Dividend Stocks in place of Bonds

[cute fuzzy bunny]

Agreed.

Its also a common individual who socks too much into low return, low volatility investment products and slowly bleeds to death over a period of decades, reducing their lifestyle to suit.

So brass balls or death by a thousand small cuts...its really a basic psychology item...playing to win or playing to avoid losing badly.

 

[clifp]

IMO, a year or two in cash and cd's, the rest in value stocks that pay a nice dividend, hang on for 20+ years, and you're going to accomplish all four objectives far better in the long run. Especially with the tax treatment that qualified dividends receive at this time.

I am with you CFB. Obviously dividend stocks aren't the same as bond, and behave well like stocks. Frankly, I was surprised that the author showed the high dividend stocks didn't outperform during bear markets. This seems counter intuitive and isn't what Speigel has claimed in the past. So now I am I am not sure what to believe.

I do know that my portfolio of dividend stocks is considerable less volatile than the market as whole. I still own both TIPS bonds in IRA and other bonds in my taxable portfolio. The death of a thousand cuts is certainly an issue with bonds. On the other hand the 10% I had in TIPs bonds with real interest rates close to 4% were darn near the only thing that registered gains during late 2000 through 2002. So pyschologically there is some comfort in that.

Obviously, asset allocation is pretty individual choice, do you sleep better know that regardless of what happens to the stock market your bonds will provide you with some income, or do you worry more that you will have to cut back on future spending as inflation takes it toll on bonds, or do you simply say I can live on 2.5% real return with TIPs.

Now, I have not experienced my first dividend cut, but right now I like the trade off of the security of income, with likelyhood of keeping up with inflation by growing dividends.

 

[mathjak107]

dividend paying stocks are no different than any other stocks except in the minds of investors . they are still stocks. basically the dividend that is payed out is a wash. the stock or fund always drops by the amount paid out. all stock prices on the nyse and american exchange are adjusted downward automatically at the open.

the concept of the dividend goes back to the markets early days when after the crash in 29 investors were distrustful of companies holding all the profits in their own pockets and were happier with companies that put some profits in the investors pockets too where it was safe form mis-use .

there are many great companies that dont send away the company assets in the form of a payout ,ala berkshire, microsoft ,apple etc.

non the less the stage was set and people began to look at this payout as a bonus. it really wasnt, it was no different than if you sold 2 or 3% a year of a non dividend paying stock but market mentality always looking for something for nothing put dividend paying stocks on a pedastal and in greater demand so over time they tended to out perform.

if you think about it a company that pays out a dividend is really saying "here we cant find anything better to do with this to grow the company so you take it "..

lets face it great companies are still great companies. ever wonder where altria [MO[ would be priced today if it never paid a dividend?

but it is what it is and investors still put the dividend payors on that pedistal, and the better ones still out perform . go figure

 

[chinaco]

Some companies take the dividend approach instead of the growth approach. In other words, they are in effect saying we (the company) are making money and do not feel that we can best employ the extra profits as investments that will grow the company over and above what you the owner could do with the money yourself so we (the company) will return the profits to you.

The growth company feels that the prospects of reinvesting the profits in new ventures will grow the share price faster.

I like getting dividends, it enables me to redeploy the money into other areas if I choose (provided there is good tax treatment on divs). This is especially attractive as I look toward retirement.

However, I wold still view equity as an equity investment. It has that basic equity risk profile. Bonds have a different risk profile.

 

[cute fuzzy bunny]

On the other hand the 10% I had in TIPs bonds with real interest rates close to 4% were darn near the only thing that registered gains during late 2000 through 2002. So pyschologically there is some comfort in that.

If I could buy those, I would. If I had them, i'd keep them!

or do you simply say I can live on 2.5% real return with TIPs.

Theres enough material that says you cant maintain a survivable scenario at less than 4% after taxes. And then again, since I dont work, own a home vs rent, pay for health care and do all sorts of other things that have no resemlance to the CPI-U scenario, I cant count on CPI-U indexed securities to produce anything 'real' other than perhaps in a hand grenade sense. An old world war II hand grenade thats pretty rusty and was buried in the ground for 20 years.

Now, I have not experienced my first dividend cut, but right now I like the trade off of the security of income, with likelyhood of keeping up with inflation by growing dividends.

