How are dividends for retirement

[Dash man]

This is what Nobel-winning economist Merton Miller called "home made dividends." https://www.investopedia.com/terms/h/homemadedividends.asp

Switch gears slightly: The trend towards stock-buybacks is something that has not been discussed much here. One major reason for the trend is tax efficiency. As mentioned, dividends get taxed when received, so essentially the dividend-payer is doing tax planning for the shareholder. Buybacks increase the price of the remaining shares, allowing the shareholder to determine when to recognize the gain for tax purposes and, presumably, make sure it is taxed as a capital gain. So IMO dividend hawks should be seeking out companies doing buybacks with just as much energy as they apply to seeking out dividend payers. Buybacks are a superior method for the company to distribute assets to shareholders.

That remains to be seen now that Congress has started taxing companies that buyback shares. (No politics please!)
They started small, but they have their foot in the door.

 

[aja8888]

That remains to be seen now that Congress has started taxing companies that buyback shares. (No politics please!)
They started small, but they have their foot in the door.

I remember when stock buybacks were illegal. Now companies with little or no earnings borrow money to buy back stocks.

 

[Billy C]

Buybacks are a superior method for the company to distribute assets to shareholders.

I respectfully disagree.

Executive compensation is frequently tied to share price which gives companies a perverse incentive to favor buybacks over dividends. But since buybacks often come with the new issuance of stock options for executives and other employees, this negates some of the share reduction benefits for regular investors.

Furthermore, the new 1% excise tax on stock buybacks is estimated to cost shareholders $74 billion over the next decade according to recent estimates from the Joint Committee on Taxation:

https://www.jct.gov/publications/2022/jcx-18-22/

Dividends are exempt from that tax, making them a superior way to return excess cash to shareholders.

 

[bada bing]

Just wonder what you guys think of Warren Buffett's investment style?

Each year, Warren Buffett collects billions of dollars just from dividends. In fact, the majority of Berkshire Hathaway’s holdings are now dividend stocks.

I didn't post the above to argue the math. I just find it interesting that so many poo poo the idea of dividend investing.

Just as aside, by invoking Warren Buffet on dividend investing, it's useful to remember that Berkshire Hathaway does not pay a dividend explicitly for the reasons several have posted in this thread. Warren will take the dividends from holdings and invest them internally, but he is explicitly negative on paying them out.

Despite being a large, mature, and stable company, Berkshire Hathaway does not pay dividends to its investors. Instead, the company chooses to reinvest retained earnings into new projects, investments, and acquisitions.

 

[youbet]

that’s not how any stock/fund should be valued. And to say a stock would be worth more if a dividend wasn’t paid is also an inaccurate statement. A stock is only worth what a buyer is willing to pay. .

I've noodled that same concept and admit it often befuddles me too. For example, when BP cut their dividend and paid out less than expected, the stock did not increase in market price because they retained the cash that was expected to be paid out. The stock price decreased because buyers were willing to pay less.

I'm certainly no expert on equity pricing, but it does seem to me that the market price involves a complicated and changing relationship between the mathematical calculations involving future earnings, the value of the company as calculated on the balance sheet, etc., and the more subjective pricing developed in a free marketplace between willing buyers and sellers.

 

[COcheesehead]

I've noodled that same concept and admit it often befuddles me too. For example, when BP cut their dividend and paid out less than expected, the stock did not increase in market price because they retained the cash that was expected to be paid out. The stock price decreased because buyers were willing to pay less.

I'm certainly no expert on equity pricing, but it does seem to me that the market price involves a complicated and changing relationship between the mathematical calculations involving future earnings, the value of the company as calculated on the balance sheet, etc., and the more subjective pricing developed in a free marketplace between willing buyers and sellers.

I don’t follow BP, but I do follow gas prices that have gone down dramatically. Maybe that had something to do with it.

 

[ERD50]

Quote:
Originally Posted by TripleLindy View Post
that’s not how any stock/fund should be valued. And to say a stock would be worth more if a dividend wasn’t paid is also an inaccurate statement. A stock is only worth what a buyer is willing to pay. .

