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Isn't it true that on the ex-dividend date, the price of the stock goes down roughly the amount of the dividend? That is, what you gain in dividend, you lose in price drop.

(Of course, sometimes it just happens that the price does not drop as much as the dividend is worth, but then again there are times when the price actually drops more, so the average drop is equivalent to the dividend amount.)

Why is everyone making a big deal out of the amount that companies pay in dividends then? Why do some people call themselves "dividend investors"? It doesn't seem to make much sense.

Edit: Before you answer, please have a look at the most common myths debunked http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2014/02/04/7-myths-about-dividend-paying-stocks

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    Comments are not for extended discussion; this conversation has been moved to chat. This can't be done a second time so new comments are subject to being completely deleted. @mark3292 - I suggest you edit your question to clarify it with any of the relevant material you added in comments. – Ganesh Sittampalam Dec 22 '15 at 17:54

14 Answers 14

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It has little to do with money or finance. It's basic neuroscience. When we get money, our brains release dopamine (read Your Money and Your Brain), and receiving dividends is "getting money." It feels good, so we're more likely to do it again.

What you often see are rationalizations because the above explanation sounds ... irrational, so many people want to make their behavior look more rational. Ceteris paribus a solid growth stock is as good as a solid company that pays dividends.

In value-investing terms, dividend paying stocks may appear to give you an advantage in that you can keep the dividends in cash and buy when the price of the security is low ("underpriced"). However, as you realize, you could just sell the growth stock at certain prices and the effect would be the same, assuming you're using a free brokerage like Robin Hood.

You can easily sell just a portion of the shares periodically to get a "stream of cash" like dividends. That presents no problem whatsoever, so this cannot be the explanation to why some people think it is "smart" to be a dividend investor.

Yes, if you're using a brokerage like Robin Hood (there may be others, but I think this is the only one right now), then you are right on.

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    Most libraries have Your Money and Your Brain and I'd recommend reading it (it helped me a lot because I am just as irrational). In general, measure the companies regardless of whether they pay dividends. Apple and Microsoft were solid companies, even when they paid no dividends, so any publication reviewing stocks is good to read to evaluate the company. So those articles you mention may be useful in identifying good companies. – DoubleVu Dec 22 '15 at 13:32
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    You are making many assumptions here. 1) That the person wants to repurchase the stock with the dividend proceeds 2) That your growth stock is as an established a company as a dividend company ie as safe 3) That you can sell at tops and buy at lows 4) That you are using a free brokerage. And finally, the big one, 5) That whatever happens in your brain when you receive a dividend, doesnt happen when you see a green arrow on the ticker next to your growth stock – von Mises Dec 22 '15 at 17:26
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    Yes, all those investment funds buying dividend shares are in it for the dopamine. I'm not sure this "everyone else in the world is irrational" interpretation really makes sense. – Andrew Dec 23 '15 at 13:07
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    @mark3292 Your responses and your acceptance of this answer make it sound like you were already 100% convinced you were correct, and were simply looking for an answer that confirmed your preexisting opinions. – Michael A Dec 23 '15 at 14:58
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    @mark3292 "It is simply a crazy idea that dividend-paying stocks are better than non-dividend-paying stocks because the dividends can be reinvested". If you knew this and were 100% sure of the answer, which is what your tone implies, why ask? Your responses don't indicate an altruistic motive of "sharing the information so others can be correct." It comes across as venting, seeking out argument, and a prime example of (attempted) confirmation bias. That's my final take, at any rate. – Michael A Dec 23 '15 at 20:36
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When you invest in stocks, there are two possible ways to make money:

  • you resell the shares at a higher price than you bought them
  • you get dividends

Many people speculate just on the stock price, which would result in a gain (or loss), but only once you have resold the shares.

Others don't really care about the stock price. They get dividends every so often, and hopefully, the return will be better than other types of investments.

If you're in there for the long run, you do not really care what the price of the stock is. It is often highly volatile, and often completely disconnected from anything, so it's not because today you have a theoretical gain (because the current stock price is higher than your buying price) that you will effectively realise that gain when you sell (need I enumerate the numerous crashes that prevented this from happening?).