Which is why you avoid seriously 'dented' companies or buy these equities in a fund such that a bad apple or two doesnt have much effect on you.

 

[Nords]

basically the dividend that is payed out is a wash. the stock or fund always drops by the amount paid out. all stock prices on the nyse and american exchange are adjusted downward automatically at the open.

You need to state a reference to back up your opinion.

In the past you've quoted a rule that says open orders are adjusted by the amount of the dividend (which protects people with tight sell stops or limit buy orders) but you've been unable to show a credible source for your speculative statement on how the market works.

I'd be happy to learn about such a rule adjusting ex-dividend prices at the open, but IMO there is no such rule. It's just market-makers matching up the orders. The stock's opening price may coincidentally drop by the dividend amount-- but it could also drop more, drlp less, stay flat, or rise. There's no legislation affecting it, and you're confusing correlation with causality.

 

[CyclingInvestor]

You need to state a reference to back up your opinion.

In the past you've quoted a rule that says open orders are adjusted by the amount of the dividend (which protects people with tight sell stops or limit buy orders) but you've been unable to show a credible source for your speculative statement on how the market works.

I'd be happy to learn about such a rule adjusting ex-dividend prices at the open, but IMO there is no such rule. It's just market-makers matching up the orders. The stock's opening price may coincidentally drop by the dividend amount-- but it could also drop more, drlp less, stay flat, or rise. There's no legislation affecting it, and you're confusing correlation with causality.

http://www.investopedia.com/articles/stocks/07/dividend_implications.asp

"Another price that is usually adjusted downward is the purchase price for
limit orders. Because the downward adjustment of the stock price might
trigger the limit order, the exchange also adjusts outstanding limit orders.
The investor can prevent this if his or her broker permits a do not reduce
(DNR) limit order. Note, however, that not all exchanges make this
adjustment. The U.S. exchanges do, but the Toronto Stock Exchange, for
example, does not."


Also, it is the previous days closing price which is adjusted for ex-dividends,
about 1-2 hours before market open (at least in the US), not the open. This
allows for the "net change" to exclude the effect of the dividend when
being calculated.

 

[Nords]

http://www.investopedia.com/articles/stocks/07/dividend_implications.asp

"Another price that is usually adjusted downward is the purchase price for
limit orders. Because the downward adjustment of the stock price might
trigger the limit order, the exchange also adjusts outstanding limit orders.
The investor can prevent this if his or her broker permits a do not reduce
(DNR) limit order. Note, however, that not all exchanges make this
adjustment. The U.S. exchanges do, but the Toronto Stock Exchange, for
example, does not."

Also, it is the previous days closing price which is adjusted for ex-dividends,
about 1-2 hours before market open (at least in the US), not the open.

Exactly. Just to be clear on the subject, what mathjak is hypothecating is that a stock's price is dropped at (or, OK, before) the following open after it goes ex-dividend. Mathjak, correct me if I'm not saying this in the manner you intended.

For example Eagle Bulk Shipping (EGLE) would have closed on Wednesday 2 May at $21.80, coughed out a 50-cent/share dividend that night, and opened Thursday at $21.30. However the Thursday open was $22.14... and if the ex-dividend date of 3 May meant the dividend was disbursed after Thursday's close of $22.04, then it should have opened Friday at $21.54. However it opened at $22.34.

 

[clifp]

Mathjack couple of comments. First Microsoft pays a dividend currently $.10/qtr which has increased from $.08/quarter in 2005.

"if you think about it a company that pays out a dividend is really saying "here we cant find anything better to do with this to grow the company so you take it "..

That is one interpretation. The other is we are so confident about our business that we want to return some of the profits to our owners.

Remember, over the very long term the only reason to own a shares in any company is the prospect of future cash-flow. These future cash flows come in the form of liquidation (which is often a bad thing) or a dividend payment.

 

[CyclingInvestor]

For example Eagle Bulk Shipping (EGLE) would have closed on Wednesday 2 May at $21.80, coughed out a 50-cent/share dividend that night, and opened Thursday at $21.30. However the Thursday open was $22.14... and if the ex-dividend date of 3 May meant the dividend was disbursed after Thursday's close of $22.04, then it should have opened Friday at $21.54. However it opened at $22.34.

Just to keep confusion down, that dividend payment had an ex- date of April 26.
EGLE closed at 22.74 April 25. EGLE opened at $23.00 on April 26, up $0.76
(23.00 - ($22.74 - $0.50)).