I've noodled that same concept and admit it often befuddles me too. For example, when BP cut their dividend and paid out less than expected, the stock did not increase in market price because they retained the cash that was expected to be paid out. The stock price decreased because buyers were willing to pay less. ....

Well, I'm not familiar with the specifics of BP, I'm making the case based on pure economics and "all else being equal", which is seldom the case, which is why we go back to basics.

But I googled BP dividend cut, and found this (emph mine):

https://www.barrons.com/articles/bp...oss-heres-why-the-stock-is-rising-51596549281

BP Cuts Dividend for the First Time in a Decade After Record Loss. Why Its Stock Is Rising Anyway.

But if BP cut it's dividend due to poor performance and inability to pay the div, that could certainly explain a drop in the stock price. It doesn't appear to be a case of "we are going to take the div we normally distribute, and keep it on our books", which is what I'm talking about.

-ERD50

 

[youbet]

Well, I'm not familiar with the specifics of BP, I'm making the case based on pure economics and "all else being equal", which is seldom the case, which is why we go back to basics.

But I googled BP dividend cut, and found this (emph mine):

https://www.barrons.com/articles/bp...oss-heres-why-the-stock-is-rising-51596549281



But if BP cut it's dividend due to poor performance and inability to pay the div, that could certainly explain a drop in the stock price. It doesn't appear to be a case of "we are going to take the div we normally distribute, and keep it on our books", which is what I'm talking about.

-ERD50

Well, I tried to think of a straight forward example and failed I guess. BP cut its div and almost simultaneously announced additional plans for a change in business strategy and direction which did cause the market price of the stock to go up temporarily. But since then it dropped below the level it was at at the time of the div cut. (I'm out about 10 kilobux, so I noticed! ) Over this time, I've read the BP div cut as contributing to a lower stock price. That's my story and I'm sitickin' to it.

Where I think we disagree is that I believe the appropriateness of a div is linked to the business the company is in. Some companies I look at appear to be companies in businesses where I would prefer that they retain earnings and deploy them and perhaps achieve growth. Others, I am much happier having them send some of the earnings to me and pay me as they go along. I don't see them as having significant growth opportunities in their business despite being profitable enough to have earnings and pay dividends or have stock buy-backs.

IOW, is the div being paid (including zero div) appropriate for the company and the business/market they are in?

 

[all4j]

Nope. Not saying that. Who looks at just the next day? I understand the concepts, but that’s not how any stock/fund should be valued. And to say a stock would be worth more if a dividend wasn’t paid is also an inaccurate statement. A stock is only worth what a buyer is willing to pay. Sometimes, a dividend is a factor in that valuation. My point is, when evaluating performance over the long term, dividend or not is not important. Overall performance, including dividend or not, is. I’m perfectly happy with my portfolio, which includes dividends that will fund 50% of my expenses in my early retirement. No one else has to be happy with it but me.

An open missive to TripleLindy…

A lengthy message of support. Won’t be universally accepted, but no one has to like as you said!

I started to put this into a pm, but decided there might be someone else who could benefit. I didn’t read the entire thread, but not my 1st dividend rodeo. Not singling out anyone. But, I once thought ‘most’ came to these boards to learn and/or share learning. I wish someone had shared with me the following perspective. Initially (previous thread/boards), I was really puzzled where some of this came from. Then I started to see the perspective of others. While I still disagree, I see why they misunderstand & I’m not trying to change their minds. I’ll walk thru some examples from this thread.

Bottom line, there are some who see share price of individual stocks as a nav. IF someone has that attitude, then you start to see where they get the idea of “free money”, “forced sales” , etc.

If you think share price is a nav, then share price is a math function. Subtract $ from the assets to distribute, it must lower the share price. Otherwise, you would have received money without it affecting your nav – thus you think you are getting it for free. Basically, it would be the same as share price equaling book value. If you are like me, you realize that isn’t how share prices work & so that never occurred to me. When I was 1st accused of thinking that, I was thrown as I hadn’t said that. Then I realized it was only put forth from one side of the discussion.

