Reader Story: Dividends or bust: Thinking critically about investment
Published on - January 13th, 2013 (by Ellen Cannon) This is shared by Steven Hogan (Twitter @stevehlaw), who has learned a few things about investing that he wanted to share. This story is part of our Reader Stories series. Some stories contain general advice; others are examples of how a GRS reader achieved financial success or failure. These stories feature folks with all levels of financial maturity and income. Want submit your own reader story? Here’s how.
The back story
When I was 18, a family member set me up with an IRA with $100 in it. That gift made me feel like I was one up on everyone else my age, planning solidly for the future and positioned to make huge gains over time by following the “buy and hold” idea. I firmly believed I would be one of those long-time investors looking at a huge nest egg when I got older.
The problem was that the mutual fund that comprised my IRA – which I sporadically put money into – charged enormous fees that ate up most of the investment gains each year. Over the next 10 years or so, the cash value of my retirement fund barely budged above the amount of money I directly invested in it.
When I finally realized how bad the fees were, I moved my account into a Total Stock Index with Vanguard. I felt better about life when I saw that the fees charged by Vanguard were minuscule compared with what I was paying before.
The big change
All of that was well and good until Mark Cuban scared the hell out of me. I discovered his blog (blogmaverick.com) earlier this year and ended up reading everything in the archives.
Cuban’s take on stocks was chilling: buying a stock and expecting it to “increase in value” over time was the same as investing in baseball cards. The only way a “stock” could be worth more in 10 years is if someone else is willing to pay you more down the road. What’s more, executives at publicly traded companies have every incentive to dilute the value of your “share” of stock by issuing options to themselves as part of their compensation packages.
The stock market is for suckers
Cuban said it best in his 2006 blog post The Stock Market Is for Suckers:
I’ve said it before, a stock that doesn’t pay dividends is valued like a baseball card. Just whatever you can sell it for. The concept that you own “your share” of the company is a joke. You are completely at the whim of the CEO and board who will dilute you on a daily basis with stock options, then try to buy back stock to cover it up and push up the price, rewarding the shareholders who get out, rather than those that continue to hold the shares. Meaning you.
That shook my “buy and hold” philosophy to the core. If I couldn’t bank on stocks appreciating in value – like magic – at 5 or 6 percent a year, what could I do as a small investor to grow any amount of capital at all?
Dividends to the rescue
Mulling over Cuban’s insight led me to a drastic change in my investment strategy. Instead of banking on stocks appreciating in value through a “buy and hold” philosophy, I would switch to a focus on cash dividends that would result in real money – each quarter – down the line when I started taking disbursements from my IRA at retirement age.
While the Vanguard account I had did have a quarterly dividend, it was not that high in proportion to the cost per share of the account.
I then went hunting for a high-dividend Vanguard fund, and found a winner in the High Dividend Yield fund. Not only was this fund paying a dividend higher than my fund, but the price per share was almost half that of the Total Stock Index fund that I was invested in.
As a result, I rolled over my funds into the High Dividend Yield fund and realized a total dividend that was almost double what I had earned in my Total Stock Index fund. The higher cash value of the dividend, coupled with the lower price per share, meant that reinvesting the dividend bought almost three times as many shares of the fund as I previously could.
The takeaway
Cuban may be right that the stock market is for suckers if you treat it like a set of baseball cards. However, if you focus on dividends you may still be able to build up an investment fund that will provide a quarterly dividend worth real money in the future.
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This is partly wrong. As Buffett stated in his letters, the dividend pays 15% in taxes. If the company can reinvest the money of dividend in itself and grow (above market grow), then it’s totally OK to keep the money saving taxes and generating grow. On the other hand, a company that pays a great dividend but later is forced to take debt to finance buys or growth because its lack of money is putting a burden on its investors.
Is responsability of the investor to analize the Company to test if the dividend yield is sustainable, or if the retained earnings are producing good returns in stock value.
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Steven: good luck in your quest.
First issue: I would be wary of investment advice from billionaire megalomaniacs. Cuban has lots of opinions, many forums from which to shout them, and the inclination to do so. He did extremely well with one or two things in his life and because our belief systems are predisposed to look for ‘stars’ and ‘gurus’ we give their opinions way too much weight.
