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Why are dividends generally seen as a good thing for investors?

For example, you can look at this Barrons article where it states Broadcom (ticker: AVGO) plans to boost its quarterly dividend by 51%, a piece of good news for investors in a company whose shares have lagged behind the market this year.

How exactly is this good news for investors? When the company issues the dividend, won't the stock price drop by the proportional amount since the company is losing that much cash (the cash that they're giving out as dividends)? This should be neutral news as Investors aren't really making/losing any money from this?

If anything, this might be bad news, since it shows the company Broadcom has nothing they deem worth investing in.

Thanks.

JTP - Apologise to Monica
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jack klompus
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3 Answers3

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Investors have different targets, and for some a continuous stream of dividends is more important than the value gain of the share itself.

For example, AT&T is a well known provider of 50 cent dividends per quarter; so if you buy them today for 30$, they will produce 6.67% per year continuous income stream: 4 * 0.50$ / 30$ = 6.67% (of course assuming they don't go bust or change that). If you are retired and want to live from that quarterly amount, this is a good solution.
Note that for the retiree in the example it does not matter much how the share value develops- of course, he prefers if they go up to 50$, but he also gets his income stream if they drop to 10$ (again, unless they go bust or change that - this is typically handled by diversifying, and buying not just AT&T, but multiple unrelated shares with similar behavior).

Aganju
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    The 6.67% paid per year in dividends is yield not total return. Yield is not an income stream (it's your own money). Only share price appreciation turns yield into income. – Bob Baerker Dec 14 '18 at 16:27
  • @BobBaerker and yet, if that company simply hoarded the cash and did not distribute it, the Price would not be any higher, it would probably be less as there would be no imagined value of a stock that distributes consistent dividend built in to the price. If you review a consistent dividend paying stock, you might find that their price remains relatively stable with the market over time. If this was purely a distribution of your own money, you would expect a 5-6% lag behind the market. – Shorlan Dec 17 '18 at 23:13
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I haven’t studied the specifics around Broadcom’s announcement, so this is just a generic answer to the question in the title.

Two reasons:

  1. Fundamentals - investors want returns, and dividends are a legitimate form of profit sharing.

  2. Business life-cycle - some businesses get to the point of diminishing returns for capital investment while taking in consistent profits (eg at least conceptually, infrastructure companies such as utilities and toll roads). Dividends are a way to return those regular excess profits to investors.

There is the risk of becoming obsolete and overtaken without appropriate company renewal. But when there are bumper profits exceeding what management can profitably and sensibly deploy, shareholders welcome having the excess funds in their own hands.

—-

Paying out dividends reduces a company’s net worth by a corresponding amount, and that reduction is reflected in the share price. E.g. a company paying a dividend of 1c per share suffers a drop in value of the shares by 1c because the shares are literally worth 1c less after the dividend has been paid.

However, there are times one doesn’t wish to sell at all: sentimental value, maintaining a critical-percentage shareholding, unwilling to crystallise a capital loss (or gain, for that matter), etc.

Getting a payout via dividends becomes an important means of participating in profits without selling any of the shares. The capital loss (attributed to the dividend causing the share price to fall) is then deemed an acceptable trade-off.

