Understanding Dividends (Part 2)

I now believe dividends are bona fide income that may or may not come at the cost of capital appreciation.

Hypothetically speaking, suppose I did the study and found dividends are future capital appreciation realized now. I cannot emphasize enough [to myself] that this is not necessarily the case.

Nevertheless, I think understanding whether investors realize a decrease in stock price offsets the dividend would be very important for determining whether it’s a bunch of financial hocus-pocus.

I asked a former director of a NYSE-listed utility company. He said yes: most savvy investors know this.

He continued on: “sometimes the stock price falls some but sometimes it doesn’t. The stock usually falls less than 1%. Investors like the stability. They get the dividend checks in the mail and they feel good about that.”

I corrected him by saying the stock falls by exactly the amount of the dividend and that is cumulative over all dividend payments (a claim I now know to be theoretical). I said total return is equal whether or not a dividend would be paid.

He said, “most investors don’t know the term ‘total return.’ People want their dividend and their cash now and that’s it.”

I argued, “we could do a study to determine whether dividend payers are more stable than non-dividend payers. It’s a hypothetical claim that we don’t know the answer to.”

He said, “stock splits are the same way and stock splits are just like dividends. Companies with stocks that split are more healthy than those that don’t. Stock splits and dividends are both signs of corporate health.”

At the very least, I came away from this discussion thinking dividends are a marketing tactic by corporate boards of directors to make a stock more appealing to a particular segment of investors. Stock splits are the same way: neither change the total value of the investment. What a crock, then, for the industry to emphasize so strongly the illusory difference between capital appreciation vs. income!

Since the conclusion is based on a hypothetical premise, though, an enthusiastic “FAHGETTABOUDIT!” is in order.

Understanding Dividends (Part 1)

I can imagine someone reading the first few posts of this mini-series and saying “okay I can see why you say there’s something misleading about dividend payments but you can’t argue that it’s income.”

A proponent of dividends might take issue with my claim that capital appreciation and income are two sides of the same coin. According to my brokerage (customer support), on the ex-dividend date the exchange lowers the price of the stock on the ex-dividend date. Were the dividends not paid, I claimed the stock would be higher by the amount of the total dividends paid. As logical as that seems, it is only hypothetical. The devil’s advocate could argue “because dividend payments are usually much lower than the average daily volatility of the stock, the impact of the dividend probably comes out in the wash.”

Designing a study to substantiate my claim would be very difficult. I would have to get intraday data and study stock price changes just after the price is reset. I would also have to use something other than an adjusted price series because when dividends are paid, all previous prices in an adjusted series are adjusted downward by the amount of the dividend. Determining a valid control group might be difficult, too. I could use non-dividend payers or any stock not paying a dividend on that day. I could probably ramp up the sample size large enough for statistical significance but would it be financially significant? Maybe not.

I can’t think of an easy way to do this study and I certainly don’t have access to the data to do it myself. I therefore must drop the claim that dividend payment comes directly at the cost of capital appreciation.

The only thing I know for sure is that the “[income] check is in the mail.” While I know for sure that the stock price is decreased, I do not know whether I will even see the difference. That gives it significantly less impact than a periodic dividend payment, which may be cashed in at the local bank.