Returns will often be more spectacular on share resale than on dividends, but it goes both ways (you can lose a lot if you resell at the wrong time). Dividends tend to be a bit more stable, and unless the company goes bankrupt (or a few other unfortunate events), you still hold shares in the company even if the price goes down, and you could still get dividends. And you can still resell the stock on top of that!

Of course, not all companies distribute dividends. In that case, you only have the hope of reselling at a higher price (or that the company will distribute dividends in the future). Welcome to the next bubble...

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    Since this is voted as the best answer, I'm going to comment and explain why I disagree. Your answer goes against every finance 101 textbook. You ignore the market value of your investments - when a stock pays a dividend, it will lose in market value compared to the non-dividend-paying stock (ceteris paribus). You probably then say that "oh, it does not matter because I don't sell". This is a common fallacy - if you never "sell" (or acknowledge the market value), you will end up holding on to stocks of companies that have gone bankrupt, yet you are not declaring a loss. – mark3292 Dec 23 '15 at 7:54
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    @mark3292 the "loss in value compared to a non-dividend stock" after the div is paid, could equally be described as "a rise in value compared to a non-dividend stock" before the div is paid. It just happens to get realised as cash on a periodic basis, rather than remaining locked into the share price. This is great if what you want is to realise a small steady income stream rather than rely on selling your capital in small increments as needed. – Andrew Dec 23 '15 at 13:09
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    @mark3292 what finance 101 is this? growth through reinvesting dividends way exceeds just the stock price growth without reinvested dividends. – Pepone Dec 23 '15 at 14:39
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    @mark3292 Assuming you are buying from the market (and not new shares from the company), reinvesting your dividends increases your share in the company. This is not the same as when the company hadn't paid dividends. – Paŭlo Ebermann Dec 23 '15 at 17:01
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    @mark3292 Also, I've never understood the penchant for dismissing an idea because it (may) contradict a "101 level textbook." Anyone that's studied at the advanced undergrad or graduate level knows that for many subjects, undergrad textbooks are at best overly simplistic and at worst completely incorrect. I'd caution you against taking your investment advice from such a low level source that's probably on-par with random information from the internet. – Michael A Dec 23 '15 at 20:34
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If you assume the market is always 100% rational and accurate and liquid, then it doesn't matter very much if a company pays dividends, other than how dividends are taxed vs. capital gains. (If the market is 100% accurate and liquid, it also doesn't really matter what stock you buy, since they are all fairly priced, other than that you want the stock to match your risk tolerance).

However, if you manage to find an undervalued company (which, as an investor, is what you are trying to do), your investment skill won't pay off much until enough other people notice the company's value, which might take a long time, and you might end up wanting to sell before it happens. But if the company pays dividends, you can, slowly, get value from your investment no matter what the market thinks. (Of course, if it's really undervalued then you would often, but not always, want to buy more of it anyway).

Also, companies must constantly decide whether to reinvest the money in themselves or pay out dividends to owners. As an owner, there are some cases in which you would prefer the company invest in itself, because you think they can do better with it then you can. However, there is a decided tendency for C level employees to be more optimistic in this regard than their owners (perhaps because even sub-market quality investments expand the empires of the executives, even when they hurt the owners).

Paying dividends is thus sometimes a sign that a company no longer has capital requirements intense enough that it makes sense to re-invest all of its profits (though having that much opportunity can be a good thing, sometimes), and/or a sign that it is willing, to some degree, to favor paying its owners over expanding the business. As a current or prospective owner, that can be desirable.

It's also worth mentioning that, since stocks paying dividends are likely not in the middle of a fast growth phase and are producing profit in excess of their capital needs, they are likely slower growth and lower risk as a class than companies without dividends. This puts them in a particular place on the risk/reward spectrum, so some investors may prefer dividend paying stocks because they match their risk profile.

