Author Topic: Why reinvest dividends?  (Read 7121 times)

Frugali

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Why reinvest dividends?
« on: May 09, 2017, 08:04:21 AM »
I think I have generally a pretty good understanding of markets/investing, but I'm going to ask a very ignorant question nonetheless...  Doesn't reinvesting dividends defeat the whole purpose of dividends in the first place??  I always read that reinvestment gives significantly better returns, which logically it would do as the amount you're investing increases.  But isn't this essentially identical to the company never having paid any dividend at all, given that the share price should have increased by exactly the same amount as a result of no dividend??

I understand of dividend investing to produce an income stream, but if you're reinvesting b dafualt, isn't it the same whether the company pays 10% or zero?

BreakTheChains

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Re: Why reinvest dividends?
« Reply #1 on: May 09, 2017, 08:27:43 AM »
A 3% dividend is functionally the same as a company liquidating 3% of itself and giving you the money in cash. If you don't reinvest those dividends, you basically own 3% less of that company going forward. If you reinvest, you actually own a BIGGER portion of that company going forward than you did before due to the number of people not reinvesting those dividends and the fact that the company is worth 3% less after the dividend is paid. I think this is one of the biggest misconceptions out there, people consider dividends to be "free money", when it's basically the same as the company selling a portion of its business. 

Frugali

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Re: Why reinvest dividends?
« Reply #2 on: May 09, 2017, 08:34:12 AM »
So that's my point...  noted about some people not reinvesting hence giving you a bigger piece of the pie, which is valid...  but imagine for a minute that EVERYONe reinvested, then isn't that identical to if the company never paid a dividend in the first place, given that all that extra cash would be retained in the company and boost the share price?

Agree there are huge misconceptions with divs, hence why I'm questioning if there is really any benefit in investing in a div paying company vs a non div paying company if you are planning to reinvest all the divs  anyway? 

BreakTheChains

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Re: Why reinvest dividends?
« Reply #3 on: May 09, 2017, 08:39:37 AM »
So that's my point...  noted about some people not reinvesting hence giving you a bigger piece of the pie, which is valid...  but imagine for a minute that EVERYONe reinvested, then isn't that identical to if the company never paid a dividend in the first place, given that all that extra cash would be retained in the company and boost the share price?

Agree there are huge misconceptions with divs, hence why I'm questioning if there is really any benefit in investing in a div paying company vs a non div paying company if you are planning to reinvest all the divs  anyway?

If everything else was completely equal besides the dividend payment, the non-div paying company is better, because you can delay the taxes you have to pay until you actually sell your holdings, as opposed to being forced to pay dividend taxes yearly. Also, even if everyone reinvested their dividends, you'd still have the tax hit every year, so all shareholders would be considerably worse off. The only time a dividend is a good business practice is when management can't find a use for the money that would generate an equal or higher returns than that which is expected by investors AND management believes the stock is overvalued. Otherwise, a stock buyback accomplishes everything the dividend would without the tax implications.

Cromacster

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Re: Why reinvest dividends?
« Reply #4 on: May 09, 2017, 08:40:10 AM »
So that's my point...  noted about some people not reinvesting hence giving you a bigger piece of the pie, which is valid...  but imagine for a minute that EVERYONe reinvested, then isn't that identical to if the company never paid a dividend in the first place, given that all that extra cash would be retained in the company and boost the share price?

Agree there are huge misconceptions with divs, hence why I'm questioning if there is really any benefit in investing in a div paying company vs a non div paying company if you are planning to reinvest all the divs  anyway?

It depend's on your strategy.  For buy and hold investing dividends aren't as necessary, but it makes sense to reinvest if dividends are offered.  The increase in shares you own is always a good thing, but you'd get the same value if they had no dividends and you just continued investing.

Another strategy is to live off dividends.  You own enough stock that the dividends provide you with enough income to live off of, obviously you don't reinvest if this is your plan.

Or if you feel you don't want to own anymore of a particular stock you can use the dividends to invest elsewhere.

BreakTheChains

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Re: Why reinvest dividends?
« Reply #5 on: May 09, 2017, 08:43:59 AM »

Another strategy is to live off dividends.  You own enough stock that the dividends provide you with enough income to live off of, obviously you don't reinvest if this is your plan.


A 3% dividend is exactly the same as selling 3% of your holdings in a stock every year. You might as well hold a non-dividend paying stock and liquidate whatever amount you want yearly and make your own "dividend". The only reason to live off dividends is if you can't grasp this concept, don't know better, or find it psychologically comforting to not have to "sell" the stock and to have the company essentially do it for you.

Frugali

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Re: Why reinvest dividends?
« Reply #6 on: May 09, 2017, 08:48:21 AM »
There are actually no taxes on divs where I live (Hong Kong), but can understand that point being a factor elsewhere.  Though even for so called 'dividend investing' to live off the income stream, this seems more a matter of convenience than anything else (which is understandable); because as breakthechains says, divs are the same as selling part of the company.  Therefore, even if the company pays no divs, surely you could just sell part of your holdings to achieve exactly the same thing (notwithstanding dealing fees obviously)?

Frugali

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Re: Why reinvest dividends?
« Reply #7 on: May 09, 2017, 08:49:42 AM »
Think our replies crossed there BtC!

Cromacster

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Re: Why reinvest dividends?
« Reply #8 on: May 09, 2017, 08:58:11 AM »

Another strategy is to live off dividends.  You own enough stock that the dividends provide you with enough income to live off of, obviously you don't reinvest if this is your plan.


A 3% dividend is exactly the same as selling 3% of your holdings in a stock every year. You might as well hold a non-dividend paying stock and liquidate whatever amount you want yearly and make your own "dividend". The only reason to live off dividends is if you can't grasp this concept, don't know better, or find it psychologically comforting to not have to "sell" the stock and to have the company essentially do it for you.

