways, hope that answered your curiousity [basically, no one here really knows the future in absolute terms so no one here can guarantee "this investing will be better than that long term"].
Last edited by fwellimort on Tue Nov 05, 2019 3:44 am, edited 1 time in total.

Thesaints
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Re: Dividend investing vs. index investing

Post by Thesaints » Tue Nov 05, 2019 3:42 am

Dividend investing is index investing too. There are countless indexes out there.

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BeBH65
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Re: Dividend investing vs. index investing

Post by BeBH65 » Tue Nov 05, 2019 5:04 am

Op,
There are regularly threads on dividend investing;
Which arguments did you find the most compelling?
BeBH65. (only an investment enthusiast, not a financial adviser, perform your due diligence). | Have a look at https://www.bogleheads.org/wiki/Outline_of_Non-US_domiciles

bberris
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Re: Dividend investing vs. index investing

Post by bberris » Tue Nov 05, 2019 5:24 am

Momus wrote:
Tue Nov 05, 2019 2:56 am
Which one is better? in Youtube, it looks like dividend investing is all in the rage. I know that every dividend payout results in lowering stock price of equal amount. How are people bragging about getting a force selling event every month on their shares in the form of dividend? Enlighten me :?

Which one is a better strategy over the long term?
Is that you, Corey?

https://familyguy.fandom.com/wiki/Corey

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nisiprius
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Re: Dividend investing vs. index investing

Post by nisiprius » Tue Nov 05, 2019 7:15 am

Dividend investing has been "all the rage" for roughly a century. It is one of a number of strategies promoted by enthusiasts, like contrarian investing, or value investing, or factor investing. There are innumerable claims that certain easily-identified categories of stock are Just Plain Better than stocks in general: low-volatility stocks, mid cap stocks, small-cap value stocks.

Dividend investing and index investing are not exclusive. There are several indexes that focus on aspects of dividend payment, and probably a couple of dozen index funds and ETFs that track them. From Vanguard, for example, you have the Vanguard High Dividend Yield Index Fund and the Vanguard Dividend Growth Index Fund.

Yes, a surprising number of naïve investors that think that dividends are a free lunch. If you can get stocks that don't pay dividends and stocks that do pay dividends, isn't it obvious that it's better to get the dividends, too? No. OK, we know that's just plain wrong and we don't have to discuss it. It does make it easy to market the strategy to new investors, however.

Non-naïve dividend enthusiasts might well understand that there's even a theorem in financial economics, the Modigliani-Miller theorem, that says that under a set of assumptions, dividends shouldn't matter. But dividend enthusiasts often argue that, is that regardless of theory, selecting dividend stocks is a good formula for identifying certain management styles that (they think) lead to superior results.

Factor enthusiasts might well agree that dividend stocks are better, but would argue that it is just because dividend stocks load heavily on certain factors, and that it is better to get the factor exposure by focussing on the factors themselves, not on something else that just happens to be a sloppy and imprecise way to get the same factors.

The results of looking at the actual behavior, in terms of total return, of dividend-focussed index funds, is not very compelling, and in a taxable account even equal total return, getting less of the return in the form of dividends may be better.

Vanguard High Dividend Yield, VHDYX, blue, versus Vanguard Total Stock Market Index, VTSMX, orange:

Source
Image

It is very noticeable that "dividend investing" is often stock-picking in disguise. When confronted with "meh" performance of dividend-oriented index funds, a common enthusiast's response is "O, I don't use index funds for my dividend investing." It turns out that rather than being an easy formula for superior results, dividend investing is simply a prescreen for identifying a universe of stocks to pick from, but within that universe you are expected to use your keen eye for value and only pick the good one. In other words, dividend investing isn't really dividend investing at all. It's just a way of saying "I do subjective stock-picking, and I like dividend stocks."
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Re: Dividend investing vs. index investing

Post by UpperNwGuy » Tue Nov 05, 2019 7:27 am

Ahhh... Yet another example of the never-ending quest for
nisiprius wrote:
Tue Nov 05, 2019 7:15 am
certain easily-identified categories of stock are Just Plain Better than stocks in general
When will we ever learn?

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RickBoglehead
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Re: Dividend investing vs. index investing

Post by RickBoglehead » Tue Nov 05, 2019 7:35 am

Momus wrote:
Tue Nov 05, 2019 2:56 am
Which one is better? in Youtube, it looks like dividend investing is all in the rage.
I guess my response would be similar to when someone asks me if buying X on eBay is a good idea vs from a company 5hat sells the item itself. eBay, and Youtube, are platforms. Anyone can post on them, which gives them zero credibility.

Dividends lower the share price so one has not made anything. But now you pay income tax in those dividends.

