E The Importance Of Dividends And My Strategy -

E The Importance Of Dividends And My Strategy

Jun 27, 2018Jeremy ParkinsonFinance0

Background

“Buy low sell high,” the dominant doctrine on Wall Street has put many investors’ focus onto price movements alone, while statistics show that as high as over 50% of the total stock returns could come from dividends over the long-term investing horizon.

Source: GuruFocus.

Conceptually, dividend payout should be the most direct way of shareholder returns; the other 2 ways are share buybacks (i.e., reducing the share counts and hence increasing EPS) and valuation multiple expansion (e.g., P/E).

Compounding

It is often said, “Compounding Interest is the 8th Wonder of the World.” If you, as an investor, still have any doubt here, check out this scenario.

Suppose someone asks you if you would rather be given one million USD today, or be given one cent that would double in value every day for 30 days. At first glance, it appears that the one million would be the better choice. Some simple excel calculation, however, proves you would be better off taking the one cent and watching it grow for 30 days, as shown in the following table:

I always recommend dividend reinvestment strategy, even starting from small. Major U.S. brokerages, such as Fidelity, Schwab and eTrade, now enable investors to have their dividend dollars automatically reinvest into shares (even fractional shares). Do check this feature out if not yet!

What about buybacks?

Many investors would wonder if share buybacks are as good as dividends to benefit shareholders. In theory, the impact of the same amount of cash (for share buyback vs. paying out dividend) should be identical. However, in the real financial world, the followings should be taken into consideration:

Taxation is a big plus for buybacks while dividend payments are taxed as personal income and usually double-taxed (i.e., at both corporate level and at investor level);

Regardless of the theoretically higher after-tax returns through buybacks, the future reward to shareholders is anything but assured as buybacks cannot guarantee an upward movement in stock prices; in terms of dividends, investors are guaranteed payments; as the old saying points out, “a bird in the hand is worth two in the bush;”

Dividend cuts are usually regarded as bad signals by the market; on the contrary, a company that initiates a dividend policy or has a track record of growing its dividends would demonstrate more confidence in its long-term business prospects in front of shareholders; Buybacks are relatively shorter-term programs; this mostly applies to Corporate America;

It is more difficult to track share buybacks than dividend payments; investors should also be aware that the buyback does not necessarily lead to a decrease in the total number of outstanding shares as the company may issue new shares to cover its employee compensation program;

As Warren Buffett often mentioned, share buybacks only make sense when the stock being repurchased is traded below its intrinsic value; otherwise, it would cause value destruction; dividend payments, however, give the flexibility to investors in terms of allocating this capital.