Lawrence
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    Also, if the company has paid out dividends (and I don't reinvest them), that money is in my bank account, and will be there if the stock tanks next week. – jamesqf Dec 14 '18 at 05:06
  • @jamesqf Indeed. Incidentally, chasing dividends is in some ways more risky than chasing yield because the company retains less profit by paying a dividend, and if its income stream is compromised, it hits the double whammy of lower dividend payout and less money in the kitty to remediate. But none of that invalidates the use of dividends to share profits ... and being given a share of profits is usually a happy thing for investors. – Lawrence Dec 14 '18 at 06:59
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    The dividends are from corporate profits. Receiving them on the ex-dividend date (the IOU paid on the Payable Date) does not result in a profit to you, the investor. You have accomplished two things by receiving a dividend 1) You have lowered your dollars at risk 2) If non sheltered, you paid taxes on your own money (negative return) – Bob Baerker Dec 14 '18 at 15:36
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    @BobBaerker You've missed the point of my answer. – Lawrence Dec 14 '18 at 16:15
  • You missed the point that I was replying to comments. – Bob Baerker Dec 14 '18 at 16:24
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    @Bob Baerker: That is simply nonsense. If I get regular payments of money, that's a profit to me. If the company sits on a pile of cash, without having any good way to invest in in further growth, it's not. – jamesqf Dec 14 '18 at 17:54
  • @jamesqf - It's only nonsense because you do not understand the ex-dividend process and you are unaware that the share price of your equity position is being reduced by the exact amount of the dividend by the stock exchanges on the ex-dividend date. If you don't comprehend that then you are one of those who mistakenly believes that dividends are Free Money. Perhaps you should look at FINRA Rule # 5330 "Adjustment of Orders" which requires brokers to reduce open order prices by the dollar amount of the cash dividend (unless marked Do Not Reduce) on the ex-dividend date. – Bob Baerker Dec 16 '18 at 19:33
  • @Bob Baerker: I think you're the one who lacks understanding. First, take a simple example. I own a small business, the business receives income, after paying expenses that income is profit to me, no? If I shared ownership with several people, my share would still be profit to me, likewise if I shared ownership with a multitude of stockholders. Now if that company retains all its profit rather than paying out dividends to stockholders, I have no profit unless the stock price increases (which it may or may not do) AND I sell the stock. – jamesqf Dec 17 '18 at 03:13
  • The last thing that I'm going to offer is that Stack has many knowledgeable contributors who don't hesitate to edit Questions edit as well as provide corrective explanations and make their opinions known in the comment sections. Given that it's awfully quiet out there and not a single person other than you is trying to refute my information, does that give you pause to think? All you have to do to understand the ex-div share price adjustment process is look at actual closing quotes before and after ex-div but that appears to be too much effort for you. Over and out. – Bob Baerker Dec 17 '18 at 14:11
  • Hi @Bob, I understand that paying out dividends reduces a company’s net worth by a corresponding amount, and that the reduction is reflected in the share price. I’m sure jamesqf does as well. However, there are times one doesn’t wish to sell at all: sentimental value, maintaining a critical-percentage shareholding, unwilling to crystallise a capital loss (or gain, for that matter), etc. Getting a payout via dividends becomes an important means of participating in profits without selling any of the shares. The capital loss that offsets the revenue gain is then deemed an acceptable trade-off. – Lawrence Dec 17 '18 at 17:27
  • @Lawrence: Or to try to explain it another way, where did the money for those dividend payments come from? From profits earned by the company that's paying them, no? So they were profit to the company: when they're paid, they're profit to me. Now IF I sold my shares on the ex-dividend date, AND nothing else happened to change the stock price, then the price would reflect the dividend payout. But I don't want to sell the shares, I want to continue to collect dividends :-) – jamesqf Dec 17 '18 at 18:32
  • Hi @Lawrence - You are correct in that 1) "paying out dividends reduces a company’s net worth" 2) "the reduction is REFLECTED IN SHARE PRICE" (which james fails to comprehend) 3) there is a "CAPITAL LOSS that offsets the REVENUE GAIN" (which james also fails to comprehend) . #1 is what happens on the corporate level. #2 and #3 occur in one'd brokerage account. Separate issues and conflating them is a mistake. Whether one wants to sell, hold or even buy more has nothing to do with the ex-div process and doesn't change the fact that share price is reduced by the exchanges on ex-div. – Bob Baerker Dec 17 '18 at 19:05
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Yes, on the ex-div date the stock exchanges reduce share price by the EXACT amount of the dividend, resulting in an equal amount of capital loss.

A common misconception among new or unsophisticated investors is that a dividend is a profit. This is magnified by authors and web sites that promulgate the theory that Dividend Capture provides “free money”.

To add insult to injury, if in a non sheltered account, they are taxed as income and that has bled over into considering them income.

Benefits? Yes. If your dividend is reinvested, you get some more bang for the buck via compounding. If not reinvested, by receiving a portion of your own capital back, your dollars at risk is lowered.

Dividends do not produce Total Return. Only share price appreciation provides that so you should be agnostic about them. One should invest in financially healthy companies that are growing. If they pay a dividend, fine. If not, no big deal.

EDIT:

I note with humor that this answer received some down votes. My guess is that the four of you are among the many who do not understand the ex-dividend process. So let's try a real world example and see if minds can be enlightened. Dividends will not be reinvested because that requires multiple calculations.

If you bought AT&T on 6/23/2015, you paid $35.91

It closed on 10/26/18 at $29.09

You have a paper loss of $6.82 per share. You are down $682

Since 6/25/15 you have received $6.82 per share ($682). If this was done in a sheltered account, you have broken even. If not, you have paid taxes for the "privilege" of receiving some of your investment capital back. You lost money. To keep this example simple, let's ignore taxes.

Dividends received in 3.35 years? $682

Total return from 6/23/15 to 10/26/18? ZERO

If AT&T were to magically rise to $35.91 before the next dividend, you would be able to sell your shares and break even (ignoring commissions). Your $682 in dividends would then be true income, aka a profit.

Some updated numbers? AT&T closed yesterday at $29.91, down $6.00 from purchase price. You received $6.82 in dividends so you have a position gain of 82 cents. IOW, share price was reduced by $6.82 by the stock exchanges over the past 3.35 years because AT&T has recovered 82 cents of that amount. Only 82 cents of the $6.82 received is profit or if you wish, income.