Before I address “forced sales” clue, it is important to highlight some of my views on share price. Share price isn’t a byproduct of a math calculation. The price is set in the marketplace where it is driven by supply (sellers) & demand (buyers), both of which have multiple motivations & objectives (as you touched on). No one manipulates the share price so that it is lowered by dividend (or anything else). There will be differences in how a “fair price” is determined. That gets me to another tangent that I’ll come back to. But in general, one approach is to determine an earnings stream over a period of time, factor in the risk of actually receiving that, and determining a fair compensation for investing capital (that is, time value of money).

So, regarding the idea of it being a “forced sale” – expressed in different ways. If I actually do sell a share of stock, then I receive cash from another party (admittedly could be the company, but that’s the exception and not the rule) AND I give up my claim to that portion of future earnings. The company assets are not affected. If a dividend is paid, there isn’t another party, the cash comes from the company, AND I still have the same claim on future earnings. The similarity is only found in the amount of $ you receive (wasn’t sure what term would suffice if we’re in denial of it being income). May not even be taxed the same. How is that “exactly the same”? It is IF you don’t really understand the dividend process.

I’ll cycle back to another ‘theory’ I have on this. I would suggest that most individuals today that own stocks (not necessarily those who’ve posted on here) do not buy individual stocks nor go through the valuation process. For example, money may be deducted from a paycheck & sometime later a 401k balance shows more in stocks. Often allocated to an index where there are lots of individual stocks that aren’t directly valued anyway.

So, consider the difference in someone who sees owning stocks as numbers on a screen and someone who sees themselves as owner of a business. Think they see “share price” the same, or even put the same valuation on it?

BTW, I don’t see the point in arguing the counterfactuals of what-ifs. For the most part, companies are paying dividends with that knowledge in advance. They manage their cash to that end & there is some level of discipline required. It wasn’t a surprise to them & the projected earnings were projected with that in mind. So, valuation when bought was made expecting $ to be received in that time frame & also impacted risk. It doesn’t sit there like a slice of bread, but can be put to work. Whether that is more productive than leaving it in company coffers depends on lots of factors. It is almost amusing though to watch the twisting of scenarios!

 

[Winemaker]

I believe this is the easiest explanation of receiving dividends, and when the price is lowered to reflect that dividend.

https://www.investor.gov/introducti...-dividend date for,date, you get the dividend.

 

[ERD50]

...
Where I think we disagree is that I believe the appropriateness of a div is linked to the business the company is in. Some companies I look at appear to be companies in businesses where I would prefer that they retain earnings and deploy them and perhaps achieve growth. Others, I am much happier having them send some of the earnings to me and pay me as they go along. I don't see them as having significant growth opportunities in their business despite being profitable enough to have earnings and pay dividends or have stock buy-backs.

IOW, is the div being paid (including zero div) appropriate for the company and the business/market they are in?

No, I'm fine with that. What I rally against is the idea that the dividend didn't have a drain on the stock, that it appeared w/o some opposite and equal reaction.

So OK, if that company doesn't have good investment growth opportunities, maybe it is best for them to distribute their cash flow. But even in that case, as they accumulate their cash over the course of the quarter, on their ex-div date, that cash moves off their books and onto the shareholders, their value decreases (and if this is stable, increases again as the quarter proceeds).

Of course, I also wonder if that's a good company to invest in, if they don't think they have anything better to do with that money than the shareholder, why not give them all of it (close down the company!)? OK, maybe they are a cash cow, but have limited growth opportunities - up for the investor to decide if that is appropriate for them.

-ERD50

 

[stevemac]

This has been a really interesting thread, and thanks to all who've taken the time to add their insights and experience. I'm grappling with a fundamental issue about the nature of the investments, vis-a-vis Dividends versus LTCG sales. My question below is from the perspective of someone already retired, in my early 60s, in case that colors the responses.

Quick background: My taxable account is currently largely made up of SCHB, and at some point next year I will have to generate cash as my cash bucket gets used up (I've been converting IRA to Roth for the past couple of years while using up cash, in order to both convert against future RMDs and to keep my income low enough for large ACA subsidies). I plan to do a conversion this year as I have enough cash to take me into Spring of next year (all things being equal).

