Why Dividends Don't Actually Matter ❌

I continue to see posts online from investors not understanding how dividends work. Let's go back to financial basics and talk about why dividends don't actually matter for returns.

First of all, what is a dividend? A dividend is a payment to the shareholders of a company directly from the profit of the company (hopefully). If you own 1 share of a stock at $100, the company can decide to pay you $1 a year in dividends, or a 1% yield. This is usually on a schedule such as quarterly payments, meaning you get 25 cents every 3 months. This payment is coming directly from the company and straight to your account.

The amount that is paid out to you as an investor is now taken out of the share price on the ex-dividend date (the day before the dividend is paid out, you need to buy a stock before this date to receive a dividend). This means when a dividend is paid out the share price will drop the same amount. If a company is $100 and pays out a $1 dividend, the share price will drop by $1. The problem is stocks are affected by other things and you may not actually see it on the graph.

A good example of it however is one I found called $TILL. If you look at Dec 22 2023, there was a massive $11 dividend payment, and so you can see the share price was directly affected by the payment. This same principle is happening with every other company.

This is where the phrase "Dividends are irrelevant" comes from, it's not that they don't matter, it just means it does nothing for your returns. You could have not been paid a dividend and kept it the same. This is why the "dividend snowball" is a common myth; The money you took out of the share price as a dividend is now just being put back in, there is no snowball to speak of.

So why are people so focused on dividends? For a few different reasons. The main one is a feeling of "income". You receive regular payments and you feel you're getting passively paid to own a business. You might fill your portfolio with high yielding companies to get those high "payments", but actually you're just moving cash from one hand to the other. You buy something like $ENB or $TD to retire off of dividends, but you're not actually getting passively paid, it's just moving from the company to you pocket.

Let's say you can buy 2 companies, one that goes from $100 to $110 with no dividend, or one that stays at $100 but has a 5% yield? Many might pick the one with a yield because share price doesn't matter to them, but you're actually doing yourself a disservice. If you pick the yield, you will end up with less money, that's a fact. You might get paid $5 every year, but what you can instead do is create your own "income" by selling shares. You sell $5 worth of shares on the $110 stock and you still end up with more money.

This is the other reason people like dividends, they can't psychologically bring themselves to sell shares. If a stock goes from $100 to $110 and I sell 5% worth of shares, I now have $5 in cash and 0.95 shares that are worth $104.50. I actually have MORE money and yet my shares went down. You might think that you'll run out of shares to sell, but that's incorrect. As long as the DOLLAR value of your shares continue to increase past what you withdraw, you'll still have shares to sell. Think of it like this, would you rather have 1 share worth $100, or 0.1 shares worth $500? I know what I would pick.

Dividends themselves are also not a sign of a good or bad company. Many companies that pay dividends are good, many that don't are bad, and vice versa. $ENB is a common bought company, and yet they actually carry a great amount of risk. They have a Payout Ratio of over 100%, which is how much of the company's profit that is paid out to shareholders. That means the business is paying dividends for MORE than the amount of money it makes. That's a big risk to take.

Higher yields often lead to worse returns and a worse business. There is a reason that tech companies often don't pay any dividend, they have better ways to invest the capital either through share buybacks or investing in the company themselves. A company that can invest internally will produce more returns than one that pays out more dividends. A business that has the ability to invest in itself will only slow down it's returns if it chooses to pay you as a shareholder instead.

Remember, your takeaway shouldn't be that dividends are bad, but rather they are only one portion of your TOTAL returns in your portfolio. $XEQT and $VFV both get dividend payments, and that is just one portion of how much returns you receive for the risk you take owning them. There are different tax implications for different kinds of payments, but when it comes to just returns dividends are no different than capital gains.

If you've been chasing dividend payments or yield, remember to learn how a dividend actually operates in a company, it's not free magic money.

