Stocks that grow their dividends have outperformed non-dividend-paying stocks over the long-term, but not in the past 5, 10, and 20 years. Why are non-dividend paying stocks outperforming dividend growers, and will it continue?
Topics covered include:
- What message do companies say when they initiate, grow, or cut their dividend
- What is dividend smoothing
- How have dividend payers performed relative to non-dividend payers
- Why have non-dividend payers, which are primarily growth stocks, outperformed dividend payers
- How the payout ratio and return on equity impact dividend strategies
- What are reasons to include dividend strategies in your portfolio
Show Notes
The dividend puzzle by Fischer Black—The Journal of Portfolio Management
Can Dividend Investing Rise From the Dead? by Jon Sindreu—The Wall Street Journal
Einhorn Says Markets ‘Fundamentally Broken’ By Passive, Quant Investing by Matthew Griffin—Bloomberg
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein. Today is episode 466. It’s titled “Does Dividend Investing Still Work?”
Meta’s New Dividend
Earlier this month Meta, formally named Facebook, announced its first quarterly dividend of 50 cents per share. The dividend will be paid on March 26th, 2024, for shareholders of record who own the stock as of February 22nd, 2024. Meta has been a public company since 2012. It’s never previously paid out a portion of its profit as a dividend. Now, it will pay about 9% to 13% of what it earned on a per share basis as a dividend to its shareholders.
The cash used to pay the dividend is cash Meta will not be able to deploy in other ways. It won’t be able to use that cash to invest in future projects, and it can’t use the cash to pay down debt or buy back shares of Meta’s common stock.
The day after Meta made its dividend announcement, its common stock jumped 20%, to $474 per share. In theory, when a publicly-traded company pays a dividend, its stock should drop by the amount of the dividend, in the same way that the net asset value of a mutual fund or ETF falls by the amount of the dividend paid. If there’s less cash that the fund has or the company has on its balance sheet, because it paid out the dividend, then the investment should be worth less. That’s not actually how it works, however.
Companies such as Meta don’t initiate a dividend or increase the dividend without serious consideration.
The Dividend Puzzle
Back in 1976, economist Fischer Black published a seminal paper on dividends. It was titled The Dividend Puzzle. In the paper, Black wrote that dividend policy says things that managers don’t say explicitly. Managers and directors don’t like to cut their dividends, so they’ll raise the dividend only if they feel the company’s prospects are good enough to support the higher dividend for some time. And they will cut the dividend only if they think the prospects for a quick recovery are poor.
So sort of the unwritten statements when companies make dividend announcements to increase the dividend, to initiate the dividend, is that there’ll be enough cash, and the prospects of the company is good enough to sustain that dividend. And it’s not just companies that do that. Managers of closed-end funds, for example, where much of the return comes from dividends, are very deliberate about raising a dividend to make sure it’s sustainable.
The idea of not making big changes in your dividend is known as dividend smoothing. Companies like to have a stable payout, and then they increase it when they feel they can. They like to increase it, clearly, but if they don’t see that the cash will be there looking out several quarters, then they’ll be hesitant to do that.
How Dividend Investing Performs
Now, the data supports the idea that companies that cut their dividend are signaling things are not going well. The worst-performing stocks are those that cut their dividends.
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