 

[terminator]

This is issue was already beat to death in this thread:

http://early-retirement.org/forums/index.php?topic=9183.75

Mathjak is correct and cited the open order rules there.

And CyclingInvestor is right about it being the ex-dividend date, not the payout date.

All you have to do to confirm this is look at the close and opening prices of a stock around the ex-div date. When I'm buying a stock and I notice it's near the ex-div date I usually just wait and buy it after it goes ex-div since I don't want to pay taxes on what is a non-event in the short term.

An example:
WaMu paid me a dividend today. It went ex-div 4/26. The close on 4/25 was $42.30. The open on 4/26 was $41.65. The dividend was $0.55.
Look at the historical prices:
http://finance.yahoo.com/q/hp?s=WM

 

[cute fuzzy bunny]

I think what Nords is pointing out is that while the stock price is 'adjusted' to accommodate the reduction in value accorded to the dividend paid, the actual bid/sell prices being used 1.2ms after the market is officially open are set by buyers and sellers and need (and usually do) bear little or no resemblance to the "official" opening price.

Which is the basis of the rift between people who think they can figure out the market and those who know they cant. Short term movements are based on peoples interest and group psychology, not on anything numeric or calculable.

 

[Gone4Good]

The more relevant point on dividend policy is not how market makers adjust opening prices, but whether paying dividends increases shareholder returns.

There is much corporate finance literature, beginning I think with the "Miller Modigliani Theorem" that dividend policy does not matter. Exceptions include things like differences in tax rates between dividends and capital gains - if any, capital markets financing friction, and the like. Some of these items, like financing costs, may actually work against the dividend paying firm.

There is also a line of thinking that dividend policy "signals" management's confidence in the company and is valuable in a world with asymmetric information. Such a signaling mechanism could be seen as enhancing the valuation of dividend paying firms. I don't think this theory has a wide academic following, but it is a view.

But the bottom line is that absent differences in tax treatment investors should be indifferent to whether a given company pays a dividend or not.

I side with Mathjack on this.


Here is a text book example of why dividend policy is irrelevant

A Proof of Dividend Irrelevance
To provide a formal proof of irrelevance, assume that LongLast Corporation, an
unlevered firm manufacturing furniture, has operating income after taxes of $ 100
million, growing at 5% a year, and that its cost of capital is 10%. Further, assume that
this firm has reinvestment needs of $ 50 million, also growing at 5% a year, and that
there are 105 million shares outstanding. Finally, assume that this firm pays out residual
cash flows as dividends each year. The value of LongLast Corporation can be estimated
as follows:

Free Cash Flow to the Firm = EBIT (1- tax rate) – Reinvestment needs = $ 100 million - $ 50 million = $ 50 million
Value of the Firm = Free Cash Flow to Firm (1+g) / (WACC - g) = $ 50 (1.05) / (.10 - .05) = $ 1050 million
Price per share = $ 1050 million / 105 million = $ 10.00

Based upon its cash flows, this firm could pay out $ 50 million in dividends.
Dividend per share = $ 50 million/105 million = $ 0.476
Total Value per Share = $ 10.00 + $ 0.48 = $10.476

The total value per share measures what stockholders gets in price and dividends from
their stock holdings.

Scenario 1: LongLast doubles dividends
To examine how the dividend policy affects firm value, assume that LongLast
Corporation is told by an investment banker that its stockholders would gain if the firm
paid out $ 100 million in dividends, instead of $ 50 million. It now has to raise $ 50
million in new financing to cover its reinvestment needs. Assume that LongLast
Corporation can issue new stock with no issuance cost to raise these funds. If it does so,
the firm value will remain unchanged, since the value is determined not by the dividend
paid but by the cash flows generated on the projects. Since the growth rate and the cost of
capital are unaffected, we get:

Value of the Firm = $ 50 (1.05) / (.10 - .05) = $ 1050 million

The existing stockholders will receive a much larger dividend per share, since dividends
have been doubled:

Dividends per share = $ 100 million/105 million shares = $ 0.953

In order to estimate the price per share at which the new stock will be issued, note that
after the new stock issue of $ 50 million, the old stockholders in the firm will own only
$1000 million of the total firm value of $ 1050 million.
Value of the Firm for existing stockholders after dividend payment = $ 1000 million
Price per share = $ 1000 million / 105 million = $ 9.523

The price per share is now lower than it was before the dividend increase, but it is exactly
offset by the increase in dividends.