If you do want to learn more about finance, make sure to subscribe to the newsletter below. As always, do your research and happy investing!
relatablefinance.substack.com

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253 Comments

Mr Financial

@mr.financial · 10moEdited

I love how the topic, why dividends don't matter in regards to total returns, goes completely over people's heads 😆 Maybe a take home point at the end would create less confusion ? 🤷 Either way it was a clear and well articulated post buddy.

In any case, I thought I'd add some context to why dividend paying stocks (not covered call distributions) can play a 'role' in porrtfolio construction leading to and in retirement (also why some institutions allocate to them).

1. They are usually very mature companies with a history of weathering market crashes

2. They usually have lower volatility (beta) and the depth of drawdowns is reduced compared to the broad market. This is due to the nature of the industries and factor exposures of DGS.

3. They produce real cashflow (we are not taking option premium here) from company profits sustainably, even during market turmoil for the majority

4. They can continue to grow payouts during flat price movements or poor market conditions due to the industries they are usually from

4. They can reduce sequence of returns risk during down markets early in retirement. not selling shares in the early stage of retirement can be a game changer for crashes. (This doesn't apply to cc ETFs since they are not cashflow producing)

5. Dividend growth stocks are a natural screen or have a natural bias towards quality, value, low vol and high yield factors. This usually also means the companies are good capital allocators, have strong balance sheets, consistent FCF, usually avoid risky leverage for growth

6. Can be a counterbalance to inflation. The dividend growth will increase unlike bonds. It can even outpace inflation in high inflation markets. That's a reason for endowments to have an allocation to DGS

7. Dividend growth stocks have a benefit to investors psychologically. They tend to want to hold despite prolonged bear markets. It's a trade off for likely lower total returns

8. Portfolio construction benefits. DGS behave differently than pure value or growth stocks or bonds. It may add to different factor exposures like quality, low vol, high dividend as mentioned.

9. Dividend growth can serve as a signal. When management turns on the tap of dividends, it's difficult for them to turn it off, leading to forced balance sheet discipline

10. Dividend growth investors have been studied for their market resilience and better overall market behavior due to seeing continually growing cashflows

11. They can be very tax efficient at low income levels. A qualified dividend in Canada, even after being grossed up, is tax free to about 80k in BC. This allows investors to have better control of their realized capital gains lowering tax drag.

12. Dividend growth stocks can be easier to value than pure growth or value stocks. Reversion to the mean is likely for companies with decades of historical yields. Payout ratios. Historical growth rates... All can be used to'value' DGS

These are just some of the reasons. I'm sure I can think of more. 😂

HOWEVER, dividend growth stocks make up a SMALL portion of the global market... meaning you're reducing your odds of an average total return because of that and can have overexposure to certain industries on top of that.

This should of been a post 😂

Gus Hk@bond747 · 10mo

Dividend matters ! Especially if you're in retirement and want a preset amount to live on .
I can rely on my RY or FTS etc...to pay for my expenses and I don't care about their price fluctuations but good luck when you're holding xeqt or vfv for example and it drops 30 or 40% and sell shares in order to live , try and do your calculations taking the loss decade example and sell your shares during years of negative return and when the only return was from dividends. Anyways enjoy your calculations and the paper gain that you accumulate and I repeat it's paper gain because it could all disappear in a second but in the mean time I'll enjoy rolling my growing dividends. Anyways personal finance is personal and whatever makes you sleep better at night.

Ja Ch@jacooch · 10mo

And as we thought no one is gonna bring this debate in 2025 again…

And no. Dividends has its place.

Example: if you consider total return as your investing metric, you will need to eventually sell to live off your investments.

Dividend is the bridge where once I get to my living expenses, I actually DONT have to sell and these stocks will pay in perpetuity. Of course, this is assuming you bought blue chip stocks and not high income dividends where you got tons of NAV erosion.

To each their own.

Kenway

@kenway · 10mo

How about we just all do our own investing with what works for each individual investor. Save your bandwidth for useful things, rather than crap on someone else’s choices.

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