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if you're a dividend investor you've no
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doubt come across people on the internet
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who question your ability to do simple
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math the comments that you've
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undoubtedly heard are dividends aren't
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free money they come out of the stock
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price dividends mean the company has no
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more good growth ideas you don't need
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dividends you can always just sell
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shares or over the long term grow stocks
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are always going to outperform dividend
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paying value stocks now we'll say there
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is some truth that's baked into each one
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of those comments and we're going to go
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over all that but what people with that
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perspective fail to realize is that
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investing is bigger than just simple
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math but first let's go over the math so
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that we understand what the argument is
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and let's start with the classic
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dividends aren't free money they come
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out of the stock price now here's how
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dividends and stock prices work in
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general let's say a stock is trading for
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$100 and on October 1st they announce
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earnings of $5 in excess cash per share
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they plan to keep $1 in retained
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earnings to use in the future for the
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business and they decide that they'll
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distribute the additional $4 per share
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as a dividend for shareholders who own
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the stock on October 11th now it takes 2
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to 3 days for stock transactions to
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clear so let's say the X dividend date
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is October 9th that means you have to
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buy the stock by the end of October 8th
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in order to receive the dividend and how
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this generally impacts the stock price
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is that on October 8th the stock should
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trade for $105 which is basically broken
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down with future earnings being worth
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about $100 then they have $1 in new
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retained earnings and a $4 dividend
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that's coming to shareholders and then
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on October 9 9th the stock goes X
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dividend meaning new shareholders won't
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receive it and they're not going to pay
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a premium for a dividend that they're
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not going to receive so the stock should
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trade for about
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$101 which breaks down with future
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earnings being worth $100 and they still
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have that $1 of new retained earnings so
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on that X dividend day the stock price
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should basically drop the amount of the
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dividend and of course those are just
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general numbers there's all kind of
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variables that impact a stock price
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whether it's news about the company or
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other things that make it go up and down
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but in general this is how the market
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handles dividends in relation to price
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so when people say the dividend comes
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out of the stock price they're right it
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does it's absolutely not free money it's
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the earnings that a company generated
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that they're giving back to its
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shareholders but that's not the whole
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story the main difference between a
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company that pays a dividend and one
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that doesn't is that the shareholders
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get to decide how they want to allocate
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their slice of the profits now here's
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what I mean so if we have company a
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which is the one that we just talked
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about and they made an extra $5 per
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share they're keeping $1 for the
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business which we still own shares in
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and they're giving us $4 for each share
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that we own to do with whatever we want
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so if we need to use it as income we can
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if we want to reinvest in a different
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opportunity we can do that as well or if
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we want we can reinvest back into the
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same company because we believe in it
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now obviously you will pay tax on that
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dividend but tax is the price that you
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pay to have the option to use the
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profits however you want that's the
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price of flexibility and then if we have
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company B that doesn't actually pay a
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dividend but keeps the full $5 in the
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business and for future growth prospects
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you still have a claim on those profits
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because you're a shareholder but you're
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trusting the management team to make
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good decisions in terms of how they
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allocate those profits so one isn't
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necessarily better than the other
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they're just different in terms of who
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makes the decision on what to do with
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your slice of the company profits either
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you or the company now obviously both
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companies could also do share BuyBacks
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with the excess profits which benefit
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shareholders as well by increasing their
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overall stake in the company and they
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generally don't have to pay taxes on
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that either but again share BuyBacks a
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version of the company making that
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decision for you and in case you think
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that share BuyBacks are always better
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than dividends there are plenty examples
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where they're not and it really has to
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do with the price that the company is
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buying the shares back at and one of the
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most obvious examples of this was
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Facebook or meta in 2021 where they did
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about $40 billion worth of share
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BuyBacks between April 2021 and January
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2022 by far their largest amount of
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Buybacks in a three-year quarter span
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ever and it was at prices between $300
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to $335
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per share and they did that just to
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watch the stock dip all the way down to
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$90 per share within the next year and
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even more recently we talked about
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Dollar General where they bought back
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shares in the $200 to $250 range just to
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watch the stock dip to $109 less than a
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year later so just like with everything
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there's nothing that's always good or
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always better it really depends on each
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individual situation and whether you
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want the company to allocate your
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profits for you or if you want to do it