Value accruing to stockholder = $ 9.523 + $ 0.953 = $ 10.476

Thus, if the operating cash flows are unaffected by dividend policy, we can show
that the firm value will be unaffected by dividend policy and that the average stockholder
will be indifferent to dividend policy, since he or she receives the same total value (price
+ dividends) under any dividend payment.

 

[Nords]

This is issue was already beat to death in this thread:

http://early-retirement.org/forums/index.php?topic=9183.75

Mathjak is correct and cited the open order rules there.

And CyclingInvestor is right about it being the ex-dividend date, not the payout date.

Yes, I agree that the subject was beaten to death.

And I stand corrected on the ex-div dates.

But all I'm asking for is someone to point me to a rule that clearly states what mathjak is claiming happens. I understand the open-order stuff, but that has to do with open bids to buy at a certain price. I haven't ever seen anything applicable to the ask price, and since as CFB says it changes from one msec to the next, I suspect that there isn't any "rule" for ask prices because it's just unecessary.

Change of subject: The reason I value dividends, especially for international stocks, is because it's difficult to lie about them. If a company's borrowing to cover their dividend then it's pretty darn hard to hide that. And cutting the dividend sends a much clearer signal than insider buying, stock option executions, or any other noise coming from the executive suite.

 

[mathjak107]

however adjusting the bids by the amount of the dividend works the bottom line is it works. the open is set just before trading at that reduced level by exactley the amount of the dividend. after that market action takes control and moves the stock lower or higher depending on the days action. point is whatever the exchages do it works.

 

[Nords]

the open is set just before trading at that reduced level by exactley the amount of the dividend.

You're more than welcome to make up your own explanations, but you can't make up your own facts. I'd appreciate it if you'd stop blathering telling us how it is and show us the rule that says that's how it's done. Because I don't think there is such a rule!

point is whatever the exchages do it works.

That's because they don't do anything...

 

[mathjak107]

im not following what it is your looking to see. the exchange rules which you can look up yourself just state that when stocks go ex-div the exchage computors will automatically reduce all bids downward by that amount causing the stock to open lower by the same amount. where investors take it from the lower opening is up to the markets. there is nothing else that happens.

 

[mathjak107]

Dividend Facts You May Not Know
February 27, 2007 | By Jim Mueller

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Price Implications
When a dividend is paid, several things can happen. The first of these is what happens to the price of the security and various items tied to it. On the ex-dividend date, the stock price is adjusted downward by the amount of the dividend by the exchange on which the stock trades. For most dividends this is usually not observed amidst the up and down movement of a normal day's trading. However, this becomes easily apparent on the ex-dividend dates for larger dividends, such as the $3 payment made by Microsoft in the fall of 2004, which caused shares to fall from $29.97 to $27.34.

 

[Gone4Good]

But all I'm asking for is someone to point me to a rule that clearly states what mathjak is claiming happens. I understand the open-order stuff, but that has to do with open bids to buy at a certain price. I haven't ever seen anything applicable to the ask price, and since as CFB says it changes from one msec to the next, I suspect that there isn't any "rule" for ask prices because it's just unecessary. . . .

On January 6, 1994, the Securities and Exchange Commission (SEC) approved an amendment adding a new Section 46 to the NASD Rules of Fair Practice that requires members holding open orders to adjust the price and the size, if necessary, of the order by the amount of any dividend, payment, or distribution on the day that the security is quoted ex-dividend, ex-rights, ex-distribution, or ex-interest. The text of the amendment, which takes effect May 16, 1994, follows the discussion below . . .

Open orders, also known as "good 'til cancelled," "limit," or "stop limit" orders, are orders to buy or sell that remain in effect until they are executed or canceled, or that expire.



Don't really understand what the big brew-ha-ha is all about.

 

[Nords]

Don't really understand what the big brew-ha-ha is all about.

Just trying to get a claim backed up by a brokerage rule.

Plenty of conjecture and media bites but nothing like the reference you just quoted. And while I understand that one, it doesn't apply to the actual distribution of the dividend.