That's true, but there is a relatively large subset of investors that invest solely in stocks for the dividends.

BreakTheChains

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Re: Why reinvest dividends?
« Reply #9 on: May 09, 2017, 09:06:48 AM »

That's true, but there is a relatively large subset of investors that invest solely in stocks for the dividends.


I would love to see a study showing what sort of effect on stock prices the distortion caused by misguided people holding only dividend stock has. Luckily for most people the majority of their retirement funds are locked in 401k(s) with relatively decent target retirement date funds.

TimmyTightWad

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Re: Why reinvest dividends?
« Reply #10 on: May 09, 2017, 09:23:43 AM »
How can I easily identify stocks that pay out dividends?

FIPurpose

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Re: Why reinvest dividends?
« Reply #11 on: May 09, 2017, 10:30:31 AM »
There is a big difference between dividends and capital gains, and it is a mistake to think that they are equivalent.

Companies that consistently payout dividends are making money. They pay out the cash that they make from their business. Typically this means that older, more mature markets are the ones that pay the most dividends. Walmart, Target, Johnson & Johnson, AT&T, etc. The only time dividends are dangerous are when companies are paying out more than they make multiple years in a row.

Capital Gains are when a company uses its profits to reinvest in itself, either buying property, attempting a new business, or improving their current business. If a business has a good plan for reinvestment, this is a much better thing to do. But you can only acquire capital gains through the market. Someone else must recognize that value and be willing to buy it at that price. Unlike dividends, capital gains can be way out of line with reality.

The best companies to invest in do both. They have powerful cash-flow machines (think of owning a rental house as buying a dividend machine), but also reinvest in themselves enough to make sure their profits continue to last for years to come.

Reinvesting dividends means owning a larger piece of the pie, a company looking to reinvest their own profits is looking to grow the pie. Reinvesting dividends means that you like the business and you are comfortable buying more of it.

Usually from the investors I know, most auto reinvest dividends in their early years, then when their portfolio is large enough, they start to instead focus their dividends on particular buys from month to month.

BreakTheChains

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Re: Why reinvest dividends?
« Reply #12 on: May 09, 2017, 11:07:50 AM »
There is a big difference between dividends and capital gains, and it is a mistake to think that they are equivalent.

From an investors point of view, no, they are exactly the same aside from different tax treatments. You could argue that dividends are more harmful as many companies actually issue debt for the express purpose of issuing dividends, harming future profitability.


Companies that consistently payout dividends are making money. They pay out the cash that they make from their business. Typically this means that older, more mature markets are the ones that pay the most dividends. Walmart, Target, Johnson & Johnson, AT&T, etc. The only time dividends are dangerous are when companies are paying out more than they make multiple years in a row.


Which is the case with plenty of dividend paying companies. Also, every dollar of dividends paid out is a dollar the company isn't investing in future growth. Management might neglect proper investment to maintain or grow an "expected" dividend payout stream, harming future performance.



Capital Gains are when a company uses its profits to reinvest in itself, either buying property, attempting a new business, or improving their current business. If a business has a good plan for reinvestment, this is a much better thing to do. But you can only acquire capital gains through the market. Someone else must recognize that value and be willing to buy it at that price. Unlike dividends, capital gains can be way out of line with reality.


You are confusing two terms here. Capital expenditures (CapEx) is investment of funds to grow a business (also called capital reinvestment, reinvestment, etc). Capital gains are what occur when you are holding an asset (i.e. stock, a house, etc) that appreciates in value over a period of time. This increase in value is called a capital gain.

When a company pays out a 3% dividend, the company stock price goes down EXACTLY 3% (plus or minus whatever market volatility exists at that point in time unrelated to the dividend) and you effectively own a company worth 3% less. When you sell 3% of your holdings in a company, your holdings go down EXACTLY 3%, you get the same amount of money as a 3% dividend, and the company value remains the same. Both outcomes are equal regardless of if the stock is over or under valued. (same amount of ownership of stock worth 3% less vs. 3% less ownership of a stock worth the same amount). Effectively, valuation is meaningless in this argument.


The best companies to invest in do both. They have powerful cash-flow machines (think of owning a rental house as buying a dividend machine), but also reinvest in themselves enough to make sure their profits continue to last for years to come.


Depends on what you mean by best. The highest growth companies are funneling all their capital back into growth instead of returning it to shareholders. Look at a company like Amazon.




*EDIT* and just to cover my butt on this, before someone chimes in that selling your stock lowers the stock price, I'm assuming you are a normal investor, not Warren Buffet, and that the amount your selling is an insignificant fraction of the company.
« Last Edit: May 09, 2017, 11:20:59 AM by BreakTheChains »

seattlecyclone

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Re: Why reinvest dividends?
« Reply #13 on: May 09, 2017, 11:27:28 AM »
I think I have generally a pretty good understanding of markets/investing, but I'm going to ask a very ignorant question nonetheless...  Doesn't reinvesting dividends defeat the whole purpose of dividends in the first place??  I always read that reinvestment gives significantly better returns, which logically it would do as the amount you're investing increases.  But isn't this essentially identical to the company never having paid any dividend at all, given that the share price should have increased by exactly the same amount as a result of no dividend??

I understand of dividend investing to produce an income stream, but if you're reinvesting b dafualt, isn't it the same whether the company pays 10% or zero?

Seems like you're confusing two separate issues:
1) Should a company pay dividends?
2) If a stock you own pays you a dividend, what should you do with it?

You're right about dividends reducing the value of the company, and that this perhaps isn't ideal if the investors were planning to reinvest dividends anyway.

