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The dividend fallacy

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Dod101
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Re: The dividend fallacy

#473096

Postby Dod101 » January 14th, 2022, 3:53 pm

I see a lot of this 'loss' when a dividend is paid as not quite true. I need the income to live off and I try to buy shares in companies that are earning reasonable profits, so that the dividend is well covered by the earnings after tax. Obviously if a company pays no dividend and is generating reasonable earnings, the full amount of these earnings can be added to the P & L Balance or what is usually called distributable reserves. OTOH if a company chooses to pay a dividend out of these earnings (as a reward to the shareholder for putting up the capital in the first place) then there is a little less of the earnings that can be added to the distributable reserves and thus a little less to be added to the value of the company. If I look at dividends in this way, I do not see the payment of a dividend so much as a reduction in the net value of the company as reducing the amount of the increase a little.

Then it can be seen not as 'costing' the shareholder in terms of NAV to distribute a dividend, but simply part of the cost of capital to the company.

I am not sure that there is any fallacy; just different ways of looking at the matter. I am not even sure if any of this matters very much to an investor and I doubt that it will make any of us a better investor which is surely what matters.

scrumyjack has as usual to my mind made excellent points and I particularly like the comment that it is a good discipline for companies to pay their owners a share of the profits. I have often thought that myself.

Dod

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Re: The dividend fallacy

#473129

Postby dealtn » January 14th, 2022, 5:43 pm

taken2often wrote: I feel that in general dividends makes the companies safer so I invest more for income than anything else.


In general dividends make companies less safe. They remove assets, and usually liquid ones at that. I suspect what you mean is companies that demonstrate an ability and confidence to pay dividends are safer ones than the ones that can't. There is probable truth to that claim, but a better demonstration of that is through earnings, not dividends. Poor companies can pay dividends even if they aren't "earned". An even better demonstration is through cash conversion of those earnings, and why of the 3 company reports (Balance Sheet, P/L Account, and Cashflow Statement) it is the third that is most important - and nearly universally the last one published!

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Re: The dividend fallacy

#473143

Postby JohnB » January 14th, 2022, 6:08 pm

The price of a share is the anticipated integral of the dividends paid until you sell the share, less the price you get from the sale at that point (with time adjusted value of those dividends, ones paid soon are valued more than long term ones). The market sets both the price now and then, its up to the investor to decide if the market is right. Small investors are very unlikely to know more than the market about a companies current and anticipated value and its dividend policy.

Companies with a tradition of paying large dividends will have a much smaller difference in initial and final share values. Growing companies might pay no dividends with the investors expecting dividends from much larger profits in future, or finding someone else to take on their shares at a much increased value. Declining companies could plan to pay out dividends as the business hollows out, leaving no value at the end. Both are valid ways to make money.

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Re: The dividend fallacy

#473150

Postby hiriskpaul » January 14th, 2022, 6:44 pm

dealtn wrote:
taken2often wrote: I feel that in general dividends makes the companies safer so I invest more for income than anything else.


In general dividends make companies less safe. They remove assets, and usually liquid ones at that. I suspect what you mean is companies that demonstrate an ability and confidence to pay dividends are safer ones than the ones that can't. There is probable truth to that claim, but a better demonstration of that is through earnings, not dividends. Poor companies can pay dividends even if they aren't "earned". An even better demonstration is through cash conversion of those earnings, and why of the 3 company reports (Balance Sheet, P/L Account, and Cashflow Statement) it is the third that is most important - and nearly universally the last one published!

Agreed. A company would be safer if, instead of paying dividends, it reduced debt and/or built reserves.

Of course, if the dividend is taken and reinvested elsewhere, then (all else remaining equal) the exposure to the company is reduced, so from the investor's point of view that might be considered safer.

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Re: The dividend fallacy

#473181

Postby hiriskpaul » January 14th, 2022, 8:19 pm

scrumpyjack wrote:In general I think it is a good discipline for companies to pay their owners a share of the profit, aka a dividend. The directors are best placed to decide how much can prudently be paid without harming the company’s ability to invest and grow. But obviously companies are at different stages of their ‘life cycle’. Mature companies should need to retain less than early stage companies who may need as much cash as possible for their growth. I suspect that most large mature UK companies have been paying too much in dividend as often their EPS is a concocted figure that leaves out all the bad stuff and then pretends that that is the figure available to pay a dividend from. It certainly isn’t as one can see from the accounts of the likes of AstraZeneca!


I am not arguing against dividends. Dividends are a fact of life. Some companies pay out too much and subsequently get into trouble as a result, requiring rights issues, debt restructuring, etc. Others may end up wasting money on hair brained aquisitions, expansions, etc. In such cases shareholders would have been better off if the money had been paid to them as dividends (or perhaps used to buy back shares).

