Dividend Investing

AsifM068

Afternoon forum,

It is my understanding that any dividends paid out from a stock, index fund / ETF reduces the share price proportionally; therefore it appears to me that there is no net gain in terms of value to your original investment - is this correct please? 

eskbanker

Yes, paying out a dividend is essentially depleting the company's value by that (aggregate) amount, so there can't be any value magically created in doing so - from a shareholder's perspective, you're effectively receiving a small chunk of your investment back....

Thrugelmir

Dividends paid out are hard cash. Unlike anything else on which a company's value is based. There's an old saying. Turnover (revenue) is vanity, profit is sanity but cash is always king. 

dunstonh

It is my understanding that any dividends paid out from a stock, index fund / ETF reduces the share price proportionally; therefore it appears to me that there is no net gain in terms of value to your original investment - is this correct please? 

Technically yes.  However, it depends on what you do with that dividend.  If you reinvest it to buy more units then the value goes up.   If you keep it and don't reinvest it then what you invested has been partially repaid.

AsifM068

If you reinvest the dividend it's a zero sum gain to my mind because you are just putting back that portion of your original investment so there is no actual growth to your investment - is this correct please and if so what is the point / value of dividend investing then?

dunstonh

If you reinvest the dividend it's a zero sum gain to my mind because you are just putting back that portion of your original investment so there is no actual growth to your investment - is this correct

No.  There are two parts to your investment returns.  Income and Growth.   

By using the dividends to buy more units, you will get greater future dividends.   Plus, you get growth on all the units you hold.

Dividends are from the profit the company has made.  The value of the company can go up despite the payment of dividends.

if so what is the point / value of dividend investing then?

Let's say you invest in a fund that has 6% dividends and 1% growth.  That is a total return of 7%.     Whereas if you invest in a fund with 1% dividends and 5% growth, then that is a total return of 6%.

You have to look at both bits. Not just growth by itself or income by itself.

Generally speaking, higher dividend payers tend to have lower growth.   Whereas companies with low dividends could be because they don't have enough profits but also could be because they are reinvesting everything they can to create growth.

Alexland

It's worth considering the difference between investing for dividends where you might actively select assets that have a high or dependable yield versus just holding a fund that happens to pay income rather than accumulate.

AsifM068

dunstonh said:

If you reinvest the dividend it's a zero sum gain to my mind because you are just putting back that portion of your original investment so there is no actual growth to your investment - is this correct

No.  There are two parts to your investment returns.  Income and Growth.   

By using the dividends to buy more units, you will get greater future dividends.   Plus, you get growth on all the units you hold.

Dividends are from the profit the company has made.  The value of the company can go up despite the payment of dividends.

if so what is the point / value of dividend investing then?

Let's say you invest in a fund that has 6% dividends and 1% growth.  That is a total return of 7%.     Whereas if you invest in a fund with 1% dividends and 5% growth, then that is a total return of 6%.

You have to look at both bits. Not just growth by itself or income by itself.

Generally speaking, higher dividend payers tend to have lower growth.   Whereas companies with low dividends could be because they don't have enough profits but also could be because they are reinvesting everything they can to create growth.

Thank you for this explanation sir👍

tebbins

1. Because if it doesn't pay you anything, or have a reasonable chance of doing so in future, it's worth nothing.

2. A healthy business should be able to generate sufficient cash to pay its owners an income with reasonable sustainability.

3. There are only so many opportunities to reinvest profits efficiently, even Berkshire Hathaway, a stalwart against dividends has started a share buyback programme. Tobacco and newspaper companies don't need that much capital anymore.
4. It's an indication from management of future expectations based on ongoing trends.
5. Over the very long term, the real total return (growth + dividends - inflation) has been made up, mostly, of the dividend.
6. Having to pay a dividend focuses and disciplines management on maintaining cash flow.
7. A business that doesn't pay a dividend or buyback its shares, and requires all, or more than all of any profits to grow, is possibly too capital intensive and that's a risk.
8. Before the post-war era of sustained real economic growth, stocks had to pay a higher dividend than gilts to make up for the extra risk, since 1957 gilts had to pay a higher yield to make up for the lack of expected growth, which reversed again in 2011 with falling interest rates.

9. You rely on timing your sale of a growth stock to realise a profit, dividends are cold hard cash and you know exactly how much you're getting and when, you dont need to worry about the market taking a dip when you plan to sell.

You are right that while you're accumulating, dividends dont help, which is why most fund houses offer accumulation funds that will reinvest dividends for you automatically.

AsifM068

With dividends reinvested is a 'dividend' stock / ETF a better investment compared to a  'growth' stock / ETF for a long term hold? 

Thrugelmir

AsifM068 said:

If you reinvest the dividend it's a zero sum gain to my mind because you are just putting back that portion of your original investment so there is no actual growth to your investment - is this correct please and if so what is the point / value of dividend investing then?

An investment is only worth what somebody else will pay you for your share holding. Don't confuse an increase in share price, with tangible (financial) growth in the business itself.  That's why measures such as the price to earnings ratio are key when evaluating individual shares. The cashflow statement is the most important page in a company's published audited financial statements. As this discloses how the company has utilised the cash generated , or indeed increased borrowings during the period under review. The profit and loss account can be manipulated presentation wise. Finance directors will wish to portray the company in the best possible light in terms of headline numbers. That's why investment banks employ analysts to dig into company accounts.

Another factor is the tax treatment of income and capital gains at a local level. In the US dividends are more highly taxed than capital gains compared to the UK. Cash generated is therefore better used for buy backs than paying dividends. In Europe dividends are highly taxed. In France for example dividend tax is 27.5%. 

When investing in shares that generate an income. The key is reinvesting the income back into further investments. Compounding over time is your friend. Put a £100 into a calculator and compound it at 4% over 30 years. You maybe surprised at the result. 

In summary I'd say don't get hung up over growth or income per se. Focus on the financial fundamentals of the investment itself.  Every dog has it's day. You don't want to be overly concentrated in a particular market segment when the music finally stops and the bubble bursts.