Selling a holding to generate the same amount of money generates a capital gain, hopefully a long term one. Capital gains are taxed at a lower rate.

Therefore, dividend generation is a bad idea.
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snailderby
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Re: Dividend investing vs. index investing

Post by snailderby » Tue Nov 05, 2019 7:40 am

OP, are you asking about (1) investing in individual dividend stocks or (2) investing in an ETF that targets (a) high dividend stocks or (b) stocks that have consistently increased their dividends over the years?
Last edited by snailderby on Tue Nov 05, 2019 8:50 am, edited 1 time in total.

Admiral
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Re: Dividend investing vs. index investing

Post by Admiral » Tue Nov 05, 2019 7:46 am

The simple answer is taxation: taxation (based on current code) is lower for LTCG than for dividends, and when the taxes are paid can be controlled by selling shares, while taxes on dividends cannot be controlled as timing is determined by the company.

Keep in mind that indexes also pay dividends, though typically the return is smaller than stocks that goose their dividends.

The more complex answer has to do with why companies pay high dividends in the first place, but I'm not going to go into that.

billfromct
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Re: Dividend investing vs. index investing

Post by billfromct » Tue Nov 05, 2019 7:53 am

Rick,

I'm no tax expert, but aren't "qualified" dividends & long term capital gains taxed at the same Federal tax rate for most people?

My understanding is that most (not all) dividends from U.S. companies are "qualified" dividends.

bill

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Re: Dividend investing vs. index investing

Post by Admiral » Tue Nov 05, 2019 7:59 am

billfromct wrote:
Tue Nov 05, 2019 7:53 am
Rick,

I'm no tax expert, but aren't "qualified" dividends & long term capital gains taxed at the same Federal tax rate for most people?

My understanding is that most (not all) dividends from U.S. companies are "qualified" dividends.

bill
Exactly.

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Re: Dividend investing vs. index investing

Post by RickBoglehead » Tue Nov 05, 2019 8:10 am

billfromct wrote:
Tue Nov 05, 2019 7:53 am
Rick,

I'm no tax expert, but aren't "qualified" dividends & long term capital gains taxed at the same Federal tax rate for most people?

My understanding is that most (not all) dividends from U.S. companies are "qualified" dividends.

bill
Last year's Vanguard list. Plenty of funds that aren't near 100% qualified dividends. https://personal.vanguard.com/us/insigh ... ncome-2018
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firebirdparts
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Re: Dividend investing vs. index investing

Post by firebirdparts » Tue Nov 05, 2019 8:34 am

Investing is better than not investing. That is the important thing by a mile.

There are many crazy and stupid people who take an interest in investments, and even they are still correct some of the time. This is certainly an argument for a balanced portfolio of index investments. On the other hand, money is good. This is certainly an argument for dividends.

So enjoy your fleeting life with the results of all your hard work. If you backtest stuff, you can certainly formulate an opinion, but if you change the backtest dates, you can probably formulate the opposite opinion.
A fool and your money are soon partners

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Re: Dividend investing vs. index investing

Post by tibbitts » Tue Nov 05, 2019 8:45 am

Momus wrote:
Tue Nov 05, 2019 2:56 am
Which one is better? in Youtube, it looks like dividend investing is all in the rage. I know that every dividend payout results in lowering stock price of equal amount. How are people bragging about getting a force selling event every month on their shares in the form of dividend? Enlighten me :?

Which one is a better strategy over the long term?
How did you establish "all in the rage"?

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David Jay
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Re: Dividend investing vs. index investing

Post by David Jay » Tue Nov 05, 2019 8:45 am

“Just Plain BetterR”- nisiprius may have a new fund idea...
Last edited by David Jay on Tue Nov 05, 2019 9:08 pm, edited 1 time in total.
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JoMoney
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Re: Dividend investing vs. index investing

Post by JoMoney » Tue Nov 05, 2019 8:48 am

Using dividends as a selection signal for stock picking isn't the worst strategy, but it tends to put people into portfolios that could otherwise be more diversified and have less active turn over.
I could list countless dividend focused mutual funds, with decades of history, and performance that was 'ok', about on par with the broad index averages, with some differences here and there... but it's nothing special.

Of note though, is there was a brief historical period in the late 1970's through early 1980's where small cap stocks, value stocks, and lots of strategies that varied from the broad market had an exceptionally large burst of out-performance. Dividend stocks are often a weaker form of "value stocks" and depending on the strategy used, may have seen some out-performance over that historical period. I am skeptical that the results over that time period can be projected forward as some sort of "risk premium" or superiority of one strategy or another.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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David Jay
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Re: Dividend investing vs. index investing

Post by David Jay » Tue Nov 05, 2019 8:52 am

tibbitts wrote:
Tue Nov 05, 2019 8:45 am
Momus wrote:
Tue Nov 05, 2019 2:56 am
...in Youtube, it looks like dividend investing is all in the rage.
How did you establish "all in the rage"?
That’s the beauty of YouTube - watching a video will produce recommendations for videos on similar topics. An automatic paradigm reinforcing mechanism...