But when you own an index fund, you have thousands of different stocks. Many of them pay dividends, many of them do not. I don't need the cash right now since my work pays me more than enough to live on, so I do the same thing with the dividend money that I do with any other extra cash: I invest it.

FIPurpose

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Re: Why reinvest dividends?
« Reply #14 on: May 09, 2017, 11:43:37 AM »

You are confusing two terms here. Capital expenditures (CapEx) is investment of funds to grow a business (also called capital reinvestment, reinvestment, etc). Capital gains are what occur when you are holding an asset (i.e. stock, a house, etc) that appreciates in value over a period of time. This increase in value is called a capital gain.

When a company pays out a 3% dividend, the company stock price goes down EXACTLY 3% (plus or minus whatever market volatility exists at that point in time unrelated to the dividend) and you effectively own a company worth 3% less. When you sell 3% of your holdings in a company, your holdings go down EXACTLY 3%, you get the same amount of money as a 3% dividend, and the company value remains the same. Both outcomes are equal regardless of if the stock is over or under valued. (same amount of ownership of stock worth 3% less vs. 3% less ownership of a stock worth the same amount). Effectively, valuation is meaningless in this argument.


I would argue that isn't exactly true. Big dividend companies are valued for their consistent dividend. There may be a blip around the payout time, but more or less, the valuation doesn't change, because the value of the company is in the cash flow, not an individual payment.

There are companies that would be acting irresponsible for not reinvesting more in themselves, and there are companies that are irresponsible for hording cash for no reason or expanding in ways that make no sense. If a company is overvalued, is in a mature market, and is well positioned, you should not want them to buy back stock; you should want them to pay out a dividend. If the company is growing at a rapid rate in a new market, you don't want them wasting money paying divdends if they're growing at +10-15% rates yoy (return of capital maybe preferable if they can't expand as quickly as intended.). They accomplish different goals. Stock buybacks IMHO for most companies at current valuations are a poor decision. Companies that have low market visibility, P/E ratios of 5-18, are prime companies for stock buybacks.

Dividends are a promise that the company makes with investors. They are more consistent and reliable, and it means that you can redeploy your new capital in ways that you see fit. Plus most investors at our level are mostly in tax sheltered accounts, so there's no tax for dividends and no expense for selling stock.

BreakTheChains

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Re: Why reinvest dividends?
« Reply #15 on: May 09, 2017, 12:21:38 PM »

I would argue that isn't exactly true. Big dividend companies are valued for their consistent dividend. There may be a blip around the payout time, but more or less, the valuation doesn't change, because the value of the company is in the cash flow, not an individual payment.


Not to be pedantic on this point, but in the very, very simplest terms, the stock price / value of a company is theoretically the sum of all future cash flows to perpetuity discounted back to today's dollars using some form of discounting factor (what that factor is / should be is debatable and varies by investor and over time, and includes things such as required return, expected return of other investments, inflation, risk free rate, blah blah blah). Paying out 3% of a company today is NOT a blip, it is reducing TODAYS cash by 3%, you don't even have to come up with a discounting factor. That is why a stock will decrease by the amount of the dividend on the Ex-Dividend Date (the date on which an owner is no longer entitled to the dividend payment).

Now, all that being said, this is considering a RATIONAL market actor. I do believe there is some justification in what you are saying about there being some sort of "premium" or "inflated" stock price related to "dividend aristocrats" based on retail investors not fully understanding what dividends actually are.



There are companies that would be acting irresponsible for not reinvesting more in themselves, and there are companies that are irresponsible for hording cash for no reason or expanding in ways that make no sense. If a company is overvalued, is in a mature market, and is well positioned, you should not want them to buy back stock; you should want them to pay out a dividend.


Unless you are paying 0% tax on your dividends, you would want them to perform a stock buyback, a non-taxable event for investors (I will get into valuation issues below). Another argument could be that paying out dividends sets a bad precedent as the company would be expected to continue if not increase the dividend in the future, regardless of changing market conditions.

For example, You can say that a mature company like Walmart should be paying out excess earnings in dividends, but imagine if they had used that money they are paying out in dividends to purchase Amazon in the early 2000s if they had the foresight to see where internet retail was going. a dividend payout policy would act like handcuffs on management, preventing them from making big moves like this if the money is instead going to dividend payouts.


Companies that have low market visibility, P/E ratios of 5-18, are prime companies for stock buybacks.

Dividends are a promise that the company makes with investors. They are more consistent and reliable, and it means that you can redeploy your new capital in ways that you see fit. Plus most investors at our level are mostly in tax sheltered accounts, so there's no tax for dividends and no expense for selling stock.

P/E is an almost completely meaningless ratio for investing, it's a snapshot in time that only tells you what the price and earnings are right now.

First, it doesn't factor in a major driver of value, Growth. PEG is a much better metric to evaluate stocks on,but good luck coming up with an accurate growth number.  Two, earnings are very, very easy to manipulate and don't tell you a whole lot. A company that would otherwise be very profitable can have abysmal earning numbers if they are plowing all of those earnings back into growth, causing expenses to grow faster than revenues during the early stages of investment. On the flip side, a company could cut back its R&D / reinvestment significantly, show a stellar earnings number, and see a precipitous decline in its value due to lack of growth as it plows all its money into dividends.

Overall, P/E ratios just do not provide enough relevant information to base any sort of rational investment decisions on. Thus, you can't say a company shouldn't buyback shares because of a high P/E.



Dividends are a promise that the company makes with investors. They are more consistent and reliable, and it means that you can redeploy your new capital in ways that you see fit. Plus most investors at our level are mostly in tax sheltered accounts, so there's no tax for dividends and no expense for selling stock.