Second issue: go back to your Malkiel (A Random Walk Down Wall Street) and read the first chapter: ‘Firm Foundations and Castles in the Air’. You will see this debate has gone on for generations.
Final issue: congrats for realizing early in the game that costs matter, especially over an investment lifetime. The race is long, and it is not so much to the swift as to those who keep running. Good luck to you.
Paul
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Changing your investing philosophy based on one person’s opinion seems to be pretty risky to me. I’m not saying you’re wrong, but I would do a lot more research before switching. And just because it seems to have paid off in the short term for your Vanguard account doesn’t mean it’s going to be the best strategy in the long run.
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I totally agree with the first two comments. Dividend stocks are all the rage these days because of low bond yields, so the fixed-income sector (baby boomers, mostly) is pushing up the prices.
The name of the game is diversification. All of your chips in dividend stocks (most likely mid- and large-cap) leaves out other asset classes like international stocks and REITs.
I suggest doing a search through the GRS archives on JD’s old book reviews and picking up a copy or two from your local library.
Congrats to you, though, for thinking of your future and trying to take control of it. It’s not an easy step, so most people won’t do it.
Travis
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Dividend stock are worth 1/3 more than non-dividend stocks over time.Reits are divbidend stocks required to pay dividend,So the company does not have to pay taxes.
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Thank you for the links, I enjoyed being able to go and look around. Nice, cogent article. Well done, and you spoke plain english rather than jargon.
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I have been convinced (from boggleheads) that it’s better to go for stocks that don’t give dividends but grow more because under tax law they’re treated better. Every time a stock gives out dividends, it loses value. Currently dividend stocks are really popular but there’s some concern that that’s a bubble.
Still, I do like having dividends mainly from an emotional sense. Even if I tend to drip them when I get them.
http://nicoleandmaggie.wordpress.com/2011/02/03/dripping/
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I could be wrong, but I believe the writer indicated he was investing in an IRA. In a tax advantaged situation such as an IRA, the difference in taxes on dividends versus stock appreciation should not be an issue. It all would get taxed as income when withdrawn.
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How does it lose value with a dividend? You get money (they take taxes out of you, but you still get something) and the stock’s price doesn’t necessarily change.
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The stock’s price does change (drop), all things equal, when you get a dividend. It’s worth less once the dividend has been spent out because the company no longer owns the money that has been paid out. Just like your net worth drops when you give away money to charity or decide to pay for a lawn service.
If you take the dividend money and DRIP it, then you have the same value of stock (minus taxes, and if it isn’t a direct drip, fees), but each share is worth less. You just have more shares.
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That change in price is a transient; the market’s opinion will take over again very shortly after. Negative transients are unimportant in long-term investment.
Look at Apple. They issued a dividend in November. Price dipped for a few days, then came back up to above the ex-dividend price. They issued one in August, too – and with that one the dip (if any) barely even paused the climb in price. As far as I can tell from this example, the ex-dividend price hit is noise and should only be relevant to higher-turnover traders. Exxon’s dividends in 2012 tell the same story.
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It isn’t the market’s opinion– it is mechanical. The company is worth less when it gives away money because it has less money. Right before it gives a dividend it is worth more than right after. (Things cause stock prices to change besides dividends.)
Like Steve S says below, the types of companies that drop dividends tend to be different than the ones that reinvest. Good sources of dividends tend to be utilities and blue-chips. Growth companies tend to choose to keep reinvesting their stock (much like Apple did until recently). All things equal, you’re slightly better off with a company that doesn’t drip than one that does because of taxes. Generally things aren’t equal, and you’re better off with growth stocks for the long-term and blue-chips over shorter terms (or a nice mix suited to your own risk levels), dividends being an unfortunate (because of taxes) side-effect of the safer stocks.
Looking at Apple as a single case is uninformative because there are many things going on that affect the stock price of a firm, and publicity around Apple’s unprecedented dividend played into that (also, you know, Apple products doing well). Most dividend stocks quietly give their dividends without fanfare because they’ve been doing it on a regular basis for quite a while. And right after they drop a dividend they’re worth less than right before. Because mechanically the company is worth less. Just like your net worth drops right after you give money away, but goes up after you get paid or the value of your house increases or what have you.