In theory the share price should go down by the amount of the dividend when it goes XD but in reality the company has only ‘lost’ that amount of value if they were selling at net asset value and if they were able to deploy that cash to earn the same return as on the rest of their asset base. Neither of those is usually the case.

Not just a theory, a demonstrable fact! Dividend per share comes off price per share. The money coming from the company is liquid cash, not subject to any NAV adjustments. It is valued at its value!

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Re: The dividend fallacy

#473184

Postby hiriskpaul » January 14th, 2022, 8:24 pm

JohnB wrote:The price of a share is the anticipated integral of the dividends paid until you sell the share, less the price you get from the sale at that point (with time adjusted value of those dividends, ones paid soon are valued more than long term ones). The market sets both the price now and then, its up to the investor to decide if the market is right. Small investors are very unlikely to know more than the market about a companies current and anticipated value and its dividend policy.

Companies with a tradition of paying large dividends will have a much smaller difference in initial and final share values. Growing companies might pay no dividends with the investors expecting dividends from much larger profits in future, or finding someone else to take on their shares at a much increased value. Declining companies could plan to pay out dividends as the business hollows out, leaving no value at the end. Both are valid ways to make money.

That's a good way of thinking about what is happening. The value of a company can be thought of as the NPV of its future cashflows to shareholders. When a company goes ex-div the front cash flow vanishes from the price. As the payment of the flow is so close, its NPV is pretty much the same as the actual dividend.

taken2often
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Re: The dividend fallacy

#473202

Postby taken2often » January 14th, 2022, 11:31 pm

One thing not mentioned is that the dislike of dividends could come from the Unit Trust industry. They may concentrate on non paying companies because they charge on growth. Companies who do pay dividends will have reduced growth. That appears to be the consensus. I do not buy Unit Trusts too dodgy unless a pure index.

Bob

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Re: The dividend fallacy

#473215

Postby GoSeigen » January 15th, 2022, 5:49 am

taken2often wrote:One thing not mentioned is that the dislike of dividends [...]


Good grief! Dislike of dividends? Who doesn't like dividends? Where did that idea come from in the context of this thread?

GS

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Re: The dividend fallacy

#473301

Postby taken2often » January 15th, 2022, 2:19 pm

Many have made comments on the effects of dividends and how they would prefer more growth. I notice that you did not address my point that Unit Trusts make their money from Growth stocks. The bigger the fund the bigger the take. Simple.

How about an alternative, that if they keep divi stocks they only buy those that pay out the month that they charge fees. Thats what I would do. That of course is not the day of declaration. So you have recovery plus added value due to the dividend. I like it.

Just a thought.

Bob

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Re: The dividend fallacy

#473371

Postby OhNoNotimAgain » January 15th, 2022, 6:58 pm

This thread is depressing proof that social media has a net negative effect on the sum of human knowledge.
So different from the high hopes we had when we set up the Fool that it would be a great mechanism for distributing knowledge, information and data.

dealtn
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Re: The dividend fallacy

#473374

Postby dealtn » January 15th, 2022, 7:08 pm

OhNoNotimAgain wrote:This thread is depressing proof that social media has a net negative effect on the sum of human knowledge.
So different from the high hopes we had when we set up the Fool that it would be a great mechanism for distributing knowledge, information and data.


Really? Can you care to explain?

What knowledge, information or data would you like to share with us we can then discuss?

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Re: The dividend fallacy

#473375

Postby ReformedCharacter » January 15th, 2022, 7:26 pm

OhNoNotimAgain wrote:This thread is depressing proof that social media has a net negative effect on the sum of human knowledge.

Except your own contributions, obviously :)

RC

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Re: The dividend fallacy

#473376

Postby AsleepInYorkshire » January 15th, 2022, 7:42 pm

OhNoNotimAgain wrote:This thread is depressing proof that social media has a net negative effect on the sum of human knowledge.
So different from the high hopes we had when we set up the Fool that it would be a great mechanism for distributing knowledge, information and data.

I can't help but feel a lack of diplomacy in your post. Are you feeling frustrated with something else in your life or have you, perhaps, unintentionally picked the wrong words?

Or have I misunderstood you?

AiY

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Re: The dividend fallacy

#473696

Postby Avantegarde » Yesterday, 9:15 am

There is indeed a dividend fallacy, though not the one addressed here. It is the idea, often espoused by Terry Smith, that investors are usually better off eschewing dividends because it is much more profitable to let a firm's management reinvest the cash in its business, expand, and produce greater cash and profits. Sounds good, eh? Especially when Terry Smith argues for it*. Sadly this big idea overlooks the sad history of many companies on the stock market. That history (take the last 40 years for instance) is littered with companies whose managers categorically did not know how best to invest their cash and wasted their shareholders funds on grotesque vanity projects, over-expansion (sometimes into business areas they actually knew nothing about) or indulged in simple but terrible misjudgements. It happens all the time.
*To give Mr Smith his due, he does argue that you have to decide exactly which firms and managements are actually good at doing this internal reinvestment. And that is, apparently, his own particular skill.

