Purpose: talk about some of my ideas about dividends vs growth in stock investments.
From a mathematical standpoint 2% growth in a stock every year is the same as getting a 2% dividend.
Additionally, I think the tax code favors growth over dividends for time periods longer than 1 year. It’s complicated so maybe I’m wrong, but if I’m wrong my next guess would be that they’re treated the same and I’d be quite surprised if dividends are taxed less than growth.
So I think in theory there’s no reason to prefer dividends over growth in the long term.
Two practical factors I think favor of dividends over the long term:
- Companies lie. They have a bunch of ways to make profit look bigger than it actually is, hide liabilities, and other accounting shenanigans. And they routinely use those methods to make themselves look better than they are. It’s relatively easy to make an earnings statement that says you had 2% growth when you didn’t. However, paying a dividend when you don’t actually have earnings is harder (not impossible, just harder because you actually have to get cash from somewhere to pay it). Dividends are a harder to fake indicator of financial fitness.
- Investors are faddish. They irrationally favor some companies or industries and disfavor others. These fads change over time. If you buy companies that are out of favor and hold them until they are back in favor you can make more than if you invest cap weighted or follow the crowd/hot stocks. In the context of an index of large companies (like the Dow or S&P 500) high dividends as a percent of stock price are an indication that a company and/or its industry is currently out of favor.
One practical factor I think disfavors dividends in the long term:
- Some people (like retirees) need regular income from their investments to pay bills. They find selling a percentage of their investments hard (emotionally or logistically) and prefer just getting a check without having to take any action. Traditionally those people invested in bonds, CDs, and other fixed income investments. But (until very recently) rates of return on fixed income investments have been both low and falling. As a result, a lot of those people have substituted dividend paying stocks for some of what would otherwise be their fixed income portfolio. These people have bid up the price if dividend paying stocks in excess of their value relative to growth stocks, because they have a specific preference for dividends over growth. This is kinda a “reverse fad” in favor of dividends, counteracting the effect of dividend stocks being generally out of favor for company or industry reasons.
I don’t know how the factors that favor vs. disfavor dividends actually play out in the market. As a result, I no longer either favor or disfavor dividends in my investments.