Do dividends really matter?

Question

Just trying to figure something out here. If I had 2 companies that were very comparable and one offered a dividend, I am going to go for the dividend one because I see it as extra return. My father says that dividends do not matter since the stock drops around the same amount when the ex-dividend date comes around.

Do dividends matter? Are they just a sort of cost recovery item?

As I see it, if I did reinvest my dividends then after 10 years, my investment will be worth a lot more since I have more accumulated shares. I know that Warren Buffet takes his dividends but that the same time, his company does not pay dividends themselves.

Concrete data proving one or the other?

Answer 1

Around 1960, Modigliani and Miller showed that in perfect capital markets, dividends do not matter.

The thing is -- markets are not perfect. In the early 1980s there was a theory paper (Miller & Rock) and an empirical paper (Asquith & Mullins) that looked at the idea of signalling private information by paying dividends. Asquith & Mullins looked at what happens when companies that have never paid a dividend start paying one. On average, there is a positive abnormal increase in price of about 4%.

Your father is right that when the company actually pays the dividend there is a corresponding drop in price. But that is after the announcement.

So -- if a stock was trading at $10 -- it might jump up to $10.40 when the company announces a $0.20 dividend. Then when the dividend is actually paid (five cents -- since the dividend is quarterly) the price would drop from $10.40 down to $10.35.

As part of my dissertation, I showed that this announcement effect is bigger for companies that have no debt -- and is nonexistent for financial companies. This makes sense -- because prior to the announcement, there is lots of private information about firms with no debt -- and little for financial institutions (which are more closely monitored).

Answer 2

Check out Jeremy Siegel's book "The Future for Investors" where these issues are discussed.

Dividends are very important and valuable, but most investors don't appreciate this. Here are a few points.

1) Be careful with weak companies that pay very high dividend yields. Such a company may be forced to cut their dividend, which is a disaster. A week ago or two, an analyst said that Citi (C) may be forced to cut divs. and the stock dropped, even though most other analysts think the div. is safe.

2) Earnings numbers can lie, but dividends are cold hard cash, and cash never lies.

3) As the stock price drops, the div. yield percentage goes up. This helps tremendously to reduce stock price volatility. I've owned a few stocks that have seen 50% or 60% price declines. Some were small caps, & some were large cap, but all paid no dividend.

4) Dividend reinvestment is fantastic for very long term investors. If the stock pays a higher div. yield (like 3% or more) then a substantial and prolonged stock price decline is not a problem. As you reinvest these divs., you will get more shares, because the price is lower.

Assuming that the stock price eventually recovers, you will make MORE return on your investment BECAUSE of the decline, compared to a steady stock price.

5) Look for stocks with good dividends, but also a history of consistently increasing the div. A stock screener that I use lists the annual div. growth rate, averaged over the last 5 years. This is an important number to maximize, since your 4% yield can become an 10% yield over time.

Finally, there are plenty of good stocks that don't pay divs. If the company is managed by a brilliant investor oriented CEO like Warren Buffett, then he can utilize the earned cash better than nearly anyone. Let these companies keep the cash. Goldman Sachs is in this catagory too. But the vast majority of CEOs just aren't that good.

Answer 3

Well to me, dividend does matter in my analysis of stocks, especially those companies that has a dividend policy. Such a policy would provide a 'floor' for the stock price, to a certain extent. High dividend yield stocks are also unlikely to fluctuate too much as well.

Dividends like what you mentioned, when we reinvest help us to earn more. That is the compounding interest a lot of finance books are saying.

About what your father said it is true, but one have to take note when someone buys the stock. The stock will increase in price when dividend is announced, assuming all other conditions holds. When the stock goes ex dividend, then the stock price will drop around the same amt of the dividend.

Answer 4

Personally I like dividends, like you say, they help the bottom line. But they also represent more stable companies. Companies who are drowning in debt can't pay dividends. Dividend stocks also can withstand a bear market better. Also the tax on dividends maxes out at 15% regardless of your personal income tax bracket.

On the other hand companies that reinvest their profits back in the company have greater room for growth - or so the argument goes.

But I think it depends some on your age - do you have time to wait for a growth stock to really blossom? And it depends on your income - higher income bracket and you want the tax savings.

Answer 5

Keep in mind that most large investors buy a non div. paying stock anticipating a future div. being paid. Newer stocks do not usually pay div. Google is an example.
I, a long time investors, have both types. I prefer the DRIP for most stocks and have one that pays more per share than the original buy price and the total value of that stock is 400 times the initial cost. Best idea is not to worry about div., but to invest on a regular basis during your work years. Also, high div. stock usually have a high risk or skeletons in their closet. Tobacco stock are a good example, MO & MRK

Answer 6

dividend factors is not my stock selection, but of course, if they do pay dividend, i'm more than happy to accept. to me, everything is about the business behind the ticker. the company must have strong growth, effective management team, in a healthy economic environment. this is all i need, and so far, none is the same to another.

the reson i don't care much about dividend is, most of the time the stock didn't give you dividend for free. the truth is, they want to maintain high ROE in their performance, so that most analysts will love their company. if the analyst fall in love with their company, the stock will get wide 'coverage' on any business update and that will eventually make their stock price climb higher without reason.

my advice, don't pay much attention to dividend. but if you really need that cash more than the company do, it is your call to choose one.