I was looking for a video on how to replace a part on my truck. I found one and YouTube presented me with a list of dozens of videos on the same topic.
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Re: Dividend investing vs. index investing

Post by patrick013 » Tue Nov 05, 2019 9:13 am

Dividend index funds should lower the beta of any portfolio. Price beta and/or return beta. Return/std. dev. ratio is usually on the high side also. So the portfolio should have more stability and upward volatility. Ticker VPU is great for that. Factor funds include SPHD, PEY, and SPYD where the dividend is a large part of total return. Frequently over 4% dividend yield. If anything beats the 500 I think these will. Total return after tax is what really matters.
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Re: Dividend investing vs. index investing

Post by snailderby » Tue Nov 05, 2019 10:05 am

I don't do this, but if you wanted to, you could create a pie in M1 Finance in a traditional or Roth IRA with roughly 50 companies compiled from the holdings of REGL. That would save you REGL's 0.40% ER and give you a midcap tilt.

14.67% CAGR | 13.82% Stdev | -33% maximum drawdown
07.09% CAGR | 14.93% Stdev | -51% maximum drawdown

(Historical comparison from Portfolio Visualizer, since 1998.)

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Momus
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Re: Dividend investing vs. index investing

Post by Momus » Tue Nov 05, 2019 4:40 pm

If dividend ETF perform more or less about the same as index fund with less drawdown, I think it's a winner in my opinion.

Is there any period where Vanguard dividend aristocrats etf underperformed the index by a large margin?

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Momus
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Re: Dividend investing vs. index investing

Post by Momus » Tue Nov 05, 2019 4:40 pm

snailderby wrote:
Tue Nov 05, 2019 10:05 am
I don't do this, but if you wanted to, you could create a pie in M1 Finance in a traditional or Roth IRA with roughly 50 companies compiled from the holdings of REGL. That would save you REGL's 0.40% ER and give you a midcap tilt.

14.67% CAGR | 13.82% Stdev | -33% maximum drawdown
07.09% CAGR | 14.93% Stdev | -51% maximum drawdown

(Historical comparison from Portfolio Visualizer, since 1998.)
Wow...

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Re: Dividend investing vs. index investing

Post by firebirdparts » Tue Nov 05, 2019 5:01 pm

Momus wrote:
Tue Nov 05, 2019 4:40 pm

Wow...
Now if we could only do that in the future.
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Re: Dividend investing vs. index investing

Post by nisiprius » Tue Nov 05, 2019 5:14 pm

Momus wrote:
Tue Nov 05, 2019 4:40 pm
If dividend ETF perform more or less about the same as index fund with less drawdown, I think it's a winner in my opinion.

Is there any period where Vanguard dividend aristocrats etf underperformed the index by a large margin?
I don't know "how big is large." A $10,000 investment in VIG, dividends reinvested, underperformed VTI by $866.80 over the 12-month period 3/2009 through 2/2010. Yes, of course, I picked this particular period because it is the worst 12-month period for VIG, compared to VTI.

Source

Image
Last edited by nisiprius on Tue Nov 05, 2019 5:20 pm, edited 1 time in total.
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Jwulgaru
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Re: Dividend investing vs. index investing

Post by Jwulgaru » Tue Nov 05, 2019 5:18 pm

Dividends investing has become somewhat less appealing to me since I started making enough money to push me out of the 12% bracket. However, the dividend stock/index-oriented part of my overall portfolio is only ~25% or so. To me, building up a dividend machine that pays me out rising income is another piece of the financial security puzzle.

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Re: Dividend investing vs. index investing

Post by arcticpineapplecorp. » Tue Nov 05, 2019 5:54 pm

Momus wrote:
Tue Nov 05, 2019 2:56 am
Which one is better? in Youtube, it looks like dividend investing is all in the rage. I know that every dividend payout results in lowering stock price of equal amount. How are people bragging about getting a force selling event every month on their shares in the form of dividend? Enlighten me :?

Which one is a better strategy over the long term?
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Re: Dividend investing vs. index investing

Post by bloom2708 » Tue Nov 05, 2019 6:03 pm

Kind of like asking do you like fruit or apples?

:arrow:
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Re: Dividend investing vs. index investing

Post by GibsonL6s » Tue Nov 05, 2019 6:10 pm

I think think dividend investors believe that one day they will be able to "live off" the dividends and so it gives them the comfort that they are protected from market downturns. This can lead to chasing yield to provide the income needed. I read a book by Geraldine Weiss which promoted using dividend yields as a part of a method to value and pick stocks. If one followed her method you probably did fine if you bought enough diversified stocks, but in the end, as we know it is hard to buy a large bunch of stocks that will outperform an index fund.

