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Tuesday, 27 July 2010

6 Common Misconceptions About Dividends

Investopedia.com
Topics:Investing Ideas & Strategies
By Jason Whitby

During periods of low yields and market volatility, more than a few experts recommend dividend stocks and funds. This may sound like good advice, but unfortunately, it is often based on misconceptions and anecdotal evidence.


It is time to take a closer look at the six most common reasons why advisors and other experts recommend dividends and why, based on these reasons, such recommendations are often unsound advice.

Misconception No. 1: Dividends are a good income-producing alternative when money market yields are low.

Taking cash and buying dividend stocks isn't consistent with being a conservative investor, regardless of what money markets are yielding. Additionally, there is no evidence that money market yields signal the right time to invest in dividend-focused mutual funds. In fact, money market yields were anemic throughout 2009, a year that is also one of the worst periods for dividend-focused funds in history.

Many advisors also call dividends a good complement to other investments during times of high volatility and low bank yields. In an October 22, 2009 article, financial guru Suze Orman recommended the following dividend funds: iShares Dow Jones Select Dividend Index (NYSE:DVY), WisdomTree Total Dividend (NYSE:DTD) & Vanguard High Dividend Yield Index (NYSE:VYM).

Reality Check: The 12-month performance after Orman's recommendation was DVY (+7.86%), DTD (+21.91%), VYM (+17.72%). These returns seem pretty good - until you realize you could have just held on to the S&P 500, which was up +26.36% over the same period.

Misconception No.2: Dividend companies are more stable and better managed.

It is generally believed that companies that raise their dividends over a long period have solid market positions and strong cash flow. As a result, the stocks' total return is likely to outpace other stocks.

It's also common to hear the argument that dividends tend to hold companies to a certain standard of financial discipline and that, as a result, these companies budget more carefully and avoid wasteful projects out of fear that shareholders will punish the stock if it fails to return profits to its investors.

Reality Check: It's easy to pick a "solid" stock in retrospect but it is impossible to pick a company today that will meet this statement moving forward. Sure, if you had purchased Coke in 1962…but what about today? In 2007 we would have said that General Electric (NYSE:GE) and AIG (NYSE:AIG) were stable and well-managed dividend companies. Would we say the same in 2009? What about in the future?

The notion that dividend-paying companies are held to higher standards does not bear out. Look no further than the financial industry. In September 2008, AIG had a $4.40 dividend - almost a 4% dividend yield. By 2009, it was clear that AIG and others such as Freddie Mac, Fannie Mae, Bank of America, Bear Stearns and Citigroup were far from being financially disciplined companies, despite that fact that they were all long-time dividend-paying companies. As it turns out, dividends aren't much of an indicator of the financial discipline or the quality of a company's management.

Misconception No.3: You can count on dividends from solid companies.

Many people believe that it's rare for a solid company to suddenly reduce or rescind its dividend payment.

Reality Check: "Solid" companies like Bank of America (NYSE:BAC), General Motors, Pfizer (NYSE:PFE) and GE, have either suspended or cut their dividends. Unfortunately, it is a lot easier to identify companies that had a solid record than to identify companies that will have a solid record going forward. It is impossible to predict which "solid" companies today are going to be on shaky ground tomorrow. There is no certainty or stability in future dividends.

The idea that dividends allow you to get paid to wait doesn't make sense. It is the total return of your portfolio that matters, not the current yield. Throughout 2008 and 2009, companies were cutting or suspending their dividend payments at record levels, proving that there is no guarantee for those who buy in to these companies. Just ask anyone holding Freddie Mac since June 12, 2008, which was when Freddie Mac last distributed a dividend and traded at $23.01 a share. At that time, Freddie Mac had a dividend yield of 4.34%. By October of 2009, the stock was down over 90% and hope for future dividends had all but evaporated.

Misconception No.4: Dividend stocks provide upside potential and downside protection.

A 2009 SPDR University brochure states that "Dividends provide a stable source of income that can help partially offset market price depreciation that occurs in turbulent markets."

Reality Check: Dividends provide very little - if any - downside protection during market corrections. The S&P 500 was down -41.82% during the September 2008 to March 2009 crash. During the same time, the SPDR S&P 500 Dividend ETF was down -35.87%, which doesn't seem like much downside protection. Additionally, some well-known, dividend-focused funds provided no downside protection and performed worse than the S&P 500 over this period. For example, the Fidelity Dividend Growth Fund was down -46.94% and the iShares Dow Jones Select Dividend Index was down -43.07%.