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You keep saying “mechanically the company is worth less” as if it’s fact. But the worth of a company is determined by the market, and while the stock price is adjusted immediately to reflect the dividend, Xenocles is correct that the effect is transient. And while you can dismiss Apple (or any one stock) as having other reasons for the stock price changing, there is plenty of academic and historical evidence that payment of dividends do not cause long term declines in stock price.
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I agree completely. Cash is one asset that a company has. Dividend is paid by the company in cash. By paying dividend the company has less cash. How can this not be clear?
I’m not a gambler. It is wise to buy stock when the market sets too low a price. It is not wise to believe the markets pricing to reflect accurately the worth of a company. Steady and existing sales may be boring but just as cash are one of the real assets a company can have.
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Good point about paying attention to how dividends and capital gains are taxed. But that only matters if you’re investing in a regular, taxable account. If, like Steven (and like most of us, I think), you’re investing in an IRA or other retirement account, the way dividends and capital gains are taxed doesn’t matter to you at all, at least in terms of the taxes that you pay, because withdrawals from a traditional IRA are taxed as ordinary income, and withdrawals from a Roth account aren’t taxed at all.
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I have just started buying stocks. Literally. I bought 3 from companies that I am comfortable, and a few weeks later all I saw were losses. I guess, like baseball cards, I am going to hold onto them for awhile and see how it all works out. It’s a learning opportunity, and like yourself, if it doesn’t seem to be panning out the right way, I will be switching it up. I’ll be sure to check out blog maverick as well.
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Interesting post, but I’m not sure dividend stocks are necessarily the way to avoid being at the whim of CEOs. I’ve been considering getting into dividend paying stocks, but people have warned me that 1) companies are free to cut dividends at any time and 2) companies can call in your stocks, forcing you to accept whatever the going rate is for your shares. If a company calls in your stock for less than what you bought it for, then that loss cuts into your earnings.
I’d like to establish a DRIP to diversify my portfolio, but I’m still looking into the benefits versus potential pitfalls as a long-term strategy.
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Eilzabeth –
Your point 2 is pretty rare. Yes, there are mechanisms where you are forced to sell your stock at a given price, but this only occurs when a majority of the shares vote to accept a given price. Note that this is for common stock, which is what most people talk about when they talk about stock.
Preferred stock and bonds both do sometimes have mechanisms to be called back at a given face value, but that is known when issued and is easy to look up. Common stock does not have this mechanism.
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Thanks for the response! A couple of people I know have had their stocks called back, but I think they were in preferred shares. Both lost a little on the price of the stock, but were pretty happy with the dividends they had been receiving.
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ETFs that focus on dividends and corporations that buyback their stock are always a good way to go. At the end of the day it’s important to diversify. However, the hands-free investor should really look at a little in a total stock index, a dividend index and the rest in a target retirement account ideally. Vangaurd has all of these.
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Couple of points:
1) I agree that Mark Cuban is probably not the person you want to look to for advice on stocks and investments. It is not his area of expertise. Advice from Buffet, Bogle, etc., is where to look for advice on stocks because they have done well with them.
2) Don’t worry about the share price of the mutual funds. It doesn’t matter if you get three times as many shares. What matters is the dividend as a percent of the investment, which it seems you are trying to maximize.
3) I like your strategy of using a diversified dividend mutual fund, especially if you continue to make regular investments. Minimizing the investment cot makes a huge difference in the long run. It might help to look at ETFs to further reduce the costs.
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Good post and easy to read and understand. Thank you for the info. I like watching and reading about Mark Cuban. I have simple money ideas on my website too.
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I love the idea of dividends, certainly. But I wonder if then reinvesting that money right back into the same stocks doesn’t sort of…lead to the same problem you were avoiding? You’re still at the mercy of share price in the end, right?
Of course, it’s Sunday and my math brain isn’t all that in gear.
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Hi! I am just starting to think about investing in the stock market (now that I’ve got rid of my student overdraft etc.) so this is a timely post for me! Thanks for the info and links. I’ll be sure to check it out!