As I like to say, the way you get rich is to concentrate your investments, unfortunately it is also the way to get poor.

Good luck.

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Re: Dividend investing vs. index investing

Post by navyasw02 » Tue Nov 05, 2019 8:16 pm

Dividend investing is fine if you buy and hold a diverse basket of quality stocks that pay a consistently increasing dividend. You can build your own index fund essentially and collect dividends when you desire to use it as an income stream without significant reduction of principal. Note that dividends are not free money, they are a small pseudo sell that creates a taxable event.

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Re: Dividend investing vs. index investing

Post by 1789 » Sun Jan 12, 2020 11:02 pm

Only holding VTSAX/SP500 worked very well for us so far. Having a selection of companies out of total stock market is a not a great idea, imo.
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Re: Dividend investing vs. index investing

Post by e.s.deslauriers » Sun Jan 12, 2020 11:19 pm

I was going to post a new topic to ask a question related to dividends, but I saw this thread and figured I'd jump in and ask the question here

Keep in mind that I realize that dividends are not "magical free money" as they proportionally subtract from the book value of the business.

Aren't dividends the ultimate reason why rational investors purchase shares of a company?

A thought experiment: if you were the only living investor in a given stock market, why would you buy shares in a company that explicitly stated that they would never issue a dividend? Since you are the only investor in this scenario, there are no buyers to sell your shares to in order to realize a profit from the capital appreciation of the business. Even if the company is extraordinary successful and their book value soars, since they pay no dividend and there are no investors to sell your shares to, there is no way to extract profit from your investment. So why would you buy shares in the company, then?

Granted, there will always be potential buyers in reality, but why should they be rationally expected to want to buy shares of the company from you if it is guaranteed never to pay a dividend? Isn't this just relying upon a "greater fool" to realize your capital appreciation? In other words, why would another buyer decide to buy shares from you of a company that has no mechanism to return profit to the shareholder besides the shareholder selling to yet another "greater fool"?

Sure, there are buybacks. But let's return to the thought experiment in which you are the only investor and there are no buyers to sell your shares to: what good do buybacks do for you? You can't spend a buyback if you can't sell the shares for cash. You can't buy groceries in shares. You need cash. Absent buyers and without dividends, how are you supposed to live off your investment? There is no mechanism to extract cash from the business without dividends or relying on there being a buyer of your shares in the future. And if they are buying the shares back from YOU... well, that's cash in your pocket: a cash dividend in another form.

But again, why should I rationally assume that there will be a buyer in the future that is willing to pay "fair value" for my shares if there is guaranteed to be no dividends -- i.e. no ability to extract free cash flow -- from the business? There must ultimately exist a mechanism for shareholders to extract profits from a business that they fractionally own besides flipping their shares to another buyer, right? Otherwise, why own the shares if you must rely on the existence of a future buyer for your shares even though there is no way to extract cash from the investment.

A business that announces that it won't pay a dividend for 20 years is a whole different story. Now an investor can rationally buy shares in that company knowing that, even though for the first 20 years of ownership, management will be plowing all free cash flow back into the business, at least there is a "light at the end of the tunnel", there is the prospect of a mechanism to extract profit from your investment.

I have no problem with businesses reinvesting 100% of FCF into the business...for a while. But isn't it true that ultimately, the company must provide a mechanism to return profits to shareholders without shareholders having to rely upon having to find a buyer for their shares? It seems to me that owning stocks should be contingent upon their ability to return profits in the form of cash to the investor even if there were zero buyers in the market.

Thoughts?

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Re: Dividend investing vs. index investing

Post by ThereAreNoGurus » Sun Jan 12, 2020 11:39 pm

e.s.deslauriers wrote:
Sun Jan 12, 2020 11:19 pm
I was going to post a new topic to ask a question related to dividends, but I saw this thread and figured I'd jump in and ask the question here

Keep in mind that I realize that dividends are not "magical free money" as they proportionally subtract from the book value of the business.

Aren't dividends the ultimate reason why rational investors purchase shares of a company?
Nope.

Shares of a publicly traded company (with voting rights) represents ownership interest of a company. Facebook does not pay a dividend. Are you telling me if you could buy the entire company for 10 dollars you would not want to be the owner of Facebook?

You should be able to extrapolate from that simple example why stock valuation is more than whether a company pays or will ever pay a dividend and why a non-dividend paying company can posses a high valuation.
Trade the news and you will lose.