Dividends are NOT more reliable or consistent than selling stock. As I've shown in my previous post, they have the exact same effect on investors. I would argue selling the stock is more reliable because you can do it whenever you want and are not at the whims of management.

Babybalrog

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Re: Why reinvest dividends?
« Reply #16 on: May 09, 2017, 12:31:12 PM »
How can I easily identify stocks that pay out dividends?

Almost any stock filtering website will do it for you.
https://www.zacks.com/screening/stock-screener
https://finance.yahoo.com/screener/new
http://www.cnbc.com/stock-screener/

Another thing to consider about dividends is that they adjust the risk/reward point a little towards "safe." Because you receive a little return every year, your up years are usually smaller, but your down years are too. Many outperforming stocks don't or didnt pay dividends (apple until recently, amazon, google, Berkshire) and trap all of their "gains" in appreciation.

Dividends are actually fun if you are <15% taxes and can pay nothing on them. Thus they act like an automatic tax gain harvest but giving you higher buy in points. Theoretically if you held BRK.A for many years, even selling one share would generate a large capital gains tax hit. But if you had a steady stream of higher buy ins you could choose to liquidate exactly what you needed.

Ursus Major

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Re: Why reinvest dividends?
« Reply #17 on: May 09, 2017, 12:36:22 PM »
Big dividend companies are valued for their consistent dividend. There may be a blip around the payout time, but more or less, the valuation doesn't change, because the value of the company is in the cash flow, not an individual payment.

Perhaps you mean that the price doesn't change, but the intrinsic value does indeed change. However since each dividend payment is only a small percentage of the stock price (e.g. a 3% yielder that pays 4 times a year, each payment is 0.75%) and valuation is an imprecise business anyway that change is hard to capture and is usually ignored.

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Dividends are a promise that the company makes with investors. They are more consistent and reliable, and it means that you can redeploy your new capital in ways that you see fit. Plus most investors at our level are mostly in tax sheltered accounts, so there's no tax for dividends and no expense for selling stock.

That is actually the main attractiveness of dividends for me, i.e. that dividends are more consistent and reliable. Yes, in a crisis some companies cut or abolish their dividends, but I'd venture that overall the volatility of dividend payments is less than the volatility of stock prices. And that to me is a very desirable feature of dividends.

FWIW I found a table of S&P dividends over the last few years: http://www.multpl.com/s-p-500-dividend/table. It looks like dividends fell by about 23%-24% between 2008 and 2009/2010. That's a steep decline, but still better than the share price decline.

Ursus Major

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Re: Why reinvest dividends?
« Reply #18 on: May 09, 2017, 01:05:28 PM »
Dividends are NOT more reliable or consistent than selling stock. As I've shown in my previous post, they have the exact same effect on investors. I would argue selling the stock is more reliable because you can do it whenever you want and are not at the whims of management.

Au contraire: I think dividends are more reliable. Certainly dividend payouts were less volatile than stock prices in the great recession, as I showed in my last post. 

There also was some discussion about that a while ago: https://forum.mrmoneymustache.com/investor-alley/dividends-vs-capital-gains-once-again/ and - using an example from a previous discussion - my calculation showed that dividends were more beneficial (primarility due to being more consistent).

And even with a dividend stock you can always sell some, thus you are no more at the whims of management than with a stock that doesn't pay dividends.

So the reduced volatility of dividend payouts compared to stock prices is enough for me to find dividends appealing.




BreakTheChains

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Re: Why reinvest dividends?
« Reply #19 on: May 09, 2017, 01:48:37 PM »
Dividends are NOT more reliable or consistent than selling stock. As I've shown in my previous post, they have the exact same effect on investors. I would argue selling the stock is more reliable because you can do it whenever you want and are not at the whims of management.

Au contraire: I think dividends are more reliable. Certainly dividend payouts were less volatile than stock prices in the great recession, as I showed in my last post. 

There also was some discussion about that a while ago: https://forum.mrmoneymustache.com/investor-alley/dividends-vs-capital-gains-once-again/ and - using an example from a previous discussion - my calculation showed that dividends were more beneficial (primarility due to being more consistent).

And even with a dividend stock you can always sell some, thus you are no more at the whims of management than with a stock that doesn't pay dividends.

So the reduced volatility of dividend payouts compared to stock prices is enough for me to find dividends appealing.

Companies were either increasing leverage / risk or sacrificing future growth by not investing retained earnings into growth prospects in order to continue paying out the dividends, this is where the consistency came from. I would argue that the absolute BEST time for a company to plow RE into growth is during the middle of a bad recession where prices drop, perfect time to do an acquisition or get a really good deal on new equipment. Things turned out OK for them because earnings / prices bounced back and growth resumed, but I would argue they would be doing even better if they hadn't paid out the dividends at all or had done share buybacks instead.

Proud Foot

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Re: Why reinvest dividends?
« Reply #20 on: May 09, 2017, 01:50:53 PM »
So that's my point...  noted about some people not reinvesting hence giving you a bigger piece of the pie, which is valid...  but imagine for a minute that EVERYONe reinvested, then isn't that identical to if the company never paid a dividend in the first place, given that all that extra cash would be retained in the company and boost the share price?
Agree there are huge misconceptions with divs, hence why I'm questioning if there is really any benefit in investing in a div paying company vs a non div paying company if you are planning to reinvest all the divs  anyway?

If you are in the accumulation phase then then there isn't really any benefit to investing in a div paying company verse a non div paying company.  A hypothetical investment in Coke where they didn't pay a dividend would in theory be the same as reinvesting the dividend for Coke. The benefit in investing in a div paying company vs a non paying is to help diversify your portfolio.

