What's with dividend fetishes?

[Juked07]

I can't understand why people like dividend paying stocks. I think it's never optimal for the company/shareholders to have dividends paid. Here's what I see:

A company owns some cash and some inventories, maybe some intangible goodliness, etc. They use these things they own to conduct a business, generating revenues that hopefully cover their costs and make them profitable. Then they have some more cash. This is commonly known as "Step 4. Profit" and immediately follows "Step 3. ???".

Anyway, now they can take the cash, and do 1 of at least 3 things:
1. Reinvest the cash in more business doing goodness
2. Pay a dividend
3. Buy back equity

In the case of 2, the company immediately owns less cash, is worth less, and their share price drops accordingly. In some countries, the dividend is taxed upon payment (in addition to whatever income taxes the country has), so the stock drops by a greater amount than the shareholder receives as a dividend. In the US, this is not the case, but the share price still drops by the amount of the dividend, and the shareholder owns the same wealth he did before the dividend was paid.

Then at the end of the year, shareholders have to pay taxes on the money they made, including dividends they received. The shareholder could have received that money at ANY TIME, by selling their stock in the market place. They didn't need the company to force feed it to them through a dividend and be forced to realize income during the current year. They could have held the stock until whatever time is optimal from a personal life or tax perspective and sold it then. Receiving a dividend seems shitty.

Option 3 seems strictly better. Those interested in receiving cash now can sell shares. Those who want to hold their equity until later do so by default. The company still gets to spend their excess cash in a way that benefits the shareholders.

But for some reason, a ton of seemingly educated investors love "dividend paying stocks." Do they really have the time to make all their other investment related decisions but can't be bothered to sell their shares on their own when they need money? Do people love realizing taxable moneys early? They're big supporters of the US government? What is going on here?

Edit: I realize I rambled for longer than most of your attention spans, so here's a final takeaway... FINAL TAKEAWAY!:
Companies are profitable (and therefore good investments) by conducting business well. Reducing the value of shares by handing out cash does not make a company more or less profitable. Dividends do, however, reduce a shareholder's flexibility in deciding when to realize gains, and this can be costly for tax and other reasons. Dividends suck. Why do people like them?

Edit2: Unfortunately this OP is apparently misleading. I am not attempting to argue that firms should reinvest rather than paying dividends. My initial argument was that firms should buy back equity rather than pay dividends. We have since discussed reasons buy backs suck. It's not clear yet that these reasons are inherent to the issue - I contend that they could be byproducts of non rational behavior and regulations; it's not clear yet. Hopefully we've all learned something..

 

[spidey07]

Because of long term capital gains of 15% on DIV and dividend re-investment. Vs. STG. The "cost" of dividend is built into price. I'll take 15% guaranteed tax and future growth vs the alternative.

You haven't thought this through. I love dividend paying stocks, good ole bluechips chugging along, nice DIV, just keep on chugging.

On your summary - you need to realize the tax implications of STCG vs. LTCG and the natural compounding effect of dividend re-investment over time to the company and the stock owner. There's a reason they pay them. It encourages the owner to hold and re-invest in the company.

 

[Juked07]

Because of long term capital gains of 15% on DIV and dividend re-investment. Vs. STG. The "cost" of dividend is built into price. I'll take 15% guaranteed tax and future growth vs the alternative.

You haven't thought this through. I love dividend paying stocks, good ole bluechips chugging along, nice DIV, just keep on chugging.

If you're investing in the conventional/conservative buy and hold sense, you'll get long term capital gains on your stock with or without dividends.

And what do you mean when you say "the 'cost' of dividend is built into price"? This is vague. If you're suggesting in any way that holding shares through a dividend ex date results in having more wealth, I'm quite confident that's wrong. I basically can't make sense of this statement.

And as for the "compounding effect of dividend reinvestment", you might want to check the math. Ignoring tax complications, if company XYZ pays dividends and you reinvest them in XYZ each time, you end up with the same wealth as if XYZ never paid a dividend at all.

 

[Juked07]

I did think of one possible benefit for dividends.. Let's say you want exposure to the full volatility (and expected return) possible from a given business. If the business pays out all excess cash as dividends, it is more levered relative to if it retained cash, and you can invest in a less diluted (by cash) company.

To get the same exposure to a company that holds a lot of cash, you would have to borrow, and you almost certainly borrow at a higher rate than any reasonable company. In that way they are providing you inexpensive leverage for your investing. If on the other hand you are more risk averse, you simply buy fewer shares.

 

[JS80]

People who like dividends fall under two categories:
1) retired/want dividend income at favorable tax treatment rates
or
2) ignorant

 

[spidey07]

You're still in school, aren't you? Companies pay dividends to encourage purchase from those that want steady stream of capital to do with as they please.

When I said "built into price" I meant the "cost" of the dividend is built into the share price.

 

[Hugo Drax]

#1 Acquisitions are typically bad. Good Example is Microsoft buying Danger and spending 1 billion in the process. Another good example HP and buying Palm.