As of yesterday, the taxable account SCHB is in positive territory by about $1 dance, and any sale would include a small amount of LTCG. Assuming the situation is roughly similar next spring, I have two options:

1. Sell some SCHB for cash, and pay the LTCG tax;
2. Do the same, but then use some or all to generate cash flow by buying a higher-dividend ETF like SCHD (some of which I already hold in tax-advantaged accounts but am not distributing now), or possibly JEPI or XYLD.

Here's where I grapple with the Dividend issue:

If I sell for cash, the asset is gone and no longer could generate future income (from stock sale or Dividends), while the stock may well return to the same level, all while generating. If I invest in a higher-Dividend ETF, I keep the asset and have current and future cash -- though possibly not yearly as much as a straight sale of ETF shares.

Through all this what strikes the hardest (and thus may distort the proper analysis), is that a straight sale for cash deprives future income -- it's really quite a puzzle.

Thanks for any insights.

 

[ERD50]

... So, regarding the idea of it being a “forced sale” – expressed in different ways. If I actually do sell a share of stock, then I receive cash from another party (admittedly could be the company, but that’s the exception and not the rule) AND I give up my claim to that portion of future earnings. The company assets are not affected. If a dividend is paid, there isn’t another party, the cash comes from the company, AND I still have the same claim on future earnings. ...

I fail to see the distinction here.

Say I own 100 shares of XYZ @ $99/share. Over the quarter all their business is running steady and as expected, they've grown cash by $1/share, that is known so their stock the day before ex-div is $100.

They pay the div, and ex-div is back to $99. I still own 100 shares at $99/share and have $100 of dividends in my pocket. I 'own' 100 x $99 = $9,900 worth of the company.

Now look at the same scenario where XYZ does not pay a div. The stock is at $100, and I sell 1 share, so I have $100 in my pocket. I still 'own' 99 x $100 = $9,900 worth of the company.

We both have $100 in our pockets, and we both still have the same investment in future earnings of the company, either way, right? What was lost in the scenario where the investor sold stock to raise the pocket money?

And if this is taxable to the investor, the entire $100 in divs is taxable, but only the gain is taxed on the sale. IIRC Qual divs and LTCG are treated the same, so that's an advantage to the sale (if either is taxable).

-ERD50

 

[RetireAge50]

In your example if you started out with 50% of the shares you end up with less shares because you sold right? What if the valuation of a company is based on some really valuable patents where the cash is coming in 10 years. The current dividend plays very little importance in the stock value but the percentage I own is very important.

 

[ERD50]

In your example if you started out with 50% of the shares you end up with less shares because you sold right? What if the valuation of a company is based on some really valuable patents where the cash is coming in 10 years. The current dividend plays very little importance in the stock value but the percentage I own is very important.

Look again at my example (I assume this was directed at me?).

In each case, the same $ amount is invested in the company, so the ability to benefit from any future gains would be the same. In one case, the investor sold some to get the cash flow (and what would have been the dividend stayed in the company, raising the share price). In the other case, the company distributed that dividend and it didn't remain as part of the company's value.

That's why a dividend is often referred to as a 'forced sale'.

In the end, (outside of taxes and tax planning), it makes no difference if the company decided to give you $100 worth of their value, or you decided to sell $100 worth of your holdings. It all comes from the same pile (the stock you own). Just 2 different subtractions.

edit/add: I recall going through this exercise a few years back - someone said "but, but, but... after X years, you'll only own ONE SHARE!!!!!". OK, so I did a spreadsheet, and it's clear that the values are all the same, regardless if the dividend is paid, or retained, but some % of shares sold off. So yes, you end up with one share. But that one share (in this example) was worth $1,000,000! Because all the dividends kept accumulating, rather than being siphoned off. Again, there's only one place for that money to come from.

-ERD50

 

[RetireAge50]

The dividend forces all the shareholders to sell and everyone keeps the same percentage ownership. Without a dividend I would need to sell to the other shareholders for money.

 

[ERD50]

The dividend forces all the shareholders to sell and everyone keeps the same percentage ownership. Without a dividend I would need to sell to the other shareholders for money.

The same percentage of a smaller pie, or a smaller percentage of a larger pie. It's all the same thing.

-ERD50

 

[RetireAge50]

I don’t invest in stocks for the dividends just the overall historical 10% is all I care about. The rest is semantics.