There is also a benefit once you are in the phase of needing income from your portfolio in retirement of using the cash dividends rather than having to sell investments. Not a bad strategy in retirement but not the optimal one in the accumulation phase.

Proud Foot

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Re: Why reinvest dividends?
« Reply #21 on: May 09, 2017, 01:59:50 PM »
Dividends are NOT more reliable or consistent than selling stock. As I've shown in my previous post, they have the exact same effect on investors. I would argue selling the stock is more reliable because you can do it whenever you want and are not at the whims of management.

Au contraire: I think dividends are more reliable. Certainly dividend payouts were less volatile than stock prices in the great recession, as I showed in my last post. 

There also was some discussion about that a while ago: https://forum.mrmoneymustache.com/investor-alley/dividends-vs-capital-gains-once-again/ and - using an example from a previous discussion - my calculation showed that dividends were more beneficial (primarility due to being more consistent).

And even with a dividend stock you can always sell some, thus you are no more at the whims of management than with a stock that doesn't pay dividends.

So the reduced volatility of dividend payouts compared to stock prices is enough for me to find dividends appealing.

Companies were either increasing leverage / risk or sacrificing future growth by not investing retained earnings into growth prospects in order to continue paying out the dividends, this is where the consistency came from. I would argue that the absolute BEST time for a company to plow RE into growth is during the middle of a bad recession where prices drop, perfect time to do an acquisition or get a really good deal on new equipment. Things turned out OK for them because earnings / prices bounced back and growth resumed, but I would argue they would be doing even better if they hadn't paid out the dividends at all or had done share buybacks instead.

What companies were increasing leverage or hurting future growth to continue dividend payments? This all depends on the company and for me personally is something I look at when evaluating the individual stocks I have invested in.  Many who do pay dividends could use those funds better to expand but if you look at some of the best dividend paying companies what would you rather them spend all the cash on? Look at ones like Coke, Clorox, Dow, Johnson and Johnson.  All have earnings which easily cover the dividend payments and are at a size where additional growth opportunities would only be a minor improvement to the bottom line.

BreakTheChains

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Re: Why reinvest dividends?
« Reply #22 on: May 09, 2017, 03:13:07 PM »
If company earnings are declining but dividend payout rates are increasing or remaining constant, the money either has to come from borrowing money or decreasing CapEx. You could argue that every company that paid out increased or consistent dividends during the recession were harming their future growth. If a company feels it can no longer achieve consistent organic growth, I'd prefer that they do acquisitions or at least stock buybacks.

FIPurpose

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Re: Why reinvest dividends?
« Reply #23 on: May 09, 2017, 03:48:47 PM »
If company earnings are declining but dividend payout rates are increasing or remaining constant, the money either has to come from borrowing money or decreasing CapEx. You could argue that every company that paid out increased or consistent dividends during the recession were harming their future growth. If a company feels it can no longer achieve consistent organic growth, I'd prefer that they do acquisitions or at least stock buybacks.

I think you're assuming that somehow, if the world acquired itself into one giant mega corp, that that would be an investor paradise, but that's not how business works. There are reasonable limits to the size a corporation can grow. The efficiencies that large corporations can run eventually turn into a bureaucracy of waste. Growth is not infinitely possible. Nor are capital gains somehow tax free, but I will say that I think they need to lower the dividend tax rate.

It's all sunshine and rainbows until the stock you starts making acquisitions or stock buyback decisions that you do not agree with at all. When companies continue stock buybacks while they're way overvalued in order to make the executive board look good by raising EPS. Companies waste trillions of dollars every year on bad business decisions. As an investor, I'd rather they leave that decision to me.

No, dividends force companies to act more responsibly. It forces them to think long-term because their investors are looking for a consistent life-time payout.

Frugali

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Re: Why reinvest dividends?
« Reply #24 on: May 09, 2017, 04:06:28 PM »
Dividends are NOT more reliable or consistent than selling stock. As I've shown in my previous post, they have the exact same effect on investors. I would argue selling the stock is more reliable because you can do it whenever you want and are not at the whims of management.

Au contraire: I think dividends are more reliable. Certainly dividend payouts were less volatile than stock prices in the great recession, as I showed in my last post. 

There also was some discussion about that a while ago: https://forum.mrmoneymustache.com/investor-alley/dividends-vs-capital-gains-once-again/ and - using an example from a previous discussion - my calculation showed that dividends were more beneficial (primarility due to being more consistent).

And even with a dividend stock you can always sell some, thus you are no more at the whims of management than with a stock that doesn't pay dividends.

So the reduced volatility of dividend payouts compared to stock prices is enough for me to find dividends appealing.

Ursula, more reliable than what exactly?  Given that the stock price drops by the dividend amount on ex date anyway,  I don't see how this is any different, regardless of stock volatility.  If in ex date a stock start at 100, paid a 3% dividend but also the price dropped in the market by 2% that day, it would end the day at 95.  If that same company didn't pay dividends, it would end the day at 98 after the 2% drop, so selling 3% of your stock in place of a dividend would also give an end price of 95%. The net effect is the same, is it not?  Regardless of whether that stock has gained or lost 50% that year does not have any impact on the effect that the dividend payment will have on the stock price on ex date.


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I think I have generally a pretty good understanding of markets/investing, but I'm going to ask a very ignorant question nonetheless...  Doesn't reinvesting dividends defeat the whole purpose of dividends in the first place??  I always read that reinvestment gives significantly better returns, which logically it would do as the amount you're investing increases.  But isn't this essentially identical to the company never having paid any dividend at all, given that the share price should have increased by exactly the same amount as a result of no dividend??

I understand of dividend investing to produce an income stream, but if you're reinvesting b dafualt, isn't it the same whether the company pays 10% or zero?