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yourself but how about when people say
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that paying dividends means the company
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has no more good ideas for growth a
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company that consistently pays and grows
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dividends over time is showing a
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strength and stability of their business
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model and the ability to generate cash
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flow for investors it's another measure
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we can use to determine how reliable or
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volatile an investment might be and
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growth investors are going to say
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exactly because the company doesn't have
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any more good ideas for growth they're
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just giving cash back and that means
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they're going to grow slower and have a
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lower return over time and if investing
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was done in a vacuum and all things
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remained equal then I would probably
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agree with that but the reality is that
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it's not done in a vacuum and things are
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never really equal between companies and
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just as an extreme example pelaton
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investors who bought in July of 2021 at
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$125 per share after they just announced
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amazing growth of over 2x year-over-year
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probably don't think all those growth
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prospects were worth it at least now
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especially for a company that never made
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a profit and is currently trading at
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less than $5 a share just brutal and I
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know that I'm picking a really extreme
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example and the reality is a lot more
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nuanced than that because you can have a
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company like Google or Amazon or
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obviously brks your half away and
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they've never paid a dividend they
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reinvest profits they buy back shares
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and they've had amazing growth and
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success but again it depends on your
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exact timeline and where each company is
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at in their story cuz if you take the
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total return of the past 5 years between
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the following companies Google Amazon
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Berkshire haway McDonald's and Starbucks
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you might be surprised at the results
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out of the five Google has had the best
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return out of all of them at 115% which
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probably isn't much of a surprise but
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then the next two best performers are
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the dividend payers McDonald's and
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Starbucks at 80.8 6 and Starbucks at
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77.0 n respectively and both of them
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have outpaced the total return of
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Berkshire Hathaway and Amazon over the
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past 5 years so again just because the
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company retains earnings and has a plan
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for growth doesn't mean that it's going
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to materialize in terms of a higher
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stock price sometimes just having a
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solid business that generates cash
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consistently is going to have a better
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overall return it just depends on each
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individual business okay but what about
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the theory that Dividends are
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unnecessary because investors can just
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sell shares whenever they need cash and
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this is one of those things that is
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technically true like if you have good
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total returns you have the flexibility
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to sell shares whenever you want then
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you can absolutely do that and it works
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what it means though is that you're more
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susceptible to Market timing and factors
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that impact the current stock price
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which could determine your tax impact
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how many shares you have to sell or how
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much money you'll be able to access at
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any one time and one of the great things
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about dividend stocks is you can plan
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for the future as to what your cash
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flows are going to be especially if
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you're investing in stocks that
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consistently pay and grow their
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dividends so while stock prices go up
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and down you know that your cash flow
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coming in is likely to stay steady or
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even grow regardless of what the market
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is doing in any given month or year plus
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being able to plan your cash flows in
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advance means you can adjust to
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complement your income needs without
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being dependent on a a certain stock
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price at the time that you need your
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money and I view investing in dividend
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companies like having a true business
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owner mindset because you've invested in
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a company and they're paying you part of
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the profit so owning Starbucks is like
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being a part owner of a coffee shop or
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owning Valero is like being a part owner
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of an energy company but I don't have to
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sell my shares to realize income from
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that ownership stake because they're
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paying me in cash every quarter there's
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nothing wrong with selling your shares
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whenever you think is best if you don't
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like dividends but it does add
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additional variability into your process
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that you have to manage an account for
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and a slightly different mindset and
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that just might not be the right thing
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for everybody okay but what about the
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claim that over the long term grow
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stocks are going to always outperform
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dividend paying value stocks so
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obviously we've already talked about
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this on an individual stock basis and
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it's really going to depend on each
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individual company that you're looking
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at so it's impossible to answer from
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that perspective and even if you're
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talking about a group of individual
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stocks it's really going to be highly
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dependent on how well the companies are
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that you pick end up doing but I think
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it's only fair to look at it from a
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general growth index versus a dividend
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index to see how they perform
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differently over time so I decided to
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use the following three Vanguard funds
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or ETFs vix vanguard's growth Index Fund
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viig vanguard's dividend appreciation
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index ETF and VM vanguard's high yield
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dividend ETF and I used ETS for two and
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a fund for one just so that I can get
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the most historical data to be able to
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compare the three and I was able to get