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Re: Dividend investing vs. index investing

Post by e.s.deslauriers » Sun Jan 12, 2020 11:48 pm

ThereAreNoGurus wrote:
Sun Jan 12, 2020 11:39 pm
e.s.deslauriers wrote:
Sun Jan 12, 2020 11:19 pm
I was going to post a new topic to ask a question related to dividends, but I saw this thread and figured I'd jump in and ask the question here

Keep in mind that I realize that dividends are not "magical free money" as they proportionally subtract from the book value of the business.

Aren't dividends the ultimate reason why rational investors purchase shares of a company?
Nope.

The value of a publicly traded company (with voting rights) represents ownership of a company. Facebook does not pay a dividend. Are you telling me if you could buy the entire company for 10 dollars you would not want to be the owner of Facebook?

You should be able to extrapolate from that simple example why stock valuation is more than whether a company pays dividends and why a non-dividend paying company can posses a high valuation.
I would buy all of Facebook for $10 if I had voting rights. But that's the only reason: power.

Without a dividend, I am reliant upon flipping the shares on a future buyer to pay for groceries. But why should I rationally expect a buyer for my shares if there is no guaranteed ability to extract cash from the investment? You can't pay for groceries with voting rights, only cash.

Facebook may not pay a dividend now, but surely it will in the future. Is this not why investors ultimately place a high valuation on Facebook; they know that some time in the future, even a couple decades from now, Facebook will begin returning profits to shareholders. Otherwise, why own the shares and have to rely on finding a buyer to flip them to when there is no intrinsic ability of the asset to return cash to the owner?

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Re: Dividend investing vs. index investing

Post by ThereAreNoGurus » Sun Jan 12, 2020 11:55 pm

e.s.deslauriers wrote:
Sun Jan 12, 2020 11:48 pm
ThereAreNoGurus wrote:
Sun Jan 12, 2020 11:39 pm
e.s.deslauriers wrote:
Sun Jan 12, 2020 11:19 pm
I was going to post a new topic to ask a question related to dividends, but I saw this thread and figured I'd jump in and ask the question here

Keep in mind that I realize that dividends are not "magical free money" as they proportionally subtract from the book value of the business.

Aren't dividends the ultimate reason why rational investors purchase shares of a company?
Nope.

The value of a publicly traded company (with voting rights) represents ownership of a company. Facebook does not pay a dividend. Are you telling me if you could buy the entire company for 10 dollars you would not want to be the owner of Facebook?

You should be able to extrapolate from that simple example why stock valuation is more than whether a company pays dividends and why a non-dividend paying company can posses a high valuation.
I would buy all of Facebook for $10 if I had voting rights. But that's the only reason: power.

Without a dividend, I am reliant upon flipping the shares on a future buyer to pay for groceries. But why should I rationally expect a buyer for my shares if there is no guaranteed ability to extract cash from the investment? You can't pay for groceries with voting rights, only cash.

Facebook may not pay a dividend now, but surely it will in the future. Is this not why investors ultimately place a high valuation on Facebook; they know that some time in the future, even a couple decades from now, Facebook will begin returning profits to shareholders. Otherwise, why own the shares and have to rely on finding a buyer to flip them to when there is no intrinsic ability of the asset to return cash to the owner?
"I would buy all of Facebook for $10 if I had voting rights. But that's the only reason: power."

People buy or start businesses so they can make money. If I owned Facebook, I would give myself a nice salary. As an owner I could do that.

Publicly traded companies are always up for sale. That's what's driving their prices. Investors (likely not you or I) who have the resources and can profit from owning a company (or selling it off) will buy the stock. It has nothing to do with the possibility of future dividend payments. That's what primarily drives stock prices... the value of owning the business.
Trade the news and you will lose.

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Re: Dividend investing vs. index investing

Post by e.s.deslauriers » Mon Jan 13, 2020 12:02 am

ThereAreNoGurus wrote:
Sun Jan 12, 2020 11:55 pm
e.s.deslauriers wrote:
Sun Jan 12, 2020 11:48 pm
ThereAreNoGurus wrote:
Sun Jan 12, 2020 11:39 pm
e.s.deslauriers wrote:
Sun Jan 12, 2020 11:19 pm
I was going to post a new topic to ask a question related to dividends, but I saw this thread and figured I'd jump in and ask the question here

Keep in mind that I realize that dividends are not "magical free money" as they proportionally subtract from the book value of the business.

Aren't dividends the ultimate reason why rational investors purchase shares of a company?
Nope.

The value of a publicly traded company (with voting rights) represents ownership of a company. Facebook does not pay a dividend. Are you telling me if you could buy the entire company for 10 dollars you would not want to be the owner of Facebook?

You should be able to extrapolate from that simple example why stock valuation is more than whether a company pays dividends and why a non-dividend paying company can posses a high valuation.
I would buy all of Facebook for $10 if I had voting rights. But that's the only reason: power.