  • Thank you, this is a comprehensive answer. What would you say is the most important reason why people (and the press) promote dividend investing as being superior to buying non-dividend-paying stocks? – mark3292 Dec 23 '15 at 19:43
  • Right - by paying a dividend (or not), company management sends a message to the market about what kind of company it is (or plans/hopes to be). – A E Dec 25 '15 at 21:07
  • @mark3292 My wild guess would be that people are afraid of another great crash. Look at the top 100 capital computer companies in the world, for example - how many of those have an actual income? In many ways, it's looking like the dotcom bubble all over again. A company that reinvests everything they make (and more in many cases) has its pros and cons - it tends to be high growth, but it can also drop dead overnight. Dividend payers tend to have a more steady growth - again, with its pros and cons. You're not going to get rich on dividends - but you might just secure your retirement :) – Luaan Dec 27 '15 at 9:45
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The answer, for me, has to do with compounding. That drop in price post-ex-div is not compounded. But if you reinvest your dividends back into the stock then you buy on those post-ex-div dips in price and your money is compounded because those shares you just bought will, themselves, yeald dividends next quarter.

Also, with my broker, I reinvest the dividend incurring no commission. My broker has a feature to reinvest dividends automatically and he charges no commission on those buys.

Edit:I forgot to mention that you do not incurr the loss from a drop in price until you sell the security. If you do not sell post-ex-div then you have no loss. As long as the dividend remains the same (or increases) then the theoretical ROI on that security goes up. The drop in price is actually to your benefit because you are able to acquire more shares with the money you just received in the dividend So the price coming down post-ex-div is a good thing (if you buy and hold).

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    Every share you own pays that dividend. If you buy more shares with your dividends then, in the future, you will get more dividends. If you continually do this your investment will snowball. Buy and hold has advantages over buy-low-sell-high. – Jack Swayze Sr Dec 22 '15 at 17:07
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    When I reinvest the dividend I own more shares. The drop in price does not affect me as I do not sell the security. The dividend does not come from the value of the stock, it comes from the operations of the company. You are buying into a post-hoc-ergo-propter-hoc logical fallacy. Correlation is not causation. – Jack Swayze Sr Dec 22 '15 at 17:29
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    @JackSwayzeSr - Not only that, but if the price does drop, it means you can get more shares with the dividend money than you would otherwise. Of course, that works in reverse too. – Bobson Dec 22 '15 at 17:47
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    @mark3292 as I and Bobson point out, a drop in price of a dividend paying security is a good thing to someone who is a buy and hold investor who also reinvest his dividends. Drops in price are only worrisome to the speculator (gambler). – Jack Swayze Sr Dec 22 '15 at 17:55
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    @mark3292, You should never buy a stock just for its dividend, that is bad investing. – user9722 Dec 23 '15 at 21:40
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  1. Dividends telegraph that management has a longer term focus than just the end of quarter share price. There is a committment to at least maintain (if not periodically increase) the dividend payout year over year. Management understands that cutting or pausing dividends will cause dividend investors in market to dump shares driving down the stock price.

  2. Dividends can have preferential tax treatment in some jurisdictions, either for an individual compared to capital gains or compared to the corporation paying taxes themselves. For example, REITs (real estate investment trusts) are a type of corporation that in order to not pay corporate income tax are required to pay out 95% of income as dividends each year. These are not the only type, MLP (master limited partnerships) and other "Partnership" structures will always have high dividend rates by design.

  3. Dividends provide cash flow and trade market volatility for actual cash. Not every investor needs cash flow, but for certain investors, it reduces the risks of a liquidity crisis, such as in retirement. The alternative for an investor who seeks to use the sale of shares would be to maintain a sufficient cash reserve for typical market recessions.