Since 1926, dividends have provided about one-third of the total return for the S&P 500, while capital appreciation has provided the other two-thirds. Focusing on dividends, which provided less returns than capital appreciation, makes little sense, especially since the dividend focus is just as risky.

Misconception No.5: Preferential tax treatment makes dividend stocks more attractive.

This misconception seems to imply that dividend stocks are more attractive investments since they are taxed at a preferential rate. Obviously, the lower rate is better than the normal income rates but what does it really mean? Does it mean you should avoid dividends in tax-deferred accounts since they are less attractive?

Reality Check: Of course it doesn't. Then why should the tax treatment warrant dividend investments more attractive than capital gains? It doesn't, which is shown by the lack of any noticeable bounce in 2003 when the preferential tax law was implemented. We need to remember that the tail should not be wagging the dog. After-tax returns are important, but taxes should not drive your investment decisions.

Misconception No.6: Dividend-focused investing is ideal for retirees and conservative investors.

An October 5, 2009, article in the Wall Street Journal stated that "Most types of fixed-rate bonds don't provide any protection against inflation and can lose value when investors are worried inflation will flare. Rising dividends, along with any appreciation in the share price of the company paying them, offer a measure of insurance against inflation."

Reality Check: This statement is incredibly misleading. First, if you want a bond that protects against inflation, you can buy an I-bond instead of taking equity risk. Secondly, all equity investments provide a measure of protection against inflation, not just dividend stocks.

No one ever said you could only have one investment. If you are a conservative investor, you can simply create a portfolio of bond funds and a little bit in a stock fund. The idea is to create an investment portfolio, not an investment collection. Each investment in the portfolio should work with the others to achieve a goal. This works much like the ingredients in a recipe, which come together to create a great dish.

Why are dividends a better way to generate income than capital gains? Capital gains are not a sure thing, but neither are dividends. And there is simply no way to know which stocks will continue to be "solid" in the future.

Conclusion

Dividends are absolutely an important part of the investment equation. Yet there is no empirical evidence that focusing on dividends is a wise decision. Actually, Miller and Modigliani received the Nobel Memorial Prize in large part for their paper, "Dividend Policy, Growth, and Valuation of Shares," in which they found that dividends are irrelevant to a company's value ("irrelevant" is their word, not mine).

On one side the media is dishing out long-lived misconceptions about dividends. On the other side, the Nobel winners are saying dividends are "irrelevant" to stock values. I'm not sure about you, but I know which one of these two groups I'm going with.

3 comments:

  1. I'VE BEEN INVESTING FOR 20 YEARS & I CAN TELL YOU THAT DIVIDEND COMPANIES ARE TO BE AVOIDED! GET INTO GOLD, SILVER, URTANIUM & RARE EARTHS AND YOU WILL EXPERIENCE $$CASH COMING OUT OF YOUR EARS AS I HAVE! NOW READ THIS & ACT ON IT!
    ================================================

    PART 1

    THE U.S. CITIZENS HAVE THEIR BRAINS SCRAMBLED VIA FLUORIDE IN THE WATER & ALL THE ASPERTAME THEY CONSUME IN POP DRINKS, BUT THERE IS MORE.....

    You see, Bush Sr., & Jr., Clinton, Regan, Carter, Obama, Ford...ALL these presidents are in what is dubbed a SECRET SOCIETY called The Moloch Axis Demoniacs (i coined the phrase myself...Dr. A.P. and i don't use my full name because WHO knows WHAT sinister crap they'd do to me IF they found out?) or M.A.D. for short.

    These people, and there’s obviously more of them (Cheney, Rumsfeld etc.) than the ones mentioned, control KEY positions not just in government, business, society etc. They are GRADUALLY erroding MORAL/FAMILY VALUES in society. SO gradual that it's like hairloss! You see it ever so slowly and you have to be a keen eye to boot!

    For example, women in the workforce...they go to work so WHO takes care of the kids? Some goofs getting minimum wage who could care less about those kids. Family split apart because NOW both parents work and the cost of life itself purposely increased to perpetuate this separation. Kids grow up with NO moral/family values. Repeat this a few generations and before you know it, you have mindless zombies that don't know RIGHT from WRONG! Easily programmable to get in debt, be anti-christ-like etc.