Repeating what I wrote, dividends do not produce Total Return. Only share price appreciation provides that (82 cents in the updated numbers). Because of that, you should be agnostic about dividends. One should invest in financially healthy companies that are growing. If they pay a dividend, fine. If not, no big deal.

Bob Baerker
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    Dividends are not part of total return? I simply don't understand this. If I had a stock that never changed its price (or only by exactly enough to match inflation), but paid out 10% dividends every year, I would think I was getting a great return on my investment. – jamesqf Dec 14 '18 at 05:04
  • Do you realize that share price is reduced by the stock exchanges on the ex-dividend date? In order to have a stock that never changed its price but paid out 10% dividends every year, the stock would have to APPRECIATE by the amount of the dividend. – Bob Baerker Dec 14 '18 at 13:21
  • No, I DON'T realize that the stock price is reduced by exactly the same amount as the dividend, because it ISN'T. Stock prices change for any number of reasons, all happening at the same time. The idea that a stock paying a constant dividend must appreciate is just wrong. (Of course in the real world other people would want to collect those dividends too :-)) At the other extreme, consider a stock that will never, ever pay dividends: is it rationally worth anything? – jamesqf Dec 14 '18 at 18:01
  • @jamesqf "consider a stock that will never, ever pay dividends: is it rationally worth anything?" Yes, because if nothing else, someone can buy a controlling stake, shut down the company, and sell off its assets (or otherwise put them to profitable use). Even investors without the resources to do this would buy the stock if it's priced much less than the value of its assets, on the expectation that ultimately a big fish would do this. – nanoman Dec 14 '18 at 18:43
  • @jamesqf - You DON'T realize that the stock price is reduced by exactly the same amount as the dividend, because you are misinformed and have no clue what is happening in your brokerage account. FINRA Rule 5330 requires brokers to adjust open orders by the amount of the dividend because share price is being reduced by the stock exchanges. It's the same exact thing as what happens on the ex-date with a mutual fund distribution. And asking what a stock is rationally worth has nothing to do with this discussion. – Bob Baerker Dec 16 '18 at 20:05
  • @jamesqf - Here's a learning moment for you. Look up Friday's closing prices of VOO (1.29), LVS (.75), LIN (.825), GCV-B (.375). They go ex-div tomorrow morning (12/17). The number in the parens is is the amount of the dividend. Tomorrow morning, look up the closing price BEFORE trading resumes. Get back to me with what you observe (Hint:Tomorrow, the adjusted closing price will be exactly Friday's closing price less the dividend). Since the adjusted closing price is lower, the value of any of these positions in your account will be lower by the amount of the dividend, aka capital loss. – Bob Baerker Dec 16 '18 at 20:08
  • @Bob Baerker: Dividend payouts are just one factor in stock prices - the price of a heavily-traded stock can change from minute to minute. So VOO's price would be the same at the start of trading, but it would almost certainly change after the first trade. If the CEO is arrested for tax evasion this weekend, I expect the share price would drop a lot more than the dividend amount; if it announces some amazing new product, the price would rise more than the amount. But in neither case do I incur a profit or loss unless I sell the stock. – jamesqf Dec 17 '18 at 03:32
  • You are conflating subsequent "minute to "minute" price change with the ex-div process. What happens after the first trade has NOTHING to do with what I have spelled out for you. Nor does CEO arrest or eclipses. As for incurring a profit or loss,you are confusing REALIZED with UNREALIZED LOSS. As for the data which you conveniently ignore, LVS closed at $54.84 Friday and the adjusted close is $54.09 this morning after ex-div of 75 cents (before any trades occurred). LIN went from $156.93 to $156.10 after 83 cent div. How do you explain that or are you going to keep ignoring the facts? – Bob Baerker Dec 17 '18 at 14:09
  • @Bob Baerker: I'm not ignoring the facts, you are, by focussing your attention on that very narrow time window - and I've already said, repeatedly, that if you limit yourself to that window, you are technically correct (due to the regulations you mention). But that is irrelevant: as the owner of the dividend-paying shares, I have money - some part of the company's profit - in my pocket, which is a profit to me. If I hold those shares, the price will keep changing in the future. Perhaps the fact that it pays reliable dividends even increases the price. – jamesqf Dec 17 '18 at 18:37
  • @jamesqf - Thank you for finally admitting that share price is reduced by the exchanges on the ex-dividend date which results in an equal amount of capital loss in one's brokerage account. What you choose to do after that event is your prerogative and it has nothing to do with the ex-dividend process. Future share price change has nothing to do with ex-div date either. – Bob Baerker Dec 17 '18 at 19:23