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    1) is complete bogus. Not paying a dividend can be a very strong signal that the management is there for the long term, and think they can do better with the extra money than paying it out. (Think of Berkshire Hathaway for example) 2) This is true, and probably the only rational explanation for dividend investors calling themselves smarter than everyone else. 3) Bogus. As discussed above, one can easily sell a small portion of the shares periodically to generate a steady cash flow like dividends. – mark3292 Dec 22 '15 at 13:59
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    You should own your investment strategy, and take all advice from third parties with a giant grain of salt. I can't defend the specific statements people in your life have made. Not every investment strategy is appropriate for every lifestyle; dividends are appropriate in retirement and less so in the accumulation phase. Dividends similarly don't make any sense for growth companies, but provide financial discipline to large stable ones. If you can't even visualize the possibility I can't help you further. – user662852 Dec 22 '15 at 14:45
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    If someone holds 10 shares and wants to keep them forever, how do you sell a whole number greater than zero every year and make this last for a couple of decades? Selling a portion can lead to having no shares, IMO. – JB King Dec 22 '15 at 17:03
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    @Erwin Berkshire Hathaway is an unusual case in that the share price is so high. The point is that the flow of dividends is unending while selling shares of a security for income taps into a finite resource. Sooner or later you will run out of shares to sell. But when you buy and hold a dividend paying security the dividend will keep on being paid. – Jack Swayze Sr Dec 23 '15 at 10:01
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    @JackSwayzeSr the idea is that companies that can invest the would-be dividends themselves better than the market average for companies with a similar risk, will create more value by reinvesting it, thereby increasing their shareprice. So the value of each share goes up, and you will need to sell less and less shares. People shouldn't hold on to x shares, they should hold on to x dollars worth of shares, and sell shares that are worth more than x dollars. If you do that, there is little difference between dividends and capital gains, apart from tax implications. – Erwin Bolwidt Dec 23 '15 at 13:44
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Dividends indicate that a business is making more profit than it can effectively invest into expansion or needs to regulate cash-flow. This generally indicates that the business is well established and has stabilized in a dominant market position. This can be contrasted against businesses that:

  1. Do not have a profit to distribute in the form of cash
  2. Are still spending all their profits on expansion
  3. Are compiling a cash reserve because they fear a future shortage

Dividends are also given preferential tax treatment. Specifically, if I buy a stock and sell it 30 days later, I will be taxed on the capital gains at the regular income rate (typically 25-33%), but the dividends would be taxed at the lower long-term capital gains rate (typically 15%).

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    This! You can't compare company stocks to funds. If a company has succeeded and can't expand the business anymore, what is it supposed to do? Raise everyone's wages? Invest in unrelated businesses? Keep the money in a savings account? It makes sense for the company to pay dividends and for the investors to invest in this kind of company as opposed to companies that haven't really succeeded yet. – gengren Dec 23 '15 at 13:38
  • This is a positive reason for dividends, but it doesn't seem safe to expect that all companies distributing a dividend are doing so for the same reason. Some may simply want the associated news blurb ("Dividend 15% larger than predicted") etc. – Ben Voigt Dec 23 '15 at 15:12
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    i admit that my question is more focused on why a rational person would seek out rational dividend paying companies. i do not really address why a typical person would seek out a typical dividend paying company. for that, i suggest you read the accepted answer. – james turner Dec 23 '15 at 15:14
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    I just thought about editing some capital letters in, but as you are "philosophically opposed" to them (on your profile), I'll just undo my upvote. – Paŭlo Ebermann Dec 23 '15 at 17:06
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Isn't it true that on the ex-dividend date, the price of the stock goes down roughly the amount of the dividend? That is, what you gain in dividend, you lose in price drop.

Yes and No. It Depends!
Generally stocks move up and down during the market, and become more volatile on some news. So One can't truly measure if the stock has gone down by the extent of dividend as one cannot isolate other factors for what is a normal share movement. There are time when the prices infact moves up. Now would it have moved more if there was no dividend is speculative.

Secondly the dividends are very small percentage compared to the shares trading price. Generally even if 100% dividend are announced, they are on the share capital. On share prices dividends would be less than 1%. Hence it becomes more difficult to measure the movement of stock.

Note if the dividend is greater than a said percentage, there are rules that give guidelines to factor this in options and other area etc. Lets not mix these exceptions.

Why is everyone making a big deal out of the amount that companies pay in dividends then? Why do some people call themselves "dividend investors"? It doesn't seem to make much sense.

There are some set of investors who are passive. i.e. they want to invest in good stock, but don't want to sell it; i.e. more like keep it for long time. At the same time they want some cash potentially to spend; similar to interest received on Bank Deposits. This class of share holders, it makes sense to invest into companies that give dividends, as year on year they keep receiving some money. If they on the other hand has invested into a company that does not give dividends, they would have to sell some units to get the same money back. This is the catch. They have to sell in whole units, there is brokerage, fees, etc, there are tax events. Some countries have taxes that are more friendly to dividends than capital gains.