#2 dividends, much better. plus harder to cheat. Potentially you can just live off the dividends without having to sell a single share if you do it right.

#3 Stock buyback, a scam. Most of the buybacks are just a back door way of enriching insiders in the company. Cisco and Microsoft are some good examples. What happens is they issue a shit load of shares as compensation to insiders, then make big buyback announcements.

I vote for dividends.

 

[spidey07]

People who like dividends fall under two categories:
1) retired/want dividend income at favorable tax treatment rates
or
2) ignorant

Or reduced volatility - bluechips

 

[Juked07]

Or reduced volatility - bluechips

No. Reduced vol comes from the nature of the business. If a bluechip bought stock instead of paying divs they would realize the same vol. It's true that being a bluechip is correlated with the decision to pay dividends, but I see no reason that this should be true.

 

[Juked07]

#1 Acquisitions are typically bad. Good Example is Microsoft buying Danger and spending 1 billion in the process. Another good example HP and buying Palm.

#2 dividends, much better. plus harder to cheat. Potentially you can just live off the dividends without having to sell a single share if you do it right.

#3 Stock buyback, a scam. Most of the buybacks are just a back door way of enriching insiders in the company. Cisco and Microsoft are some good examples. What happens is they issue a shit load of shares as compensation to insiders, then make big buyback announcements.

I vote for dividends.

1. You don't have to acquire to reinvest. If the equity of a company grows, they are reinvesting capital. Who said anything about acquisitions????

2 and 3. Who said anything about saying you're going to do one thing and then doing another? I don't care about the scams surrounding declarations of taking certain actions, only the merit of the actions themselves. Saying you're going to pay dividends and then issuing a lot of equity to insiders is the same as saying you're going to buyback stock then issue stock to insiders. It sounds like you have a stance against corruption, which I agree with. But you haven't said anything that actually addresses the merit of either course of action.

 

[spidey07]

No. Reduced vol comes from the nature of the business. If a bluechip bought stock instead of paying divs they would realize the same vol. It's true that being a bluechip is correlated with the decision to pay dividends, but I see no reason that this should be true.

So call me an idiot then. It's tax time and all my 1099-DIVs are coming in along with price gains on held shares. I'm pretty damn happy and have no intention of selling. I intend to live off these and I'll take the cash in hand at low LTCG rate.

This is me giving you the perspective of an owner, think about my perspective than your academic one. If paying a dividend was a bad move for the company, they wouldn't do it.

 

[Juked07]

So call me an idiot then. It's tax time and all my 1099-DIVs are coming in along with price gains on held shares. I'm pretty damn happy and have no intention of selling. I intend to live off these and I'll take the cash in hand at low LTCG rate.

This is me giving you the perspective of an owner, think about my perspective than your academic one. If paying a dividend was a bad move for the company, they wouldn't do it.

As long as reasonably intelligent investors recognize dividend paying as a sign of health, it's correct to pay dividends as a signal of health. But that signalling is an antiquated leftover of times when companies had little transparency and poor reporting. I really think it doesn't need to happen anymore.

You're not an idiot - you're just another investor within an imperfect system. The system could be better in many ways; I'm only pointing out one.

 

[z0mb13]

Apple has about $100 billion of cash in its balance sheet (granted 60% is from foreign operations).
I find it hard to believe the massive cash is utilized efficiently by them rather than giving it out to investors.

 

[basslover1]

Meh, I like dividends because for me it's another paycheck in July. Granted, my company's stock isn't publicly traded and since we literally own every object in our operation (property, plant, & equipment), the dividends are usually pretty sweet. Last years was $.53 a share. I know some guys that get 100k dollar checks each year for the dividend.

For publicly traded stocks, if the company isn't suffering financially I don't see anything wrong with them. I see dividends as a way to keep you as a share holder, or for you to potentially reinvest into the same stock.

 

[spidey07]

Meh, I like dividends because for me it's another paycheck in July. Granted, my company's stock isn't publicly traded and since we literally own every object in our operation (property, plant, & equipment), the dividends are usually pretty sweet. Last years was $.53 a share. I know some guys that get 100k dollar checks each year for the dividend.

For publicly traded stocks, if the company isn't suffering financially I don't see anything wrong with them. I see dividends as a way to keep you as a share holder, or for you to potentially reinvest into the same stock.

One in hand is worth two in the bush.

 

[manly]

1. You don't have to acquire to reinvest. If the equity of a company grows, they are reinvesting capital. Who said anything about acquisitions????

2 and 3. Who said anything about saying you're going to do one thing and then doing another? I don't care about the scams surrounding declarations of taking certain actions, only the merit of the actions themselves. Saying you're going to pay dividends and then issuing a lot of equity to insiders is the same as saying you're going to buyback stock then issue stock to insiders. It sounds like you have a stance against corruption, which I agree with. But you haven't said anything that actually addresses the merit of either course of action.

you don't understand that the "scam" Hugo Drax described is perfectly legal and accepted practice. If the executive options granted are essentially offset by share buybacks, shareholders are not diluted and thus it's hard to say how their equity was affected.