I think the journalist had it right-- you can't tell what's happening because the price is moving. But I don't think there's any exchange rule requiring that the price be adjusted and I'm just trying to get mathjak to stop making claims that he can't reference with a shred of rules or other requirements.

I think posters should be responsible for documenting their claims about the way the market works, especially when they feel entitled to state so in such an authoritative manner... or at least until they're asked to simply provide the reference for such a statement.

 

[Gone4Good]

And while I understand that one, it doesn't apply to the actual distribution of the dividend.

Maybe I'm not understanding your point, but the price is changed on the ex-dividend date . . . not the distribution date.

Market makers adjust downward for the dividend the day it begins trading ex (i.e. without the dividend). When the market opens that day it will push the stock up, or down, or sideways from there. On the dividend payment date, nothing happens with the stock price . . . because it is already trading ex-the dividend.

 

[saluki9]

You need to state a reference to back up your opinion.

In the past you've quoted a rule that says open orders are adjusted by the amount of the dividend (which protects people with tight sell stops or limit buy orders) but you've been unable to show a credible source for your speculative statement on how the market works.

I'd be happy to learn about such a rule adjusting ex-dividend prices at the open, but IMO there is no such rule. It's just market-makers matching up the orders. The stock's opening price may coincidentally drop by the dividend amount-- but it could also drop more, drlp less, stay flat, or rise. There's no legislation affecting it, and you're confusing correlation with causality.

Nords there is such a rule (at least for NYSE stocks) it's called Rule 118 and it applies only to open to buy orders (at market) and open stop orders.


Just checked and NASDAQ has the same rule (#3220)

 

[Nords]

Nords there is such a rule (at least for NYSE stocks) it's called Rule 118 and it applies only to open to buy orders (at market) and open stop orders.
Just checked and NASDAQ has the same rule (#3220)

Thanks, Saluki.

Are those references available on the Internet or just Bloomberg terminals & professional manuals?

 

[mathjak107]

i didnt bother to re-post the exchange rules again because the last time we had this discussion and there were quite a few dis-believers i posted it.

non the less here it is:
Rule 118 . Orders To Be Reduced and Increased on Ex-Date
When a security is quoted ex-dividend, ex-distribution, ex-rights or ex-interest, the following kinds of orders shall be reduced by the value of the payment or rights, and increased in shares in the case of stock dividends and stock distributions which result in round-lots, on the day the security sells ex:

(1) Open buying orders;

(2) open stop orders to sell.

The following shall not be reduced:

(1) Open stop orders to buy;

(2) open selling orders.

(See 124.40 [¶2124.40] for the reduction of odd-lot orders)

• • • Supplementary Material: ------------------

.10 Reduction of orders—Odd amounts.—When the amount of a cash dividend is not equivalent to or is not a multiple of the fraction of a dollar in which bids and offers are made in the particular stock, orders shall be reduced by the next higher variation.

.20 Reduction of orders—Optional amounts.—When a dividend is payable at the option of the stockholder either in cash or securities, the stock will be ex-dividend the value of the cash or securities, whichever is greater.

.21 Reduction of orders—Proportional procedure.—Open buy orders and open stop orders to sell shall be reduced by the proportional value of a stock dividend or stock distribution on the day a security sells ex-dividend or ex-distribution. The new price of the order is determined by dividing the price of the original order by 100% plus the percentage value of the stock dividend or stock distribution. For example, in a stock dividend of 3%, the price of an order would be divided by 103%.

is otherwise permitted by this rule. The specialist must document the status of a converted percentage order on the book as a limit order at the price it was converted.

Notwithstanding the provisions of this Rule permitting percentage orders to be converted on destabilizing ticks, where a member holds orders of 10,000 shares or more or a quantity of stock having a market value of $500,000 or more (whichever is less) to buy or sell a particular stock which he proposes to cross at or within the prevailing market, the specialist may not, unless asked to do so by the member with the cross (assuming the cross is at or within the 0.25 point price parameter of this Rule), convert any percentage order on a destabilizing tick for execution in such proposed cross transaction unless the specialist can (at or within the 0.25 of a point price parameter specified in this Rule, and within the limit price of the order) provide a better price to one side or the other of the proposed cross.

 

[ats5g]

Nords,

NASD Rule 3220: Adjustment of Open Orders

NASDAQ Rule 3220: Adjustment of Open Orders

NYSE Rule 118: Orders To Be Reduced and Increased on Ex-Date