Thus its an individual choice whether to invest into companies that give good dividends or into companies that don't give dividends.

Giving or not giving dividends does not make a company good or bad.

  • Ok, I get your point, but in today's markets, the brokerage fees/commissions can be so low that they are almost negligible. So the only explanation that remains is the different tax treatment of dividends vs. capital gains. However, to me it seems that the most likely explanation is that people think they are Warren Buffet for finding a stock that pays dividend. – mark3292 Dec 22 '15 at 13:24
  • Buy and hold investor are more like Warren Buffet than buy-low-sell-high speculators (gamblers). Warren Buffet is a buy and hold kind of guy. – Jack Swayze Sr Dec 22 '15 at 17:02
  • And both Buffet and Graham like company's that pay sensible dividends - less likely to go bust like enron – Pepone Dec 23 '15 at 19:32
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Technically, the difference between dividends and growth ought to be that dividends can be reinvested in stocks other than the one that paid them, which is a definite advantage if you actually have a strategy. Dividend -paying stocks used to be preferred for exactly that reason, back in the days when fewer people were directly playing in the market and more knew what they were doing.

Unfortunately, getting a periodic dividend from a stock whose price is relatively steady isn't as exciting a game as watching your stock's value bounce around and (hopefully) creep upward on a second-by-second basis. Those who are thinking in gambling terms rather than investment terms -- or who think they can beat the pros at high frequency trading, comment withheld -- want the latter, and have been putting a lot of pressure on companies to operate in the latter mode. That doesn't make it better -- certainly not for the longer-term investors -- just more fashionable.

And fashion often means getting stuck with something impractical because everyone else is doing it.

On this, I second Scrooge: Humbug!

  • Are you saying that stocks NOT paying a dividend are more fashionable these days? That seems to be the total opposite observation to my question/problem here. – mark3292 Dec 22 '15 at 14:11
  • Stocks not paying a significant dividend are more popular than they used to be. Thete are arguments in favor of that too; it SHOULD mean the company is using that money to grow... but ss I say, it's a change from 30 years ago. Or so I understand it. – keshlam Dec 22 '15 at 14:15
  • Well that does not explain at all why the majority of people I talk to think that dividend investing is like pooping gold. – mark3292 Dec 22 '15 at 14:17
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    The only thing that will explain what the majority of people that you talk to think is probably how you choose the people that you talk to. @mark3292 This has nothing to do at all with investing. – user32479 Dec 22 '15 at 14:20
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    @mark3292 'Investing' should actually mean buy and hold. I think what you are talking about is speculation (gambling). True buy-and-hold investors reinvest their dividends and see exponential growth in their holdings. Speculators (traders) are just gambling and feeding the brokers with unnecessary commissions. – Jack Swayze Sr Dec 22 '15 at 15:57
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There are strategies based on yields. Dogs of the Dow being a specific example while Miller Howard has a few studies around dividends that may be of use if you additional material.

Selling off a portion of the holding can run into problems as how could one hold 10 shares, selling a non-zero whole number every year for over 20 years if the stock doesn't ever pay a dividend in additional shares or cash?

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Mostly we invest in companies to make money.

The money can be paid to as in the form of dividends that are a share of the profit. Or the company can convince enough people that it will make a lot higher profit next year, so its stock prices increases.

Clearly a company that reinvests its 20% profit from one shop to open an 2nd shop is doing well and is a good investment.

But, But, But... we only have the companies word for it! A dividend paying company finds it a lot harder to hide bad news for long, as it will not have the money in the bank to pay the dividends.

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Someone who buys a stock is fundamentally buying a share of all future dividends, plus the future liquidation value of the company in the event that it is liquidated. While some investors may buy stocks in the hope that they will be able to find other people willing to pay more for the stock than they did, that's a zero sum game. The only way investors can make money in the aggregate is if either stocks pay dividends or if the money paid for company assets at liquidation exceeds total net price for which the company sold shares.

