Not sure about this you know

Investing in steady dividend-paying companies has not been a brilliant strategy over the last 30 years. The so-called Dividend Aristocrats, a group of companies within the S&P 500 that have increased dividends without fail for at least 25 years, have underperformed the overall S&P 500 in that period, according to Bloomberg data.

Could be true for price only, doubt it is for total return. But does anyone actually know?

19 thoughts on “Not sure about this you know”

  1. There’s loads of that divi stuff at Lemonfool website, practical HYP discussion board. As I understand it, Motley Fool UK discussion boards were axed so they had a new similar one to replace them.

  2. Dennis: Oppressor, Warmonger, Capitalist and Consumer of Petroleum Products

    In an influential 1961 paper, Merton Miller and Franco Modigliani, two Nobel laureates in economics, said that dividends were essentially irrelevant. Corporate earnings and cash flow are critically important, they said. But whether investors reap those rewards through dividends, stock price appreciation or buybacks is economically insignificant, their work suggested.

    And in this, Miller and Modigliani are wrong. If the investor deems dividends to be important, then they are important. What is more, the market has confirmed they are important, and has done so for decades and decades. If dividends weren’t important, there wouldn’t be a market for them, now would there? You could, of course, argue that investors don’t know what they are doing, but then you’re getting into Richard Murphy style economics.

    As with most prominent economists, Miller and Modigliani were both brilliant and unable to see the forest for the trees.

  3. A lot would depend on what was done with the dividends. If they were reinvested in the market (including the issuing stock) the total return and ending portfolio balance would be considerably different than if you spent them on consumption. Which is not to say that spending them might not have been more fun. Grasshopper and ant thing.

  4. I think you’re misrepresenting M+M Dennis. Their point is rather more like “provided the investors get their returns by some means or another (and dividends are just one such means) and provided a list of assumptions hold true (which the economists are not so blind as to believe to be the case) then whether that return is via dividend or not is essentially irrelevant” and the way that an economist might read that and think about it in practice is more like “to whatever extent dividends matter, it can be analysed in terms of which of that list of assumptions is being violated and how strongly”.

    One of those assumptions is about tax for example, and in practice different tax regimes on different investors produce preferences for dividends or not – so there’s a clientele effect where different securities with different dividend policies attract different clienteles of investors.

  5. “A lot would depend on what was done with the dividends”

    What the investor does with the divs is not relevant, using IRR to measure performance, one is looking at the DCF of the investment. For example, larger capital gain and lower divs versus lower gain and higher divs, after tax.

    And it needn’t be a timing of cash issue for the investor as in theory one could get the same cash effect of dividends by selling the relevant % of the (higher gaining in value) stock. Tax (capital versus income) will make a difference.

    The issue is for the company. Can the company generate an improved IRR for the investor by reinvesting their profits rather than paying divs.

    Tim, “logically”, the answer might be that the steady dividend companies should produce a lower overall (total) return, as otherwise the company might have reinvested the profits instead (if the potential was there)? Yes, sure, it’s more complicated than that (and no, I don’t know the actual answer to your question wrt to the S&P 500).

  6. @TD

    I think Timmy’s point is what would happen if you reinvested the dividend solely in the same stock, and compared the performance to stocks where managers reinvested profits rather than distributing them as dividends. Though I suspect you know this and I think you’re right that in practice a lot of people who buy stocks with reliable dividends are people who actively intend to spend the income!

  7. The notion that investors should be indifferent to dividends assumes that the managers of the firm could continue to invest their surplus cash flow in other profit generating activities that would enhance the value of the firm, offsetting any benefit to dividends. ie, more cash in pocket vs more valuable shares, with the latter tax deferred. But we’ve just seen many examples of firms piling up huge amounts of cash overseas in order to avoid their home countries’ tax, particularly among US companies. The managers of these firms just didn’t know what to do with this cash, so they let it sit or sometimes looked for big acquisitions or perhaps started practicing the bladder theory of cash management.

    Compounding assumes that new cash generated will be invested at a return similar or higher than earlier cash investments. That clearly is not necessarily the case if left in the hands of the managers whose actions generated that cash, and sometimes investors might prefer that surplus cash go back to them for other purposes.

  8. Having just looked at the performance of the SPDR S&P US Dividend Aristocrats over the last 10 years or so – October 2011 to date, the S&P has returned 296% and the ETF 277%.

    Whether that is worth bothering about is up to the individual. Volatility is roughly the same. I am not able to guess at how that ETF might have been composed before its inception.

  9. A growing, but maybe risk prone, company won’t be paying steady dividends, whereas a more mature company might be. So could any the difference could be better explained by the degree of risk the share represents?

  10. Growth does tend to suck up cash, though interestingly, in this modern world those growing firms that can put their customers on a subscription basis can greatly speed up their cash flows by hitting a credit card or bank account each month over the old method of creating an invoice and mailing it hoping to be paid within 30 days.

  11. Modern Portfolio Theory would suggest that the total return for steady dividend paying companies would be lower than other companies since the risk is lower so the “Equity Risk premium” would be smaller.
    Therefore it has not been a “brilliant strategy” but it has suited a large proportion of small/medium-sized individual investors who can sleep soundly at night. What price do you put on that?

  12. Over the past ten years (available on the S&P website) the aristocrats have underperformed significantly) in TR as well as price return.

  13. The constituent companies change over the years. So you would expect the index itself to do better over a period than the majority of companies that comprise it over the entirety of same period. Failing companies drop out. Fast growing companies come in. It’s selecting for success.

  14. If you index buy, you risk paying at the top of companies coming in, and selling at the bottom as they drop out. So you perform worse than the index says you should.

    Buy good companies and take the steady money. It’s not sexy, but who cares?

    Plus some people, like my parents, live off their dividends. They don’t want to be having to sell shares in dips they know will not last. They will be happier now to get dividends than have to sell while the market is down. They’re too old to ride out storms in the hope of capital gain.

  15. Not at my workstation so I can’t check right now. But if it’s true, it may simply be because Facebook, Apple, Amazon, Google etc. happen not to pay dividends.

    Dividend-base investing may not be that great at capturing generational shifts in technology, by its nature. I suspect there would have been quarter-century periods when the railroads would have outperformed whilst no LT paying out significant dividends (an an aggregate basis – corporations were typically more project-based back the )

  16. I don’t think my parents are going to be catching any generational shifts in technology.

    I’m 55, and I won’t be trying to do that either. That I might make it stonkingly rich in 20 years isn’t helpful, because I will need the money before then.

  17. Can’t answer the question.

    I can say the best investment I ever made was in Dominion Resources, the parent of Virginia Power. NYSE symbol: D.

    I did automatic dividend reinvestment. I paid income tax on the dividends each year. But whatever the amount, it bought more Dominion stock. In 20 years, it returned THOUSANDS of percent.

    For someone with long savings horizon, I highly recommend it. Dominion is a regulated monopoly. Guaranteed return. Very secure business. Unless President Stacey Abrams bans electricity.

  18. The three traditional investment goals are security, growth and income. Seldom are all three present in one investment. When they are, it’s called a blue chip. There is of course a fourth investment goal, to increase one’s sense of virtue.

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