From what I understand, dividends aren't free money as the amount you receive is taken from the price of the stock. So in a way, distributing dividends is forcing you to sell your stock as your net worth doesn't change, but your stocks got converted to cash.
So my question is, why do people chase dividend stocks or build dividend portfolios when you can get the results by just selling the stock?
ELI5 why do people chase dividend stocks?
byu/Specific_Ad_6522 ininvesting
Posted by Specific_Ad_6522
25 Comments
Because they’re mathematically illiterate.
Some people believe that dividends are an indicator that the company is focused on giving capital back to shareholders. Some prefer the consistency of a business that keeps turning a profit and giving its owners a piece of that profit, and are content to have less capital growth. Some want the flexibility of incoming cash payments, and don’t want the decision to reinvest into the company being forced on them.
simpler to have a steady income instead of having to actively sell
Terminal mathematical and financial illiteracy
A truly awful disease
>**From what I understand**, dividends aren’t free money as the amount you receive is taken from the price of the stock…
I’m sorry to tell you this, but you do NOT understand.
First, dividends are simply a share of the profits of the business. It is like you are the owner of a business and you pay yourself a salary out of the business earnings. All this malarkey about the stock price being adjusted down is true, but totally irrelevant.
Retirees like dividend payments because cash piles up in the account rather predictably as the year goes on, providing a base of cash to supplement other retirement income sources. This income is much more predictable than knowing what stock prices are going to be throughout the year so that one can avoid selling when stocks are down (and they do go down, and sometimes stay down for years).
The dividends are taxed in the year earned, so that creates a tax drag on the portfolio in taxable accounts. However, the taxes are a non-issue when the dividends are collected in an IRA or Roth.
Would I as a 30 year old invest in a portfolio of Utility stocks? No. As a retiree could that make sense? Yes, it could.
I have dividend stocks but it reinvests so I get more and more shares. When I retire I’ll put my account in a few dividend funds to have quarterly paychecks because stores don’t like accepting stocks for groceries.
Here’s an extreme illustration. Steve Ballmer makes 1 billion a year in dividends.
Dividends are extra money. You can either have them deposited in your cash account or you can have them rolled back in to buy more stocks automatically. They are either an extra boost to investments or they’re extra income.
You need quite a bit these days to add up to much, but it’s still more money. Even if it’s an extra 1000 a year, that’s a $1000 to spend or invest.
First I want to say “chasing dividends” typically means you are investing in companies with a high dividend, often unable to sustain it, so you end up losing out when they cut it.
Otherwise as one person said, if you are paying dividends and have been for years, then that shows that you are profitable, and returning something to shareholders. Stock can go up, but stock can collapse when overhead explodes due to new CEO or something.
Typically dividend companies are focused on being profitable, and becoming more efficient , that they already have a solid product that people want. J&J has their shampoo, there isn’t a huge need to innovate there, but they can make it more efficient. Also nothing stops someone from taking those dividends and buying up more shares.
The case where non-div wins is if AND ONLY IF the company is taking that money, and reinvesting it in a way that could produce more. If they give everyone a 10% raise, and produce 2% more output, then a good chunk of my dividend is going to non-productive things.
Also, many div’s go up with inflation, because there is no real innovation happening, when input costs go up, item costs go up, margins stay the same, but same margin on more expensive item means more money, thus more dividend. For example there is a stock that I have that pays 6% div at current share price, but I bought it back when it was 1/3 of the share price. That is effectively making me get an 18% dividend on my original money.
With enough dividend stocks, your account is constantly getting little bits of money, and then if you are like me, and like to pick stocks, that is “fun money” to pick stocks. I am not putting more of my paycheck in.
If they’re retired it’s not a terrible way to get some income, you could do worse (yes you can also do better)
1. Income: income means money “coming in”. Not all investors are future-minded.
2. Dividends often mean stable profits for the companies issuing the dividends – less risk profile.
They don’t understand how taxes work
Where the hell did you get the idea that dividends come out of the price of the stocks?
I put about $20,000 into Applied Materials stocks over the last five years.
I get paid around $60.00 in dividends every three months.
That $20,000 in stocks is now worth more than $81,000.
Approximately 75% of the companies within Berkshire Hathaway’s public equity portfolio produce dividends. While BRK doesn’t pay a dividend, Buffet likes to receive them.
Total return = dividends received + the change in share price
This is how *all* investors make money.
Since you seem willing to believe that retained earnings drive share price growth, then all you need to know is that as long as dividends paid are less than profit earned, retained earnings grow, thus growing the share price.
How returns are paid doesn’t fundamentally matter. You always make money when the company makes money.
It’s a good litmus test for intrinsic value without getting deep into manual price discovery
https://freedomisntfree.co.uk/articles/what-is-intrinsic-value
I try to get my longterm portfolio to at least a 5-7% yield. Most of that money goes into SPYM, a portion into SPYI, and a portion into beat down stocks. I wouldn’t say I’m chasing it but it takes a lot of drag off of my salary contributions to stocks and I can keep a bit more cash from my job. So I wouldn’t say I chase them, I like to buy them when they are beat down.
The basic idea is that a company can fake cash flows earnings revenues etc but it can’t fake dividends. So dividend bearing companies tend to be safer companies.
Old
I don’t necessarily chase dividends but I expect companies to return capital to shareholders if they cannot use it to organically/inorganically grow the company at an appropriate return on invested capital.
Returning capital to shareholders through buybacks relies on the management/board of the company timing the repurchase of its stock. Many companies enjoy repurchasing their own stock at record highs rather than record lows, which you may not want as a long term investor.
LOL who told you dividends are “taken” from the price of stocks? That is not true at all
Think you have a misunderstanding of the concept of dividends.
Dividends are simply an extra payout by the company to all the shareholders. It is paid from the company’s earnings and is a discretionary choice of the company on how much and when to pay.
They aren’t intelligent.
It’s actually worse than being forced to sell your stock, since you pay ordinary income tax rates instead of long-term capital gains.
As to the reason… Us in the asset management industry have scratched our heads over this for quite some time. The simple answer is: people just like having the dividend checks come in.
No amount of “this is better from a tax perspective!” Or “paying yourself a dividend is the same as being paid a dividend” does any good. People just want it.
dividends have 0 tax where ilive
I know it’s a tax drag, but at the end of the day, no investment is guaranteed.
At least if you’ve had distributions, you’ve realized some return on your investment.