Even if you exclude that scam, buybacks are not easily justified. Companies are not objective when looking inward and frequently "invest" poorly. Netflix blew off hundreds of millions of dollars buying back shares averaging roughly $200. Now even though they're the leaders in streaming, they face a potentially existential threat as they'll need significant cash to acquire content licenses going forward. For all the well-documented marketing blunders Netflix made to piss off customers, share buybacks are arguably the worst single mistake Reed Hastings and company should be fired for.

 

[Juked07]

you don't understand that the "scam" Hugo Drax described is perfectly legal and accepted practice. If the executive options granted are essentially offset by share buybacks, shareholders are not diluted and thus it's hard to say how their equity was affected.

Even if you exclude that scam, buybacks are not easily justified. Companies are not objective when looking inward and frequently "invest" poorly. Netflix blew off hundreds of millions of dollars buying back shares averaging roughly $200. Now even though they're the leaders in streaming, they face a potentially existential threat as they'll need significant cash to acquire content licenses going forward. For all the well-documented marketing blunders Netflix made to piss off customers, share buybacks are arguably the worst single mistake Reed Hastings and company should be fired for.

I admit I didn't bother thinking about the "scam." I just recognized that it has nothing to do with the actual comparison between buying stock and paying dividends and moved on.

As for shitty buybacks.. it is unfortunate that companies can fail so hard at something like simply buying stock. Maybe there are regulatory issues that make it hard for insiders to buy shares, but if they just participated in closing auctions buying reasonable amounts at a time, they could get filled at a reasonable level without really understanding market structure at all.

 

[Slew Foot]

So call me an idiot then. It's tax time and all my 1099-DIVs are coming in along with price gains on held shares. I'm pretty damn happy and have no intention of selling. I intend to live off these and I'll take the cash in hand at low LTCG rate.

This is me giving you the perspective of an owner, think about my perspective than your academic one. If paying a dividend was a bad move for the company, they wouldn't do it.

I love dividends. Its like getting a bonus check in the mail. Especially when you're investing in huge blue chip multinationals, its not like that little bit they pay out is going to significantly change their capital investment.

 

[JS80]

Or reduced volatility - bluechips

blue chips are usually leveraged and have meager dividend yields. I'd rather they first pay down debt, then make acquisitions, and if the stock price is at a low valuation do a stock buyback (and retire the shares instead of handing them back out in stock grants). Dividends should be last resort. AAPL would be a good example of a company that should be making dividends.

 

[spidey07]

I admit I didn't bother thinking about the "scam." I just recognized that it has nothing to do with the actual comparison between buying stock and paying dividends and moved on.

As for shitty buybacks.. it is unfortunate that companies can fail so hard at something like simply buying stock. Maybe there are regulatory issues that make it hard for insiders to buy shares, but if they just participated in closing auctions buying reasonable amounts at a time, they could get filled at a reasonable level without really understanding market structure at all.

That's it.

Were not doing your homework for you. This is homework.

 

[spidey07]

blue chips are usually leveraged and have meager dividend yields. I'd rather they first pay down debt, then make acquisitions, and if the stock price is at a low valuation do a stock buyback (and retire the shares instead of handing them back out in stock grants). Dividends should be last resort. AAPL would be a good example of a company that should be making dividends.

Stop doing his homework.

 

[SSSnail]

Company equities can gain value AND pay dividends. Keep on being poor.

 

[Juked07]

Lol wtf kind of hw would bashing on dividends be? If anything most professors seem to buy into loving dividends as much as the next guy. Plus it'd be easier to get help by searching the web than posting here.. This is just a pretty solid place to rant.

I graduated last year and work on an options desk now. Dividends affect options valuations so I occasionally think about them. They're generally more or less exogenous to pricing, so I don't need to understand why companies pay them, but I do wonder sometimes.

It would be satisfying to find a good reason, but I have become increasingly convinced that it doesn't exist.

And SSSnail: If you're suggesting you gain wealth by having share price go up and receiving dividends, you're right, except that I think in pretty much every reasonable case you gain equal or less wealth through this arrangement than if the company did not pay the dividends, and you chose when to sell stock instead. Did you read the thread at all?

 

[Juked07]

JS80: I've never looked into it, but I would expect that bluechips are generally less highly levered than the universe of stocks that are not bluechips. There are so many shitty stocks.. and only like 30 "bluechips."

Speaking of shitty stocks, count that as a small +1 for paying dividends. Buying stock requires crossing spreads, which can get real expensive if the stock is shitty and there's no liquidity. On the other hand.. don't invest in shitty stocks. It's bad for your happiness.

 

[SSSnail]

And SSSnail: If you're suggesting you gain wealth by having share price go up and receiving dividends, you're right, except that I think in pretty much every reasonable case you gain equal or less wealth through this arrangement than if the company did not pay the dividends, and you chose when to sell stock instead. Did you read the thread at all?

Taxes. As others have mentioned.