Without a dividend, I am reliant upon flipping the shares on a future buyer to pay for groceries. But why should I rationally expect a buyer for my shares if there is no guaranteed ability to extract cash from the investment? You can't pay for groceries with voting rights, only cash.

Facebook may not pay a dividend now, but surely it will in the future. Is this not why investors ultimately place a high valuation on Facebook; they know that some time in the future, even a couple decades from now, Facebook will begin returning profits to shareholders. Otherwise, why own the shares and have to rely on finding a buyer to flip them to when there is no intrinsic ability of the asset to return cash to the owner?
"I would buy all of Facebook for $10 if I had voting rights. But that's the only reason: power."

People buy or start businesses so they can make money. If I owned Facebook, I would give myself a nice salary. As an owner I could do that.

Publicly traded companies are always up for sale. That's what's driving their prices. Investors (likely not you or I) who have the resources and can profit from owning a company (or selling it off) will buy the stock. It has absolutely nothing to do with the possibility of future dividend payments. That's what primarily drives stock prices... the value of owning the business.
But ultimately that "buyer of last resort" is willing to buy shares of the company because they can leverage them into the power to extract profit from the company. So in this sense, you can always rely upon there being a buyer willing to pay fair value because there will always exist a mechanism for an owner with voting power to extract cash profit from the company (even if that means using your voting power to give yourself a salary .... i.e. a dividend).

That makes rational sense to me. It would not make sense to me if the shares did not have voting power AND didn't pay a dividend though.

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ThereAreNoGurus
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Re: Dividend investing vs. index investing

Post by ThereAreNoGurus » Mon Jan 13, 2020 12:09 am

e.s.deslauriers wrote:
Mon Jan 13, 2020 12:02 am
ThereAreNoGurus wrote:
Sun Jan 12, 2020 11:55 pm
e.s.deslauriers wrote:
Sun Jan 12, 2020 11:48 pm
ThereAreNoGurus wrote:
Sun Jan 12, 2020 11:39 pm
e.s.deslauriers wrote:
Sun Jan 12, 2020 11:19 pm
I was going to post a new topic to ask a question related to dividends, but I saw this thread and figured I'd jump in and ask the question here

Keep in mind that I realize that dividends are not "magical free money" as they proportionally subtract from the book value of the business.

Aren't dividends the ultimate reason why rational investors purchase shares of a company?
Nope.

The value of a publicly traded company (with voting rights) represents ownership of a company. Facebook does not pay a dividend. Are you telling me if you could buy the entire company for 10 dollars you would not want to be the owner of Facebook?

You should be able to extrapolate from that simple example why stock valuation is more than whether a company pays dividends and why a non-dividend paying company can posses a high valuation.
I would buy all of Facebook for $10 if I had voting rights. But that's the only reason: power.

Without a dividend, I am reliant upon flipping the shares on a future buyer to pay for groceries. But why should I rationally expect a buyer for my shares if there is no guaranteed ability to extract cash from the investment? You can't pay for groceries with voting rights, only cash.

Facebook may not pay a dividend now, but surely it will in the future. Is this not why investors ultimately place a high valuation on Facebook; they know that some time in the future, even a couple decades from now, Facebook will begin returning profits to shareholders. Otherwise, why own the shares and have to rely on finding a buyer to flip them to when there is no intrinsic ability of the asset to return cash to the owner?
"I would buy all of Facebook for $10 if I had voting rights. But that's the only reason: power."

People buy or start businesses so they can make money. If I owned Facebook, I would give myself a nice salary. As an owner I could do that.

Publicly traded companies are always up for sale. That's what's driving their prices. Investors (likely not you or I) who have the resources and can profit from owning a company (or selling it off) will buy the stock. It has absolutely nothing to do with the possibility of future dividend payments. That's what primarily drives stock prices... the value of owning the business.
But ultimately that "buyer of last resort" is willing to buy shares of the company because they can leverage them into the power to extract profit from the company. So in this sense, you can always rely upon there being a buyer willing to pay fair value because there will always exist a mechanism for an owner with voting power to extract cash profit from the company (even if that means using your voting power to give yourself a salary .... i.e. a dividend).

That makes rational sense to me. It would not make sense to me if the shares did not have voting power AND didn't pay a dividend though.
"That makes rational sense to me. It would not make sense to me if the shares did not have voting power AND didn't pay a dividend though."