One advantage of dividends from a market-rationality perspective is that dividend payments are easy to evaluate than company value. Ideally, the share price of a company should match the present per-share cash value of all future dividends and liquidation, but it's generally impossible to know in advance what that value will be. Stock prices may sometimes rise because of factors which increase the expected per-share cash value of future dividends and liquidations.

In a sane market, rising prices on an item will reduce people's eagerness to buy and increase people's eagerness to sell. Unfortunately, in a marketplace where steady price appreciation is expected the feedback mechanisms responsible for stability get reversed. Rapidly rising prices act as a red flag to buyers--unfortunately, bulls don't see red flags as signal to stop, but rather as a signal to charge ahead.

For a variety of reasons including the disparate treatment of dividends and capital gains, it's often not practical for a company to try to stabilize stock prices through dividends and stock sales. Nonetheless, dividends are in a sense far more "real" than stock price appreciation, since paying dividends generally requires that companies actually have sources of revenues and profits. By contrast, it's possible for stock prices to go through the roof for companies which have relatively few assets of value and no real expectation of becoming profitable businesses, simply because investors see rising stock prices as a "buy" signal independent of any real worth.

  • You write "In a sane market, rising prices on an item will reduce people's eagerness to buy and increase people's eagerness to sell." But isn't it the case that (in a sane market), rising prices are due to people's increased eagerness to buy? – mark3292 Dec 24 '15 at 7:15
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    @mark3292: Precisely. In a stable system, it is important that feedback loops have negative gain. Some good becomes scarce, people become more eager to buy it, prices rise, people become less eager to buy and more eager to find alternatives, and the good will consequently become less scarce. If rising prices spur demand, this will in turn push prices even higher, and spur more marketplace demand. This will make people holding the good seem richer, but the actual quantity of the good for which there is any genuine need will be unaffected. – supercat Dec 25 '15 at 16:35
  • @mark3292: It's possible for speculators/investors to pump an essentially unlimited amount of money into a bubble market, but the total amount of money they'll get out is essentially fixed. Any money injected beyond that will be effectively lost to the people who contributed it (in essence, it will be a gift to earlier investors). – supercat Dec 25 '15 at 16:37
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Dividends are one way to discriminate between companies to invest in.

In the best of all worlds, your investment criteria is simple: "invest in whatever makes me the most money on the timeline I want to have it." If you just follow that one golden rule, your future financial needs will be taken care of!

Oh... you're not 100% proof positive certain which investment is best for you? Good. You're mortal. None of us magically know the best investment for us. We wing it, based on what information we can glean. For instance, we know that bonds tend to be "safer" than stocks, but with a lower return, so if something calls itself a bond, we treat it differently than we treat a stock.

So what sorts of information do we have? Well, think of the stock market linguistically. A dividend is one way for a company to communicate with their stockholders in the best way possible: their pocketbooks. There's some generally agreed upon behaviors dividends have (such as they don't go down without some good reason for it, like a global recession or a plan to acquire another company that is well-accepted by the stockholders). If a company starts to talk in this language, people expect them to behave a certain way. If they don't, the stock gets blacklisted fast. A dividend itself isn't a big deal, but a dividend which isn't shunned by a lot of smart investors... that can be a big deal.

A dividend is a "promise" (which can be broken, of course) to cash out some of the company's profits to its shareholders. Its probably one of the older tools out there ("you give investors a share of the profits" is pretty tried and true). It worked for many types of companies. If you see a dividend, especially one which has been reliable for many years, you can presume something about the type of company they are.

Other companies find dividend is a poor tool to accomplish their goals. That doesn't mean they're better or worse, simply different. They're approaching the problem differently. Is that kind of different the kind you want in your books? Maybe. Companies which aren't choosing to commit a portion of their profits to shareholders are typically playing a more aggressive game. Are you comfortable that you can keep up with how they're using your money and make sure its in your interests? It can be harder in these companies where you simply hold a piece of paper and never get anything from them again.