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In the ideal situation:
Growing dividends come from growing earnings per share which results in a higher share price over time.
I think the key is to recognize the quality dividend growth companies, wait for them to go on sale during a market downturn, and load up the truck.
Anyone interested in dividend growth investing should check out the CCC list updated by David Fish every month. It’s awesome and free.
http://dripinvesting.org/Tools/Tools.asp
Larry
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As a UK Investor I have taken dividends very seriously ever since I read that a person investing £100 in UK Equities in 1900 would have had £162 in capital growth by 2003. But by reinvesting dividends that £162 becomes a far more impressive £22,438.
Here in the UK a simple FTSE All Share tracker can today give you a dividend yield of 3.5% which is far above the S&P500′s 2.1%. I take it a step further and buy ASX200 trackers which are yielding 4.6% and and have started to build a High Yield Portfolio using UK Shares which is today yielding 5.5%.
I’m with you – Dividends Matter
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It’s not a good idea to put all your money in a just high dividend mutual fund (large value cap). You need to be diversified with large growth, and mid/small cap funds as well as bonds.
Plus Cuban is wrong, the whole idea of growth funds is they hold companies that continue to grow, going up in price.
People should do research themselves at sites like Boggleheads or Vanguard. A good starting point is Total index, total international and total bond. Or build your own mix of funds but make sure it’s diversified.
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All dividends are not created equal. I look for companies that have a long track record of raising dividends year after year. Google “dividend aristocrats” for a list of companies that have raised dividends for at least 25 years in a row. Also, pay attention to the payout ratio. You don’t want to buy stock in a company that is using almost all of its profits to pay the dividend. A payout ratio under 50% is ideal. Good luck!
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Experts say
Don’t Buy & Hold
1) buy Growth Stocks
. . . BabyBoomers are turning over 65 years of age and
. . . people over 65 spend 4 times more on medicine.
. . . So I bought a Pharmaceutical Company stock.
2) Diversify so that you don’t lose money on a bad stock
. . . My Pharmaceutical Company was made up of
. . . over 250 individual companies,
. . . in 4 major sectors.
3) Buy foreign stocks that are not based on one countries currency
. . . My Pharmaceutical Company was a Global company
. . . doing business all over the world.
. . . Baby boomers are growing over 65, World Wide
4) Buy Stocks that have more Assets than Liabilities
. . . My Pharmaceutical Company not only has more
. . . Assets than Liabilities, it has more Cash then Liabilities.
5) Buy Dividends
. . . My Pharmaceutical Company has paid Dividends for 50 years
6) Don’t pay a lot of Fee’s
. . . My Pharmaceutical Company has a Dividend Re-Investment Plan
. . . that does not charge management of Brokerage Fee’s
7) Get the best expert managers to advice
. . . My Pharmaceutical Company is has been run by the smartest
. . . managers in the World for longer than
. . . most people have been alive.
. . . Buy & Hold with reinvested dividends and optional Cash input,
. . . allows “Compounding,” the most powerful force in the Universe
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and the company is…?
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Johnson & Johnson?
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http://www3.valueline.com/dow30/f4979.pdf
You’ll never “get rich fast,” but you will “get rich slowly.”
http://www.investor.jnj.com/divhistory.cfm
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I have a JNJ DRIP, and Computershare does charge a purchase fee for it ($1 per purchase). Am I missing something?
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It’s frustrating to me that someone that obviously has no market or (or very, very limited as indicated about how she is speaking about them) investing experience is offering advice to others.
I love the idea of the blog and many of the day-to-day things you can do to save money, but there should be a line in the blog, and this crosses it.
Ellen just doesn’t have the knowledge to have a full conversation with someone about the risks of investing (including individual risks of particular sectors/asset classes), how to diversify and into what asset classes, and how past performance doesn’t equal future results.
While I know she was talking about herself and what she’s done, readers also weren’t made aware that every investor is different and no two people should automatically invest the same. (for example, regardless of what Cuban says, PLENTY of people have made a lot of money on growth stocks/funds. Also, Cuban should invest differently as he has A LOT of money and should be looking at capital preservation more than capital growth).
Please don’t give this “advice” and put your un-knowing readers at risk when they are blindly trusting what you are saying – you may be doing them a dis-service.