Yesssssssssss! :happy

I merely take issue with the idea that the way to value a publicly traded company (with voting rights) is to value it based on its dividend or a possible future dividend. It is the value of the company that counts. Sure you can rephrase other actions such as taking a salary or selling the company, as a dividend, but that is not how the term is normally used and is certainly different from valuing a company solely based on dividend payouts.
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Re: Dividend investing vs. index investing

Post by oldcomputerguy » Mon Jan 13, 2020 5:46 am

e.s.deslauriers wrote:
Sun Jan 12, 2020 11:19 pm
A thought experiment: if you were the only living investor in a given stock market, why would you buy shares in a company that explicitly stated that they would never issue a dividend? Since you are the only investor in this scenario, there are no buyers to sell your shares to in order to realize a profit from the capital appreciation of the business.
In your given scenario, if you are the only living investor in a given stock market, you wouldn't be buying any shares of any kind, since there would be nobody to buy them from.
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Re: Dividend investing vs. index investing

Post by Admiral » Mon Jan 13, 2020 7:37 am

e.s.deslauriers wrote:
Sun Jan 12, 2020 11:19 pm
I was going to post a new topic to ask a question related to dividends, but I saw this thread and figured I'd jump in and ask the question here

Keep in mind that I realize that dividends are not "magical free money" as they proportionally subtract from the book value of the business.

Aren't dividends the ultimate reason why rational investors purchase shares of a company?

A thought experiment: if you were the only living investor in a given stock market, why would you buy shares in a company that explicitly stated that they would never issue a dividend? Since you are the only investor in this scenario, there are no buyers to sell your shares to in order to realize a profit from the capital appreciation of the business. Even if the company is extraordinary successful and their book value soars, since they pay no dividend and there are no investors to sell your shares to, there is no way to extract profit from your investment. So why would you buy shares in the company, then?

Granted, there will always be potential buyers in reality, but why should they be rationally expected to want to buy shares of the company from you if it is guaranteed never to pay a dividend? Isn't this just relying upon a "greater fool" to realize your capital appreciation? In other words, why would another buyer decide to buy shares from you of a company that has no mechanism to return profit to the shareholder besides the shareholder selling to yet another "greater fool"?

Sure, there are buybacks. But let's return to the thought experiment in which you are the only investor and there are no buyers to sell your shares to: what good do buybacks do for you? You can't spend a buyback if you can't sell the shares for cash. You can't buy groceries in shares. You need cash. Absent buyers and without dividends, how are you supposed to live off your investment? There is no mechanism to extract cash from the business without dividends or relying on there being a buyer of your shares in the future. And if they are buying the shares back from YOU... well, that's cash in your pocket: a cash dividend in another form.

But again, why should I rationally assume that there will be a buyer in the future that is willing to pay "fair value" for my shares if there is guaranteed to be no dividends -- i.e. no ability to extract free cash flow -- from the business? There must ultimately exist a mechanism for shareholders to extract profits from a business that they fractionally own besides flipping their shares to another buyer, right? Otherwise, why own the shares if you must rely on the existence of a future buyer for your shares even though there is no way to extract cash from the investment.

A business that announces that it won't pay a dividend for 20 years is a whole different story. Now an investor can rationally buy shares in that company knowing that, even though for the first 20 years of ownership, management will be plowing all free cash flow back into the business, at least there is a "light at the end of the tunnel", there is the prospect of a mechanism to extract profit from your investment.

I have no problem with businesses reinvesting 100% of FCF into the business...for a while. But isn't it true that ultimately, the company must provide a mechanism to return profits to shareholders without shareholders having to rely upon having to find a buyer for their shares? It seems to me that owning stocks should be contingent upon their ability to return profits in the form of cash to the investor even if there were zero buyers in the market.

Thoughts?
The shares of the company have value because they are based on earnings, or the expectation of future earnings. Whether the company pays a dividend or not, this is still the case. Remember the dot com bubble? Lots of companies paid no dividends and had no earnings, but their shares were highly valued (erroneously, as it turns out). Until there are no buyers left with those expectations, the stock will continue to exist. Dividends are irrelevant.

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Re: Dividend investing vs. index investing

Post by JoMoney » Mon Jan 13, 2020 9:23 am

e.s.deslauriers wrote:
Sun Jan 12, 2020 11:19 pm
...
A thought experiment: if you were the only living investor in a given stock market, why would you buy shares in a company that explicitly stated that they would never issue a dividend? Since you are the only investor in this scenario, there are no buyers to sell your shares to in order to realize a profit from the capital appreciation of the business. Even if the company is extraordinary successful and their book value soars, since they pay no dividend and there are no investors to sell your shares to, there is no way to extract profit from your investment. So why would you buy shares in the company, then?...
If you're the only investor, you're the owner. Pay yourself a salary for running the board.
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Re: Dividend investing vs. index investing

Post by lostdog » Mon Jan 13, 2020 9:46 am

It's a forced sale, period. It's all just psychological.
The feeling of not selling shares and thinking it's a free lunch.