 

[RetireAge50]

The same percentage of a smaller pie, or a smaller percentage of a larger pie. It's all the same thing.

-ERD50

Ok if that is the case cool.

 

[youbet]

Say I own 100 shares of XYZ @ $99/share. Over the quarter all their business is running steady and as expected, they've grown cash by $1/share, that is known so their stock the day before ex-div is $100.

They pay the div, and ex-div is back to $99. I still own 100 shares at $99/share and have $100 of dividends in my pocket. I 'own' 100 x $99 = $9,900 worth of the company.

Now look at the same scenario where XYZ does not pay a div. The stock is at $100, and I sell 1 share, so I have $100 in my pocket. I still 'own' 99 x $100 = $9,900 worth of the company.

We both have $100 in our pockets, and we both still have the same investment in future earnings of the company, either way, right? What was lost in the scenario where the investor sold stock to raise the pocket money?

And if this is taxable to the investor, the entire $100 in divs is taxable, but only the gain is taxed on the sale. IIRC Qual divs and LTCG are treated the same, so that's an advantage to the sale (if either is taxable).

-ERD50

I think you are intertwining the value of the company (calculated from the balance sheet and number of existing shares) and the price of the stock determined by sometimes subjective buyers and sellers in a free market and reported by the exchange.

Yes, when the $1 div is paid out, current assets decline impacting the value of the company on the balance sheet. But the price of the stock is determined by buyers and sellers in the marketplace.

Most business owners withdraw a percentage of profits to live on as they go along, either private or public companies. I do. I'm only concerned when companies I own are paying (or not paying) out dividends at a level I feel is appropriate for their business situation. A small start-up vs. a cash cow for example.

 

[target2019]

This has been a really interesting thread, and thanks to all who've taken the time to add their insights and experience. I'm grappling with a fundamental issue about the nature of the investments, vis-a-vis Dividends versus LTCG sales. My question below is from the perspective of someone already retired, in my early 60s, in case that colors the responses.

Quick background: My taxable account is currently largely made up of SCHB, and at some point next year I will have to generate cash as my cash bucket gets used up (I've been converting IRA to Roth for the past couple of years while using up cash, in order to both convert against future RMDs and to keep my income low enough for large ACA subsidies). I plan to do a conversion this year as I have enough cash to take me into Spring of next year (all things being equal).

As of yesterday, the taxable account SCHB is in positive territory by about $1 dance, and any sale would include a small amount of LTCG. Assuming the situation is roughly similar next spring, I have two options:

1. Sell some SCHB for cash, and pay the LTCG tax;
2. Do the same, but then use some or all to generate cash flow by buying a higher-dividend ETF like SCHD (some of which I already hold in tax-advantaged accounts but am not distributing now), or possibly JEPI or XYLD.

Here's where I grapple with the Dividend issue:

If I sell for cash, the asset is gone and no longer could generate future income (from stock sale or Dividends), while the stock may well return to the same level, all while generating. If I invest in a higher-Dividend ETF, I keep the asset and have current and future cash -- though possibly not yearly as much as a straight sale of ETF shares.

Through all this what strikes the hardest (and thus may distort the proper analysis), is that a straight sale for cash deprives future income -- it's really quite a puzzle.

Thanks for any insights.

In practical Schwab lingo, SCHB = SCHG + SCHD, or Broad Market = Growth Companies + Value Companies.

In your situtation you sell SCHB for needed income. Pay LTCG tax or reap loss.

In our present case, we use the dividends from SCHD in a taxable account for some needed income. Pay taxes.

You can construct a quad, and compare the outcomes for your case. Even beyond that, if you highly value retaining shares, then your analysis may come out in favor of SCHD.

Since this is nowhere near an explanation of our total portfolio, YMMV.

 

[all4j]

I fail to see the distinction here.

Say I own 100 shares of XYZ @ $99/share. Over the quarter all their business is running steady and as expected, they've grown cash by $1/share, that is known so their stock the day before ex-div is $100.

They pay the div, and ex-div is back to $99. I still own 100 shares at $99/share and have $100 of dividends in my pocket. I 'own' 100 x $99 = $9,900 worth of the company.