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up until January 2007 so a little over
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25 years of data and if you look at the
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performance over that time there is no
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question that the growth fund perform
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better with an overall average of
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11.37% compound annual growth rate
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compared to 99.07% for the dividend
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appreciation ETF and
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7.77% for the high dividend yield ETF
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now part of that in theory is that it's
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kind of designed to do that I mean the
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growth fund is called growth for a
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reason plus from a macro perspective we
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had multiple zero interest rate time
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frames in this 25e period to where if
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you look at the data we only had about
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four or 5 years in that 26e period where
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the federal funds rate was higher than
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0.5% that's actually pretty crazy when
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you think about it like there was only
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four or five years higher than that
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level and in environments like that
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growth should definitely outperform but
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here's the point as crazy as this may
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sound we don't have to choose one way
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over another because investing in growth
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and investing in dividends both have
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their advantages and disadv advantages
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for example growth in general will
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outperform value over time assuming
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there's no weird macro environment
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things going on but it's also going to
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have wild price wings that impact people
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emotionally and there's a recent study
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that said 66% of investors have made an
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impulsive or emotionally charged
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investing decision that they later
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regretted this is more common for Gen
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zers at 85% than any of the other age
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groups which Trend down from there and
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now this was just a study of about 1,00
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Investors so small sample size but I
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think it's important to talk about how
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emotions impact our investing let's take
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the Facebook example again so Facebook
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or meta has been one of the most popular
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and profitable companies to ever exist
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and it has been for a long time so let's
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say you bought it 5 years ago around
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$166 a share you look now and you say
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hey it's at 298 a share and I've made an
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80% return it's pretty good but what you
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don't realize is that during that 5
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years your stock would have done this it
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would have dropped to $53 per share 1
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and 1/2 years after you bought it so you
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would have been negative on your
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investment 1 and 1/2 years after buying
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and then it would have risen to $380 per
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share a year and a half later so you
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would be 2x your initial investment
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after 3 years but then it would have Dro
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back down to $90 per share about one
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year after that so after 4 years you
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would have been down 46% on your initial
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investment and then ultimately it Rose
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back up to $298 where it's at today so 5
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years later you're back to that 80%
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total gain so while it's easy to look at
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that performance chart and say oh yeah I
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definitely would have held in reality
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that's a lot harder and this is only a
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5-year time Horizon which in investing
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terms is relatively short so imagine
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what it's like over 10 years or 20 or
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even 30 I mean how many people who
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bought at $166 a share 4 years later
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were really holding when it was at $90 I
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just don't know and it's not that
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dividend stocks don't have price wings
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too they have absolutely do but one
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advantage dividend stocks have is that
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they're giving you consistent and
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growing dividend payouts so even when
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the price is going crazy your dividend
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payments are steadily growing over time
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so from a mental standpoint it helps to
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reduce the anxiety and panic around
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share prices because if you can still
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see that your income stream is steadily
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growing over time you're less likely to
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overreact just because there's some
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temporary massive drop in share prices
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and this is really the main point not
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only do we all have different investment
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goals but we all have different
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personalities and temperament and they
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play a huge part in our results when it
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comes to investing so while it's easy to
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say oh I'll just invest in growth for
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the next 30 Years the reality of Market
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swings in The Daily News cycle make that
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very difficult so we have to be able to
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focus on what our long-term goals are
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and when you're building a dividend
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income stream that's steadily growing no
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matter what it really helps with that
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but as you guys know I'm a fan of mixing
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these ideas for the best results if you
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have a 30-year timeline it's probably
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good to get exposure to growth stocks
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and investing in your retirement account
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into a growth index or fund is a great
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way to do that because you just keep
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adding to it and you don't mess with it
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too much since it's for retirement that
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way the swings and price won't bother
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you all that much to where you make any
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emotional decisions and building a
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portfolio of dividend payers is a nice
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complement to that because it focuses
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your mind on a long-term outcome that
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incrementally shows your progress as you
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go it's not meant to give you the
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absolute highest return that you ever
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could have gotten it's meant to slowly
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and reliably build an income stream that
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helps you meet your goals in life which
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is ultimately the reason Reon that we're
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doing any of this in the first place so
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what do you guys think am I totally off
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base with how we should be looking at
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dividend investing let me know down in
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the comments below hope you guys have a
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great day out there Financial
00:13:40
Independence is true Freedom so keep
00:13:41
building and stacking wins and I'll see
00:13:43
you guys in the next one peace
00:13:48
[Music]