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Steve, this is not my column. It was written by a reader, as identified in the first paragraph.
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I agree that dividends matter. £100 invested in UK Equities in 1900 would have only been worth a real (after inflation) £162 in 2003 without dividends reinvested. Reinvest those dividends and that £162 becomes £22,438.
My investing style values dividends. Today I’m getting 5.5% from a self created UK based High Yield Portfolio (HYP). Additionally, I am getting close (just have to subtract fund expenses) to 4.6% from an ASX200 Equity Tracker and 3.5% from a FTSE100 All Share Tracker.
In contrast I also hold some US Equities and it galls me to see a dividend yield of 2.1%.
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I strongly recommend the AAII for investment education. There’s a 30 day free trial, membership is $29/yr, and the newsletter is free. It’s been well worth it for me!
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“If I couldn’t bank on stocks appreciating in value – like magic – at 5 or 6 percent a year…”
It isn’t really magic. This is missing the whole point of why a company issues stock in the first place. They need your cash to expand operations and grow the strength/profitability of the business. The increase in stock price comes when they realize the gains from the machines or personnel they acquired with your money (by producing more, increasing market share, releasing a new product, etc.)
A company that pays dividends is basically saying “we don’t have any way to profitably invest this cash to expand our business, so we’ll just give it back to you”. This is why large, stable companies like Coca Cola and Proctor & Gamble pay good dividends. They have so much extra revenue from their sales and not enough profitable ways to spend it.
So in reality, you could look at a dividend paying stock as a laggard in the market, resting on its laurels and counting on continued, uninterrupted market dominance. That obviously doesn’t apply to all, and doesn’t make them bad investments, but it’s worth thinking about whether a non-dividend paying stock is really just a “baseball card” growing in price by “magic”.
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There is so much bad info in this post/comments that it speaks very badly for the website.
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I did not know Mark Cuban blogged. I will add his opinion to the many that I use to form my own.
I invest in an automatic DRIP (dividend reinvestment program) and the automatic reinvestment of the dividend income to new shares will help my very small portfolio grow. I purchased my first shares in 2012.
I need to increase the number of companies I hold shares in to about 12 from the current 3. I will concentrate on Canadian banks and resource companies.
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The baseball card analogy breaks down on several levels, but for me the most convincing is the “bigger problem” argument: unlike baseball cards, if your investment in total-market indexes becomes valueless(or even lose huge amounts of value over the course of decades) the odds are you have significantly greater problems to worry about then personal investment strategy.
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I’m a big proponent of dividend growth investing, although I prefer to pursue my investment strategy through purchasing individual stocks rather than mutual funds. That way I can avoid the fees all together.
However, I would give you a word of caution. Dividend investing, just like any other subset of investing, requires some degree of effort. You need to lay out a basic plan and stick to it over the long run to be successful.
If you aren’t willing or able to put in the needed effort, stick to major market index funds with low fees.
But if you are willing to expend the effort to educate yourself about investing, it can be a very rewarding (mentally and financially) activity.
If you start bouncing all over the place chasing high yields, you’ll get burned.
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I believe in dividend growth or just dividend investing. I hope at one point to be earning enough dividends to cover all of my living expenses, then I can choose what to do with my time.
I especially find it gratifying when I see people in Wal-Mart (stock I own) buying products in stock I own (Pepsi, Coke, Tylenol) and even using banks or credit cards I own stock in to pay for their purchases (Visa, Wells Fargo). It’s like the circle of life.
The key is having a plan, if the dividend gets cut or stays the same for a number of quarters, the fundamentals of the company change, then sell and redeploy.
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Someone should wake up. There is something called risk-reward.
“High yield means high risk.”
You can get very high yield dividends, if that’s what you want, by investing in junk bonds and very risky companies. Good luck if you go that route.
Personally, I like dividends. But I also don’t want to take high risks. So I don’t go for the highest dividends.
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The other problem, one that I’m sure Mark Cuban ignored, was that when the recession hit, a lot of companies got rid of their dividend or drastically reduced it. GE’s has yet to recover to its pre-2008 dividend, as did Citigroup’s. I’m pretty sure I didn’t buy the only two stocks in that situation.