Seems like you're confusing two separate issues:
1) Should a company pay dividends?
2) If a stock you own pays you a dividend, what should you do with it?

You're right about dividends reducing the value of the company, and that this perhaps isn't ideal if the investors were planning to reinvest dividends anyway.

But when you own an index fund, you have thousands of different stocks. Many of them pay dividends, many of them do not. I don't need the cash right now since my work pays me more than enough to live on, so I do the same thing with the dividend money that I do with any other extra cash: I invest it.

I'm not debating reinvestment of divs if they are paid; more so questioning the benefit of chasing div paying companies if you plan is to reinvest anyway.  If you are looking for a steady income stream for convenience fair enough, though as above, you could achieve the same effect by selling a portion of your stock anyway. Granted your point about index funds, but that is more a byproduct of the wider discussion; if none of the underlying companies paid a div, presumably the index fund wouldn't either.


taiwwa

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Re: Why reinvest dividends?
« Reply #25 on: May 09, 2017, 04:09:51 PM »
Generally speaking, I'd recommend never reinvesting dividends.

Reason is simple: it costs money to execute trades. If you look at it like that...dividends are cost-free distributions.

Even if free reinvestment is offered, I still wouldn't do it. Take it as income. When you have enough, buy another stock. If you want a growth stock, buy a growth stock. Don't try to turn a dividend stock into growth.

taiwwa

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Re: Why reinvest dividends?
« Reply #26 on: May 09, 2017, 04:41:54 PM »
Generally speaking, I'd recommend never reinvesting dividends.

Reason is simple: it costs money to execute trades. If you look at it like that...dividends are cost-free distributions.

Even if free reinvestment is offered, I still wouldn't do it. Take it as income. When you have enough, buy another stock. If you want a growth stock, buy a growth stock. Don't try to turn a dividend stock into growth.
No offense, but this is not good advice.

Almost every broker and shareholder offers transaction cost free dividend reinvestment with a single click.  Also, just about every good ETFs and mutual funds can be bought and sold when money is needed without transaction costs.   

So a choice to save up dividend cash up to buy a new stock: 1) costs you returns...you are out of the market while you wait and save up, (unless you buy immediately...oh wait that is exactly what automatic reinvestment does) and 2) Does have any transaction costs on the buy, even if an individual stock.

Whether you choose to hold so called growth or income stocks or funds is not relevant.  Your asset mix is totally unrelated to dividend reinvestment.

Well, the cash you hold could simply be held as a financial cushion against unexpected events, or used for every day expenses. Most people probably have a few thousand "sitting idle" in their checking accounts just for that.


Fishindude

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Re: Why reinvest dividends?
« Reply #27 on: May 09, 2017, 04:55:09 PM »
I cash my dividend checks and use the money for every day stuff.  Don't really want to own any more of that company so why reinvest?    Meanwhile the stock price continues to gradually improve so I'm making gains there too. 

Ursus Major

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Re: Why reinvest dividends?
« Reply #28 on: May 09, 2017, 05:17:40 PM »
Dividends are NOT more reliable or consistent than selling stock. As I've shown in my previous post, they have the exact same effect on investors. I would argue selling the stock is more reliable because you can do it whenever you want and are not at the whims of management.

Au contraire: I think dividends are more reliable. Certainly dividend payouts were less volatile than stock prices in the great recession, as I showed in my last post. 

There also was some discussion about that a while ago: https://forum.mrmoneymustache.com/investor-alley/dividends-vs-capital-gains-once-again/ and - using an example from a previous discussion - my calculation showed that dividends were more beneficial (primarility due to being more consistent).

And even with a dividend stock you can always sell some, thus you are no more at the whims of management than with a stock that doesn't pay dividends.

So the reduced volatility of dividend payouts compared to stock prices is enough for me to find dividends appealing.

Ursula, more reliable than what exactly?  Given that the stock price drops by the dividend amount on ex date anyway,  I don't see how this is any different, regardless of stock volatility.  If in ex date a stock start at 100, paid a 3% dividend but also the price dropped in the market by 2% that day, it would end the day at 95.  If that same company didn't pay dividends, it would end the day at 98 after the 2% drop, so selling 3% of your stock in place of a dividend would also give an end price of 95%. The net effect is the same, is it not?  Regardless of whether that stock has gained or lost 50% that year does not have any impact on the effect that the dividend payment will have on the stock price on ex date.

More reliable (aka less volatile) than the stock price. If your stock price drops by 50%, then all the sudden you have to sell twice the amount of shares to get the same proceeds (the negative cost average effect in retirement). But with a dividend you don't have that problem. Again in the thread at https://forum.mrmoneymustache.com/investor-alley/dividends-vs-capital-gains-once-again/ I run through an example posted in an earlier thread.

This has nothing to do with the effects of the dividends on the stock price at the ex div dates. I agree completely with you that dividends are not "free money", so on the ex div date there is a drop in value of the company in the amount of the dividend (even though that effect is oftentimes obscured by other effects on the stock price).

But the lower volatility of dividend payouts compared to stock prices helps you avoid the negative cost average effect in retirement to a degree. And that has some value to me.

Ursus (not Ursula)

Frugali

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Re: Why reinvest dividends?
« Reply #29 on: May 09, 2017, 05:45:47 PM »
Apologies, I did type Ursus but my autocorrect obviously had other ideas!  :D

Telecaster

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Re: Why reinvest dividends?
« Reply #30 on: May 09, 2017, 06:04:26 PM »
There are only two reasons not to reinvest dividends:

1) You want the cash

2) You want the cash to invest in something else that's better.  Which probably means you should be re-thinking the original investment.   