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Re: The dividend fallacy

#473716

Postby 88V8 » Yesterday, 10:09 am

Avantegarde wrote:There is indeed a dividend fallacy, though not the one addressed here. It is the idea, often espoused by Terry Smith, that investors are usually better off eschewing dividends because it is much more profitable to let a firm's management reinvest the cash in its business, expand, and produce greater cash and profits.

Yes.
As I think of it, on the whole dividends are certain, growth is not.

V8

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Re: The dividend fallacy

#473742

Postby dealtn » Yesterday, 10:50 am

88V8 wrote:
Avantegarde wrote:There is indeed a dividend fallacy, though not the one addressed here. It is the idea, often espoused by Terry Smith, that investors are usually better off eschewing dividends because it is much more profitable to let a firm's management reinvest the cash in its business, expand, and produce greater cash and profits.

Yes.
As I think of it, on the whole dividends are certain, growth is not.

V8


Earnings retained, but not paid out, don't increase the balance sheet then. Where do they go?

If that was indeed preferable why do we not see you, or others, insisting company boards approve the payout of all earnings (or more) as dividends?

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Re: The dividend fallacy

#473749

Postby OhNoNotimAgain » Yesterday, 11:01 am

88V8 wrote:
Avantegarde wrote:There is indeed a dividend fallacy, though not the one addressed here. It is the idea, often espoused by Terry Smith, that investors are usually better off eschewing dividends because it is much more profitable to let a firm's management reinvest the cash in its business, expand, and produce greater cash and profits.

Yes.
As I think of it, on the whole dividends are certain, growth is not.

V8


Dividends are not certain.

But if you get one you can spend it, unlike retained profits in, say, Carillion, Patissiere Valerie or Enron, or you can reinvest. You have a choice which you don't have with retained earnings.

Moreover, it suits Terry Smith, and every other active manager, to ignore the evidence from BEGS, Dimson, Fama, French, Sharp, Markowitz, Malkiel and many others.

Dod101
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Re: The dividend fallacy

#473751

Postby Dod101 » Yesterday, 11:02 am

Avantegarde wrote:There is indeed a dividend fallacy, though not the one addressed here. It is the idea, often espoused by Terry Smith, that investors are usually better off eschewing dividends because it is much more profitable to let a firm's management reinvest the cash in its business, expand, and produce greater cash and profits. Sounds good, eh? Especially when Terry Smith argues for it*. Sadly this big idea overlooks the sad history of many companies on the stock market. That history (take the last 40 years for instance) is littered with companies whose managers categorically did not know how best to invest their cash and wasted their shareholders funds on grotesque vanity projects, over-expansion (sometimes into business areas they actually knew nothing about) or indulged in simple but terrible misjudgements. It happens all the time.
*To give Mr Smith his due, he does argue that you have to decide exactly which firms and managements are actually good at doing this internal reinvestment. And that is, apparently, his own particular skill.


I agree with those comments and as has been said by scrumpyjack a commitment to regular dividend payments is a good discipline for company managements and provide some confidence to shareholders that they are at least getting some sort of return. These days the dividend usually just appears as a number on a bank statement or in an account on a platform. I recall the time when they used to appear with some regularity in the form of a cheque reassuringly landing on my doormat.

Dod

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Re: The dividend fallacy

#473758

Postby dealtn » Yesterday, 11:20 am

OhNoNotimAgain wrote: You have a choice which you don't have with retained earnings.


Yes you do, indeed more choice.

You can sell any part of your holding, at any time, to access those retained earnings. You aren't constrained to the 2 or 4 times a year a dividend payment arrives, and you are likely to have less of a tax deduction too.

OhNoNotimAgain wrote:Moreover, it suits Terry Smith, and every other active manager, to ignore the evidence from BEGS, Dimson, Fama, French, Sharp, Markowitz, Malkiel and many others.


What evidence are you referring to? Can you provide any links as I am fairly sure Terry Smith is au fait with much of the works of the above quoted (although I can't say that is true of "every other active manager").

(disclosure, not that it affects my argument, and only really an opportunity for me to show off, but I was taught by Paul Marsh - a very generous man with his time and intellect and got to meet Elroy Dimson on a number of occasions).

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Re: The dividend fallacy

#473787

Postby mc2fool » Yesterday, 12:52 pm

dealtn wrote:(disclosure, not that it affects my argument, and only really an opportunity for me to show off, but I was taught by Paul Marsh - a very generous man with his time and intellect and got to meet Elroy Dimson on a number of occasions).

Now that's name dropping! Yeah, you're a show off. :D

I've been to a couple of talks by Shiller at the London School of Economics. Does that count? .... Ok, probably not .... :lol:


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