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Mark Cuban’s depiction of stocks as capricious is wrong, at least according to Warren Buffett. Given a choice, I’d accept Mr. Buffett’s version. Mr. Cuban may have more money than I do, but Mr. Buffett has more than Cuban. And Mr. Buffett made his money on nothing but stocks, and he’s been sharing his wisdom freely for more than 20 years. So I’d much rather listen to him.
Some companies pay dividends, others not. The theory is that if the management of a company can earn more than I can, then they should reinvest the money. If they think I can get more on the money than they can, then they should pay it out as dividends.
When you’re young and you want to grow your money outside of an IRA or 401(k), then having a no-dividend stock makes sense, because you don’t pay any tax until you sell the stock. And if you pick a good company like Berkshire (Buffett’s company) then you’ll never need to sell until you need the money.
On the other hand, if you’re retired and you need to buy food and gas, well, then there’s nothing wrong with a dividend.
As for the recession, and the risk of a missed dividend, there is a class of stocks called dividend aristocrats. Look them up; those companies have never skipped a dividend, and have grown it every year for 25 years or more.
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Ben Graham talks about dividends a lot in Security Analysis. His basic point is that companies should pay dividends because historically, companies that “plow money back into the company” end up losing value at some point, and the shareholders would have been better off had they been given a dividend instead. I wish I had the book in front of me, I’d quote it.
Graham also makes the point, in several of his books and writings, that dividends are the end game. They are the whole point of owning a stock. Without at least the prospect of dividends, a stock is worthless: it’s just a piece of paper (like a baseball card), barring takeovers, etc. If all that was possible was capital gains then it would just be a game of finding a greater fool. The whole point of a business is to make money for its owners. Dividends are how shareholders get paid. Like others have pointed out, you don’t necessarily want a dividend right now if that money could build more value for the company, but it is the ultimate goal.
The whole argument of whether companies should “plow money back in,” in a general sense, is nonsensical because it all depends on the individual company. I will say, though, that I believe Graham was right: too many companies withhold dividends and end up losing money for the shareholders.
I like dividends because they can be reinvested, and can compound the growth of your equity.
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If you like to read . . . you will really enjoy these letters
http://www.berkshirehathaway.com/letters/letters.html
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I am confused why people in the comments who prefer dividends to capital gains end up re-investing their dividends in the same stock or fund anyways?
Under your theory, the stock is a baseball card teetering on the edge of worthlessness the second a company performs poorly. Why do you want to own more of it? Why not take the cash and invest elsewhere? I guess maybe because owning more shares increases future dividends…but what else am I missing?
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The Power Of ‘Double Compounding’ In Dividend Growth Stocks
http://seekingalpha.com/article/714501-the-power-of-double-compounding-in-dividend-growth-stocks
There’s one more thing thing,
. . . whenever the stock price goes up, you make a paper profit,
. . . whenever the stock price goes down, you make a real profit,
. . . as your dividends buy more shares cheaper and
. . . if your smart, you throw some optional cash in at that time.
Once, you realize, that your making money no matter if the price
. . . goes up or down, you stop worrying and sleep nights, and
. . . if your company has a tripple-A rating,
. . . you have a money making machine.
Recessions, scare off other investors,
. . . but that’s when your reinvested money machine is automatically,
. . . buying more shares, that will pay growing dividends, that
. . . compound year after year.
1) Dividend 3.4%
2) Dividend payout $ grows each year
3) Recession drives price down, allowing Dividend $ to buy
. . . more shares for the same amount of money.
4) Re-invested shares “Compound” total stock $ value.
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I know first hand that at least one company does EXACTLY what Mark Cuban describes in his blog regarding the stock. That being said, I am still a boglehead (although I do S&D).
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Mark Cuban is an interesting guy and his opinions should always be taken into account and looked at, but aren’t always right. Then again, who is?!
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Really interesting and great point about dividends. I’m invested in Vanguard’s High Dividend Yield ETF, which has an even lower expense ratio – .13% – and, of course, the other advantages that come with investing in an ETF. The dividends are just reinvested, and the fund is held in my SEP IRA, so I don’t take any tax hits.
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