DividendMeter

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Re: Why reinvest dividends?
« Reply #31 on: May 09, 2017, 09:29:37 PM »
There are only two reasons not to reinvest dividends:

1) You want the cash

2) You want the cash to invest in something else that's better.  Which probably means you should be re-thinking the original investment.

I let my dividends build up in the cash portion of my brokerage account (rather than automatically reinvest), to about $500.00 or so, then make a purchase of more shares of stock - sometimes it's the original investment, but most of the time I'm buying a different dividend-paying stock that's trading with a yield near the high of its historical dividend yield range.

chasesfish

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Re: Why reinvest dividends?
« Reply #32 on: May 10, 2017, 08:28:08 AM »
I view dividend reinvestment as a cost-saving strategy.

Fidelity doesn't charge me anything for dividend reinvestment, so the stocks/ETFs/mutual funds I want to own more of, its a cheap way of buying them.  If I don't want to own more of them or need the money, I'll choose not to have the dividends reinvested.

BreakTheChains

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Re: Why reinvest dividends?
« Reply #33 on: May 10, 2017, 10:33:08 AM »

I think you're assuming that somehow, if the world acquired itself into one giant mega corp, that that would be an investor paradise, but that's not how business works. There are reasonable limits to the size a corporation can grow. The efficiencies that large corporations can run eventually turn into a bureaucracy of waste. Growth is not infinitely possible. Nor are capital gains somehow tax free, but I will say that I think they need to lower the dividend tax rate.


Of course one giant mega corp would be an investors paradise, that's the definition of a monopoly. The company can set prices at whatever level it would like without regards to competition and consumers would have to accept what they were given. A perfectly monopoly would be the best case scenario for investors in that company, but it's not realistic, for the reasons you mentioned above. It's the same reason communism and aggressive socialism fails whenever its implemented, once an organization gets to a certain size it can no longer be centrally managed effectively

I should also note that its very possible for a company to grow very large and diversified and still function well. Berkshire is a great example of a company that functions as a holding company, purchasing large businesses and letting them run themselves, decentralized, with only very important decisions on CapEx or strategic changes being funneled through the central organization.

What is the end result? Oligopoly, multiple very large companies controlling markets. Whenever one stumbles, its competitors gain ground and vice versa. Pretty much any modern industry is run as an oligopoly.

I disagree with you on growth. Growth is infinite. If a company is not growing, its dying. Show me a successful company that says "well, we've grown as large as we ever will, time to crank out dividends!". That's complacency and that company would soon be overtaken by competitors until its acquired or goes out of business. 


It's all sunshine and rainbows until the stock you starts making acquisitions or stock buyback decisions that you do not agree with at all. When companies continue stock buybacks while they're way overvalued in order to make the executive board look good by raising EPS. Companies waste trillions of dollars every year on bad business decisions. As an investor, I'd rather they leave that decision to me.

No, dividends force companies to act more responsibly. It forces them to think long-term because their investors are looking for a consistent life-time payout.

I think you have your logic twisted around 180 degrees here to defend your position on dividends.

 You say that you want a business to leave decision making to you, but I've proved in my posts above that dividends are effectively the same thing as selling stock, but you don't get to decide when the dividend is paid! For all purposes a dividend is a forced liquidation of the company, the exact opposite of having control.

You say that dividends force companies to think long term. The exact opposite it true. Once a dividend rate is established, management is forced to continue paying that dividend at the same or an increasing rate regardless of if there are better uses for that money to satisfy dividend fanatics. This is the exact opposite of long term thinking, it neglects investment in the business and harms future results.

As to your point about stock buybacks when a company is overvalued... explain to me what overvalued means. No one knows if a company is actually overvalued consistently. If you could you'd be on a beach somewhere. And, as I said, I consider stock buybacks a last option for capital if management doesn't expect higher returns from CapEx, Acquisitions, or even buying bonds.

mpcharles

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Re: Why reinvest dividends?
« Reply #34 on: May 12, 2017, 04:45:49 AM »
So can I clarify, if I want to buy an ETF that pays dividends, reinvest them, ill pay tax on them but I will own more of them. If I invest in an ETF that doesn't pay dividends, but reinvests in itself then I will be better off, as the share price will be higher, but I won't own anymore stock?.

Sent from my ASUS_Z00AD using Tapatalk


beltim

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Re: Why reinvest dividends?
« Reply #35 on: May 12, 2017, 05:27:55 AM »
As to your point about stock buybacks when a company is overvalued... explain to me what overvalued means. No one knows if a company is actually overvalued consistently. If you could you'd be on a beach somewhere. And, as I said, I consider stock buybacks a last option for capital if management doesn't expect higher returns from CapEx, Acquisitions, or even buying bonds.

This comes up a lot.  You would think that management would know best the value of their own stock.  However, like active mutual fund managers, the data show that they're wrong more often then they're right.  The result of this is that in the real world stock buybacks are worse for investors than dividends. 

Where did I say I miatrust management and that I want a 100% payout ratio? You seem to be taking my posts to their logical extremes. I'm not really sure why.

You said "IMO the better option is to take the dividend and choose how to allocate the capital instead of letting others choose for you." Yes, you didn't say anything about a 100% payout ratio; that was more me asking a Socratic question: if you can allocate capital better than management, why would you not demand a 100% payout ratio (or sell all your shares)? Again, there's a logical conflict between you wanting to choose how to allocate the capital, but allowing the company decide the time and the amount for you to reallocate.

Companies are good are investing to expand their business, on average.  Companies are bad at reinvesting in their stock, on average.


