Mar

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 1. Tax savings to the shareholder.  The shareholder receiving those dividends must pay taxes on them at a fairly high rate, and in that tax year.  If alternatively the corp uses that cash to repurchase its own shares on the open market or otherwise, the overhanging supply of shares decreases resulting in a higher price for all shares.  Thus the shareholder experiences a capital gain, which historically has been taxed at a lower rate.  Thus his after-tax return increases.  And he can choose the tax year.  Taxes deferred are taxes denied.

2. The shareholder receives the dividend at a time not determined by himself, and the odds are that it is not the most desirable time for him to receive that payment.  If the shareholder wants some cash, he can sell some shares when it is convenient and/or necessary for him to do so.  If you want some annoying experience with dividends, buy some HOLDERS (an early/anachronistic version of ETFs).  You will get dividend announcements several times a week and your accountant will be delighted with all of the work you have given him.

3. (Opinion) Corps that have cash available to pay dividends are not efficient investors of the capital entrusted to them.  By giving the shareholder a dividend they are saying effectively, "we do not have any good investment ideas; take the money because you probably can do better."  This is not to suggest that all corps should be acquirers of other companies, but they could put some money in R&D to either enlarge share or reduce expenses in the future.  And R&D expenses are tax deductible.

4. (Opinion) The payment of dividends is a public relations game to get investors to hold the stock for long periods.  The process lulls investors into not reevaluating their investment options as regularly or often as they should, which is not in the shareholder's best interest.  (N.B. That opinion is different from what the "buy and ignore" crowd will tell you.)

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Stefan Jovanovich comments:

I think the point about the taxation of dividends belongs to an earlier time.  The taxable portfolios of individual investors (as opposed to IRAs, SIMPLE IRAs, 401(k)s, etc.) are not a significant part of the overall market.  Most of the shares owned are in the hands of tax-exempt institutions.  Most of the taxable investors are corporations; because of the dividends received exclusion their effective tax-rate on payouts from other corporations is - at most - 15%.  I would hardly want to quarrel with Bill's maths, but it could be argued that the advantage of having a cash payout diminished a 15% by tax could be a better return than allowing corporate management to hold on to the cash and then use it to speculate in their own company's securities.  There are very few Henry Singletons.

George Parkanyi adds:

The dividends-are-bad argument misses the point that dividends are not always static, and when companies keep increasing them regularly, after a while you can be earning a very high yield on your original investment in addition to the capital appreciation.  Companies can also squander money, and perhaps paying a dividend is a better choice than overpaying for some acquisition that blows up.  Dividends can also be good indicators of value where your primary objective is capital appreciation.  Look around you now.

I also would be careful using generalizations like "hope for the buy and hold crowd", implying they are a bunch of bovine followers.  A lot of people have gotten rich by holding on to companies that have grown and dramatically appreciated in value.  In addition to the appreciation, there are tax-deferral and transaction cost avoidance benefits.  In fact, it takes a LOT of discipline to be that patient, especially if you follow the markets regularly.

As for dividend-paying stocks, they're just another useful tool - not for everyone, but for many - in the arsenal of investment vehicles available to traders and investors.  Personally I think that quality companies paying dividends are going to rocket off the bottom first when things turn around because of the yield support and recognition of value, and many of us will be lamenting "How did I miss _________ at 6%?"

Phil McDonnell replies:

Dividends can be an important part of returns.  Most studies of long term stock market returns show that re-investment of dividends accounts for about half of the long term return.  So in the long term they are very important.

In the short term they may be less important.  If a stock pays a dividend of $.50 then it will probably drop and average of $.50 on the day it goes ex-dividend.  So there would seem to be no apparent gain.  But if the dividends are reinvested in the stock the investor is buying the stock a little bit cheaper after the ex-dividend event.

Added to this are the benefits of dollar cost averaging. Specifically when the stock is generally at a low price more shares are purchased with the dividend.  When the stock is high fewer shares are purchased with that same dividend.  Over time this leads to an average price per share that is below the average price of the stock during the same period.

In looking at yields and total returns it is important to look at how the reporting institution does its calculation.  You would think that this is not important and that people like S&P report things on a consistent basis.  A good case in point is that the S&P index is a cap weighted index.  Big cap stocks like IBM, GE and XOM get far more weight than their smaller brethren.  But when S&P reports the earnings for the index, bizarrely, they do not use cap weighting.  The earnings are equal weighted.  Thus an earnings to index level comparison for the S&P is completely meaningless.  An example is that S&P calculates the equal weighted reported earnings as negative for the first time in history.  But if they were cap weighted the earnings would be positive.  If the operating earnings were reported on a cap weighted basis they would be 80% higher than the equal weighted earnings that S&P actually reports.

Dr. McDonnell is the author of Optimal Portfolio Modeling, Wiley, 2008


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