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    "you can presume something about the type of company they are" -- specifically, that they seek to generate more cash than they will use for new business opportunities and acquisitions. It's always good to generate more cash (all else being equal), but as you say it's not necessarily better to leave cash in the bank, or aggressively spend it, than it is to give it to investors. Some companies have too much cash in the opinion of almost everyone (whether they even can efficiently repatriate it in order to pay it out is another matter). – Steve Jessop Dec 27 '15 at 1:58
  • But actually I think from the way the question was asked, the questioner is not interested in what dividends reveal about fundamentals. Rather, they wish to hold everything equal and argue that investors should not care about the difference between two companies that are exactly the same except that one is paying a dividend at a particular time and the other is not, because total return is the same either way! – Steve Jessop Dec 27 '15 at 2:02
  • @SteveJessop You're probably right, but I have a tendency to wax philosophical on some of these issues because there's clearly a difference, or we wouldn't have been taught there was one, but pinning down exactly what the difference is can be quite tricky. I have a tendency to challenge the assumption that you can say "assume everything is the same except X" because its remarkably, even frustratingly, difficult to change something like this about a company without a whole host of corresponding underlying changes. Trying to synthetically differentiate them can often add more confusion. – Cort Ammon Dec 27 '15 at 2:57
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The upvoted answers fail to note that dividends are the only benefit that investors collectively receive from the companies they invest in. If you purchase a share for $100, and then later sell it for $150, you should note that there is always someone that purchases the same share for $150. So, you get $150 immediately, but somebody else has to pay $150 immediately. So, investors collectively did not receive any money from the transaction. (Yes, share repurchase can be used instead of dividends, but it can be considered really another form of paying dividends.)

The fair value of a stock is the discounted value of all future dividends the stock pays. It is so simple! This shows why dividends are important.

Somebody might argue that many successful companies like Berkshire Hathaway do not pay dividend. Yes, it is true that they don't pay dividend now but they will eventually have to start paying dividend. If they reinvest potential dividends continuously, they will run out of things to invest in after several hundred years has passed. So, even in this case the value of the stock is still the discounted value of all future dividends. The only difference is that the dividends are not paid now; the companies will start to pay the dividends later when they run out of things to invest in.

It is true that in theory a stock could pay an unsustainable amount of dividend that requires financing it with debt. This is obviously not a good solution. If you see a company that pays dividend while at the same time obtaining more cash from taking more debt or from share issues, think twice whether you want to invest in such a company.

What you need to do to valuate companies fairly is to estimate the amount of dividend that can sustain the expected growth rate. It is typically about 60% of the earnings, because a part of the earnings needs to be invested in future growth, but the exact figure may vary depending on the company. Furthermore, to valuate a company, you need the expected growth rate of dividends and the discount rate. You simply discount all future dividends, correcting them up by the expected dividend growth rate and correcting them down by the discount rate.

  • "The fair value of a stock is the discounted value of all future dividends the stock pays" -- supposing that we consider the proceeds of any hypothetical final liquidation or private sale of the company to be a 100% dividend :-) Which is a perfectly reasonable definition for the purpose, but it does create a special case that I suspect the questioner isn't considering when they talk about whether a company "does" or "doesn't" pay dividends. – Steve Jessop Dec 27 '15 at 2:09
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Why do people talk about stock that pay high dividends? Traditionally people who buy dividend stocks are looking for income from their investments. Most dividend stock companies pay out dividends every quarter ( every 90 days). If set up properly an investor can receive a dividend check every month, every week or as often as they have enough money to stagger the ex-dates. There is a difference in high $$ amount of the dividend and the yield. A $1/share dividend payout may sound good up front, but... how much is that stock costing you? If the stock cost you $100/share, then you are getting 1% yield. If the stock cost you $10/share, you are getting 10% yield. There are a lot of factors that come into play when investing in dividend stocks for cash flow. Keep in mind why are you investing in the first place. Growth or cash flow. Arrange your investing around your major investment goals. Don't chase big dollar dividend checks, do your research and follow a proven investment plan to reach your goals safely.

  • Hi, James, welcome to Money.SE. This is not a site to place links that have no context. If you quote IRS regs, or a Forbes article, by all means, offer the link to the source. Tacking on a link to an answer (with no context) looks like spam. – JoeTaxpayer Nov 30 '16 at 19:48

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