Now look at the same scenario where XYZ does not pay a div. The stock is at $100, and I sell 1 share, so I have $100 in my pocket. I still 'own' 99 x $100 = $9,900 worth of the company.

We both have $100 in our pockets, and we both still have the same investment in future earnings of the company, either way, right? What was lost in the scenario where the investor sold stock to raise the pocket money?

And if this is taxable to the investor, the entire $100 in divs is taxable, but only the gain is taxed on the sale. IIRC Qual divs and LTCG are treated the same, so that's an advantage to the sale (if either is taxable).

-ERD50

Thanks for the chance to clarify. I think I see where we differ & hope I can communicate it. It is really in the assumptions you have & a fundamentally different view of how things work. I won't try to be comprehensive, but give examples.

In both cases, you have the share price the same. I suggest the valuations would be different. For example, the non-dividend case...they are developing a new product & pouring all their available cash into it. Should hit the market in x years. Or the dividend case....paying some cash out now in quarterly dividends realizing it will take longer to get to market because they have less cash than if didn't pay. Do you see a difference in risk? Why would they both have same valuation? Growth rate? Look at what happens when a company changes its dividend policy & see if that affects the price.

Also gives me a chance to explicitly say that I'm not contending that the price NEVER changes when a dividend is paid; just that it may or may not. Which also happens on days when a dividend is not paid (& why to me it isn't relevant). There are several factors that affect opening price & probably it usually does change by the amount of the dividend.

If someone sees the price as a function of math, then the share price would adjust. I say it may or may not & if it does it won't stay there. .Might go up, might go down. There is the whole discussion about the effect of p/e -- I'm intentionally not going there as I doubt there is interest.

It is relevant as to what happens with the $1 in question of being paid out or not. Generally assumptions are made to affirm ones bias!

As for taxes...you bring up another difference when you mention paying tax on entire dividend or only on the gain.The easiest case for when the tax rates differ is when the cap gain is short term & investor is in a higher bracket. Think of impact on agi & associated things that can trigger. But there are others.

Spreadsheets are great & I use them. Only as good as assumptions & data. The projections will change. It used to be that you paid commission on stock sales, but not dividends. Couldn't buy/sell fractional shares. Hard to get all that into the math formulas

 

[ERD50]

I think you are intertwining the value of the company (calculated from the balance sheet and number of existing shares) and the price of the stock determined by sometimes subjective buyers and sellers in a free market and reported by the exchange.

Yes, when the $1 div is paid out, current assets decline impacting the value of the company on the balance sheet. But the price of the stock is determined by buyers and sellers in the marketplace.

Most business owners withdraw a percentage of profits to live on as they go along, either private or public companies. I do. I'm only concerned when companies I own are paying (or not paying) out dividends at a level I feel is appropriate for their business situation. A small start-up vs. a cash cow for example.

Certainly, there are market fluctuations and differing views of the companies value, and events positive and negative, all influencing the stock price. Including the market's perceived value of a company that pays dividends. That often makes it hard to see the effect of dividends on NAV.

But I think that in the long run, that washes out, and the dividend pay out is reflected in the NAV (often buried in noise). If it didn't, there would be money in just trading around the ex-div date. And I think someone did point to a study some years ago that ran enough data to have the noise cancel itself out, and the ex-div value did closely match the expected delta from the div.

-ERD50

 

[Chuckanut]

I don’t follow BP, but I do follow gas prices that have gone down dramatically. Maybe that had something to do with it.

Gasoline is still about 40 cents a gallon higher than Fall of 2021 in my area. And food prices are easily 20% higher. Not so good.

 

[all4j]

Certainly, there are market fluctuations and differing views of the companies value, and events positive and negative, all influencing the stock price. Including the market's perceived value of a company that pays dividends. That often makes it hard to see the effect of dividends on NAV.

But I think that in the long run, that washes out, and the dividend pay out is reflected in the NAV (often buried in noise). If it didn't, there would be money in just trading around the ex-div date. And I think someone did point to a study some years ago that ran enough data to have the noise cancel itself out, and the ex-div value did closely match the expected delta from the div.

-ERD50

Yep, this confirms what I was thinking in my earlier post. Not picking on you, but this is the heart...is a stock's share price the NAV?