Quote
If we make the opposite assumption, and you don't trust company management to correctly know the amount of capital that you should reallocate elsewhere, then you always have the ability to perform these reallocations whenever you'd like (by selling the amount of shares you deem appropriate). A dividend is not necessary for you to perform reallocation.

Investors don't have the ability to invest in a company's new project - management does.  I'm happy to let management decide whether they need funds to reinvest in their business - but unless they've shown better than average market timing, they shouldn't be in the business of doing buybacks.  Because, like most mutual funds managers and individual investors, their stock investments don't beat the market.


Equally, though "share buybacks" get a bad rep, for a growth investor that doesn't need the cashflow, a company using its excess cash to execute share buybacks and drive up the equity and share price of existing stock holders is surely a more efficient play?

IMO, those following a dividend stock strategy from day one of their investment careers are losing a chunk of change to brokerage commissions and are following a substantially sub-optimal investment strategy.

What am I missing here?

In principle, I completely agree that share buybacks are better for investors because of tax efficiency.  In practical terms, however, they aren't as good as dividends because management is terrible at market timing.  What do I mean by this?  Well, unlike dividends, which in the US (unlike much of Europe) are relatively fixed, share buybacks are usually cyclical, and share buybacks peak when market prices peak, and trough when market prices trough.  On average this destroys shareholder value relative to dividends.  See for example page 12 of this report, which found that stock buybacks underperformed the market 77% of the time  (https://doc.research-and-analytics.csfb.com/docView?language=ENG&source=emfromsendlink&format=PDF&document_id=979523241&serialid=cbWwRRD8BPCNJ%2B%2BehG6tXJo50lwZZncJDGPsGRFN%2B54%3D)

TimmyTightWad

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Re: Why reinvest dividends?
« Reply #36 on: May 12, 2017, 09:03:07 AM »
How can I easily identify stocks that pay out dividends?

Almost any stock filtering website will do it for you.
https://www.zacks.com/screening/stock-screener
https://finance.yahoo.com/screener/new
http://www.cnbc.com/stock-screener/

Another thing to consider about dividends is that they adjust the risk/reward point a little towards "safe." Because you receive a little return every year, your up years are usually smaller, but your down years are too. Many outperforming stocks don't or didnt pay dividends (apple until recently, amazon, google, Berkshire) and trap all of their "gains" in appreciation.

Dividends are actually fun if you are <15% taxes and can pay nothing on them. Thus they act like an automatic tax gain harvest but giving you higher buy in points. Theoretically if you held BRK.A for many years, even selling one share would generate a large capital gains tax hit. But if you had a steady stream of higher buy ins you could choose to liquidate exactly what you needed.

Thanks a lot for the info!

FIPurpose

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Re: Why reinvest dividends?
« Reply #37 on: May 12, 2017, 12:27:18 PM »
As to your point about stock buybacks when a company is overvalued... explain to me what overvalued means. No one knows if a company is actually overvalued consistently. If you could you'd be on a beach somewhere. And, as I said, I consider stock buybacks a last option for capital if management doesn't expect higher returns from CapEx, Acquisitions, or even buying bonds.

This comes up a lot.  You would think that management would know best the value of their own stock.  However, like active mutual fund managers, the data show that they're wrong more often then they're right.  The result of this is that in the real world stock buybacks are worse for investors than dividends. 

Where did I say I miatrust management and that I want a 100% payout ratio? You seem to be taking my posts to their logical extremes. I'm not really sure why.

You said "IMO the better option is to take the dividend and choose how to allocate the capital instead of letting others choose for you." Yes, you didn't say anything about a 100% payout ratio; that was more me asking a Socratic question: if you can allocate capital better than management, why would you not demand a 100% payout ratio (or sell all your shares)? Again, there's a logical conflict between you wanting to choose how to allocate the capital, but allowing the company decide the time and the amount for you to reallocate.

Companies are good are investing to expand their business, on average.  Companies are bad at reinvesting in their stock, on average.


Quote
If we make the opposite assumption, and you don't trust company management to correctly know the amount of capital that you should reallocate elsewhere, then you always have the ability to perform these reallocations whenever you'd like (by selling the amount of shares you deem appropriate). A dividend is not necessary for you to perform reallocation.

Investors don't have the ability to invest in a company's new project - management does.  I'm happy to let management decide whether they need funds to reinvest in their business - but unless they've shown better than average market timing, they shouldn't be in the business of doing buybacks.  Because, like most mutual funds managers and individual investors, their stock investments don't beat the market.


Equally, though "share buybacks" get a bad rep, for a growth investor that doesn't need the cashflow, a company using its excess cash to execute share buybacks and drive up the equity and share price of existing stock holders is surely a more efficient play?

IMO, those following a dividend stock strategy from day one of their investment careers are losing a chunk of change to brokerage commissions and are following a substantially sub-optimal investment strategy.

What am I missing here?

In principle, I completely agree that share buybacks are better for investors because of tax efficiency.  In practical terms, however, they aren't as good as dividends because management is terrible at market timing.  What do I mean by this?  Well, unlike dividends, which in the US (unlike much of Europe) are relatively fixed, share buybacks are usually cyclical, and share buybacks peak when market prices peak, and trough when market prices trough.  On average this destroys shareholder value relative to dividends.  See for example page 12 of this report, which found that stock buybacks underperformed the market 77% of the time  (https://doc.research-and-analytics.csfb.com/docView?language=ENG&source=emfromsendlink&format=PDF&document_id=979523241&serialid=cbWwRRD8BPCNJ%2B%2BehG6tXJo50lwZZncJDGPsGRFN%2B54%3D)

Thanks for the repost of that article on share buybacks Beltim. I hadn't followed that thread before. Even in my own experience of seeing companies buyback stocks, they tend to buy high and horde low. I'll have to devour that thread now.