Most of those videos are just trying to sell you something else. A book about dividend investing or a seminar etc....
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e.s.deslauriers
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Re: Dividend investing vs. index investing

Post by e.s.deslauriers » Mon Jan 13, 2020 9:52 am

ThereAreNoGurus wrote:
Mon Jan 13, 2020 12:09 am

Yesssssssssss! :happy

I merely take issue with the idea that the way to value a publicly traded company (with voting rights) is to value it based on its dividend or a possible future dividend. It is the value of the company that counts. Sure you can rephrase other actions such as taking a salary or selling the company, as a dividend, but that is not how the term is normally used and is certainly different from valuing a company solely based on dividend payouts.
When I used the term "dividend", I was basically referring to a mechanism through which a shareholder can extract profit from the company in the form of cash.

But you clarified my question 100%, that was exactly the answer I was looking for. I always like to return to first principles, and the fact that owning shares conveys voting rights and true ownership in the company makes everything else fall into place. There will always be a "buyer of last resort", but not because they are the "greater fool", but because they are Warren Buffet. Therefore, you don't need dividends to extract profit from your investment, because there will always be a buyer willing to pay fair value for ownership in the business.

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Re: Dividend investing vs. index investing

Post by Monster99 » Mon Jan 13, 2020 10:29 am

Been investing in the market since the 80's - 401k, tIRA and roth - DW has both tIRA and roth IRA. After maxing out retirement accounts, taxable account used for any remaining extra. Always thought that dividend payers were more "stable" - after finding this site several years ago, I see the rationale of total return but now the capital gains distribution of the taxable account "cleanup" will take a while.... The income in retirement is a good thing, but would like more control over when and where it comes from. As the say, a first world problem....

APX32
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Re: Dividend investing vs. index investing

Post by APX32 » Mon Jan 13, 2020 6:52 pm

navyasw02 wrote:
Tue Nov 05, 2019 8:16 pm
Dividend investing is fine if you buy and hold a diverse basket of quality stocks that pay a consistently increasing dividend. You can build your own index fund essentially and collect dividends when you desire to use it as an income stream without significant reduction of principal. Note that dividends are not free money, they are a small pseudo sell that creates a taxable event.
This is spot on. There was a guy who had a blog that became a bit popular in the dividend community, I believe it was called the “Dividend Mantra”. A few years ago I recall seeing a reference to it in a Seeking Alpha article and followed it for a few months. He basically built his own index fund with an ultimate goal of building a portfolio that would yield him 3% and cover most of his expenses. He eventually sold the blog and then retired somewhere in SE Asia. In one of his last updates, he was getting close to collecting $800-900 month in dividends and figured it was enough to address the majority of his living expenses as an expat. In other words, he appeared to have found something that worked for him.

I, too, have begun the process of building a dividend component in my taxable account. I have no interest in maintaining 100-150 stocks, instead looking for a mix of VYM, VYMI, and VIG, with a goal of reaching $500,000 in about 10 years. This would be approximately 25% of my investment assets, the other 75% being my pre-tax 401k and Roth (both IRA and 401k).

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Re: Dividend investing vs. index investing

Post by Admiral » Tue Jan 14, 2020 7:39 am

APX32 wrote:
Mon Jan 13, 2020 6:52 pm
navyasw02 wrote:
Tue Nov 05, 2019 8:16 pm
Dividend investing is fine if you buy and hold a diverse basket of quality stocks that pay a consistently increasing dividend. You can build your own index fund essentially and collect dividends when you desire to use it as an income stream without significant reduction of principal. Note that dividends are not free money, they are a small pseudo sell that creates a taxable event.
This is spot on. There was a guy who had a blog that became a bit popular in the dividend community, I believe it was called the “Dividend Mantra”. A few years ago I recall seeing a reference to it in a Seeking Alpha article and followed it for a few months. He basically built his own index fund with an ultimate goal of building a portfolio that would yield him 3% and cover most of his expenses. He eventually sold the blog and then retired somewhere in SE Asia. In one of his last updates, he was getting close to collecting $800-900 month in dividends and figured it was enough to address the majority of his living expenses as an expat. In other words, he appeared to have found something that worked for him.

I, too, have begun the process of building a dividend component in my taxable account. I have no interest in maintaining 100-150 stocks, instead looking for a mix of VYM, VYMI, and VIG, with a goal of reaching $500,000 in about 10 years. This would be approximately 25% of my investment assets, the other 75% being my pre-tax 401k and Roth (both IRA and 401k).
This makes very little sense to me. If you want $800-$900/month, there's a better solution: buy bonds or a bond fund. You make money with very little volatility and almost no risk to principal (neither of which is the case with dividend stocks). Also, let's be clear: For almost all of its history the S&P 500 paid a dividend of over 3% (less lately of course). You don't need high-dividend stocks or funds to create that low level of return.

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