    Also, the coming mark of the beast 666. Remember HOW it all used to be ca$h only? Then they introduced checks, then credit cards to get yourself in serious financial troubles, then ATM cards, and now that STUPID SWIPE-PASS card. What is the purpose of all this? To get people broken down enough and stupid enough through putting FLUORIDE in the drinking water and ASPERTAME in soda drinks/pop cans so we ALL can accept the 666 chip. So NOBODY can buy or sell or own ANYTHING lest he has the mark of the beast (anti-christ) which is 666.

    I can go on for days & days as to the subtleties and more examples but i think you all SEE the points i make here. It's all SUBTLE and GRADUAL negative changes day in & day out that these M.A.D. demons (because they are demonic and have placed their trust in demons in exchange for their souls and material possessions here on earth) are passing into laws in Canada, USA, UK, SPAIN, FRANCE etc.

    ReplyDelete
  2. PART 2
    They are genetically modifying the food so that the REAL NORMAL SEEDS will eventually be extinct and the modified canola, corn, soy and cotton seeds will be the ONLY ones left. Genetically modified means that these NEW seeds that are in almost ALL USA store bought products have the herbicide, fungicide, pesticide and who knows what already in the seed. THEREFORE, when you eat that mishmash, WHO THE HELL KNOWS WHAT IT WILL DO TO YOUR INTESTINES OVER TIME! And of course, the industry (Monsanto) TELLS US.."Ohhh..it's ALL safe to eat jajajaja". SAFE TO EAT? Just look at the bees landing on these genetically modified crops and their stomachs are being ripped apart & THEY DIE! Yet you SEE HOW funny it is on TV/MEDIA that NOBODY, including the M.A.D. payed-off demonic scientists don't even whisper/mention the OBVIOUS that i just stated here?

    Like i said, i can go on and on for days giving you more & more & more examples of the gradual demonic end-game these M.A.D. are playing with us. But like i said, i think you all reading this get the picture. And by the way, i am a Dr. and guess what? I DO NOT WORK FOR THE M.A.D. OR HAVE SOLD MY SOUL TO A DEMON! But....i live in virtual poverty somewhere on this planet with a family to feed and barely scrape by. And IF you think that sounds bad, well, this AIN'T nothing compared to what the M.A.D. have in store for ALL of us in the aforementioned countries (and more) i listed. And again, ALL their moves are subtle and gradual like a chessgame being played out with the regular folks as the pawns.

    I sometimes WONDER WHY the regular folks in these countries NEVER do ANYTHING TO STOP these demonic morons. It doesn't matter IF you vote Republican or Democrat because from those 2 choices, they are BOTH a part of M.A.D. Same with Canada and their Liberal or Conservatives...same M.A.D. , and on and on and on. I sometimes wonder.....you NEVER see ANY of these M.A.D. criminals go to trial or imprisoned for fraud on the people yet IF little billy J-Walks across a bussy street he gets a ticket he must pay! When will Bush Jr. & Cheney and ALL those involved in blowing up 3 buildings in Manhattan and blaming it on Arabs EVER be brought to justice? NEVER because when it FINALLY is discovered what they did, they'll be safely dead from old age and the vast majority of the people in the USA will be soooo brainwashed with NO moral/familiy values they will have already taken up the 666 mark and be worshipping the anti-christ.

    ReplyDelete
  3. PART 3
    Sometimes it makes one wonder WHY there are NO good people that will step up (with God as their guide) and put a STOP to these M.A.D.?? That is one of the BIGGEST questions i ask myself almost everyday! Maybe people are SCARED? Maybe they are waiting for God to MAGICALLY guide them without realizing that God doesn't work in that manner/way.

    I just HOPE somebody puts a STOP to M.A.D. or we are ALL going to be really in BIG trouble!

    The above is a LOT to think about, believe me, i have been living it since 2005, and jobless to boot! And i am a Dr. so go figure?? But i WILL NEVER SELL MYSELF TO A DEMON OR THE M.A.D. so how about them cookies :)

    Peace be unto you and please WAKE UP PEOPLE!
    +Dick Cheney Loves the demon moloch from hell and wants to destroy earth too! Just look at what his
    Moloch Axis Demoniac HALLIBURTON company did in the Gulf of Mexico with the offshore oil rig…need I say more? Cheney is RESPONSIBLE for the atmospheric CHEMTRAIL pollution program sprinkling toxic Aluminum & Barium Oxide to alter the weather and poison the plants, soil and people to make way for genetically modified foodstuffs to further poison us! STOP THESE DEMONS NOW!!!!!!!

    ReplyDelete

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