Vanguard expert on total return vs. income producing

[samclem]

• signaling: management knows that cutting the dividend is received negatively by investors. so a manager that establishes a dividend is signaling that the firm has good prospects and won't need to cut the div

And, for the same reason, management sometimes keeps paying a high dividend when it shouldn't (e.g. the company sacrifices its long-term future by reducing investment in order to avoid short-term pain).

If we seek out companies that focus too much on the dividend, we can end up with a stock worth a lot less than it should be--and eventually the dividends have to give. In these cases, we were really withdrawing from our principal every year, we just didn't realize it.

 

[RunningBum]

Yeah, I'm not saying a dividend approach is bad either. Dividends + gains in share prices may give the best overall return over lower dividend stocks, or maybe be close enough with a lower risk of loss. If I went for a dividend strategy I might lower my bond allocation.


What I'm saying, and I think the VG analyst is saying, is that just focusing on the income flow is a mistake, in our opinion. It might be analogous to the person who goes into a car dealer and says they want $XXX monthly payment on a car, not paying attention to the loan details and what it's actually costing you.

 

[mathjak107]

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And, for the same reason, management sometimes keeps paying a high dividend when it shouldn't (e.g. the company sacrifices its long-term future by reducing investment in order to avoid short-term pain).

If we seek out companies that focus too much on the dividend, we can end up with a stock worth a lot less than it should be--and eventually the dividends have to give. In these cases, we were really withdrawing from our principal every year, we just didn't realize it.

that is a point i have been trying to get across to people for years.

your investment dollars available for compounding at the start of each quarter are either less if you pocket the dividend or identical to what you had before the dividend is paid .

it is only the value of your dollars that are compounded by market action over the next quarter that matter. .

if you had a 100k before the dividend and 95k after the exchange mandatory price reduction plus 5k in pocket all that matters is you have 95k compounding for you working for you now and not 100k.

reinvest the dividend and now you have your same 100k compounding at the ring of the bell.

 

[Mulligan]

that is a point i have been trying to get across to people for years.

your investment dollars available for compounding at the start of each quarter are either less if you pocket the dividend or identical to what you had before the dividend is paid .

it is only the value of your dollars that are compounded by market action over the next quarter that matter. .

if you had a 100k before the dividend and 95k after the exchange mandatory price reduction plus 5k in pocket all that matters is you have 95k compounding for you working for you now and not 100k.

reinvest the dividend and now you have your same 100k compounding at the ring of the bell.

I have no disagreements at all with what you are saying and personally believe it to be true. (I just enjoy the topic, personally) A nonpaying dividend stock can certainly be multitudes better than one that pays a dividend. And a company that pays dividends is not inheritantly safer than one that does not.
That being said investors expectations also matter on the stock, not just "the stock would automatically be 50 cents higher today if it hadn't gone Ex D today".
As a theoretical example take a high dividend illiquid stock. If it was a $10 stock with $1 annual dividend and never traded, in 10 years it would be worth zero in theory without a purchase. And we all know that is not possible assuming it is a profitable company.
I purchased a stock that last traded April 2014 at $102. It had paid out $9.69 in dividends since last traded, yet its price was not the implied $93.31. It was still sitting at $102 unchanged before I purchased some this week. One website (Fidelity) did move it down by the quarterly dividend to $100.06, but them immediately the following day adjusted right back to $102 without any shares trading hands.
So there can be an implicit value on a stock that pays a good safe dividend.



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[mathjak107]

your math is wrong .

trying to pull that 1 dollar dividend from the 10 buck non dividend payer will not take a share as the stock appreciates. it will take a smaller and smaller pice of a share over time to equal that dividend.

with no appreciation in theory the dividend payer will go to zero value and the non dividend payer will go to zero shares .

but if the stock appreciates at least enough to cover the dividend then the dividend payer will never go to zero and the appreciating non dividend payer will need a smaller and small piece of a share to equal the dividend never running out of shares . it does not stay 1 share would equal the dividend , less and less of a share gets sold to equal that dividend as the non dividend payer appreciates .

given same total return the non dividend payer will always be worth more . . .

 

[mathjak107]

I have no disagreements at all with what you are saying and personally believe it to be true. (I just enjoy the topic, personally) A nonpaying dividend stock can certainly be multitudes better than one that pays a dividend. And a company that pays dividends is not inheritantly safer than one that does not.
That being said investors expectations also matter on the stock, not just "the stock would automatically be 50 cents higher today if it hadn't gone Ex D today".
As a theoretical example take a high dividend illiquid stock. If it was a $10 stock with $1 annual dividend and never traded, in 10 years it would be worth zero in theory without a purchase. And we all know that is not possible assuming it is a profitable company.
I purchased a stock that last traded April 2014 at $102. It had paid out $9.69 in dividends since last traded, yet its price was not the implied $93.31. It was still sitting at $102 unchanged before I purchased some this week. One website (Fidelity) did move it down by the quarterly dividend to $100.06, but them immediately the following day adjusted right back to $102 without any shares trading hands.
So there can be an implicit value on a stock that pays a good safe dividend.



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the stock didn't adjust back up on the same amount of money though. if you had 100k in stock before the dividend and 95k after and 5k in pocket a 10% move upward by market action means you have 104,500

you recovered the pay out but have only 104,500.


if you had the full 100k working for you in a non dividend payer you would have 110k not 104,500.00 assuming same cagr . .


it is all about the dollars in value you have invested at the opening bell and where you are compounding wise at the close of the next quarter.

as long as the stock appreciates it will look like you recovered the dividend but that fact is you would have been even higher if you didn't have the dividend pulled out of your investment amount.

if you reinvested the dividend it is just a wash and you have the original 100k back working for you , nothing gained ,nothing lost . . you just have the original amount of dollars .

if you pulled out that same 10% from the non payer you would have the same amount compounding in both cases .

 

[Mulligan]

Mathjack, I fully understand and agree with your thinking. But I must admit, I don't understand your explanation above relating at all to my illiquid stock example. The dividend was deducted, the stock should drop in relation to that amount of said dividend; as compared to an non dividend stock that would not have dropped.
An illiquid $102 no dividend stock that did not trade would remain at $102. An illiquid $102 stock that just went ex D of $1.94 should drop to $100.06, but yet it didn't. Point being is there are also forces at play in determining a value of a stock price. "Buying yield" can be in vogue at certain times, and at times it will not. This could then be in turn a detriment to said stock or a benefit depending on when in the cycle you purchased it.



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[mathjak107]

it did drop at the open , it has to , that is exchange law and done automatically before the open . so what ever balance you had the night before the deduct is starting out lower. there is no question .

from that point on for not just the day but the quarter , market action takes your balance to wherever it compounds to.

if you had 10k invested and got a 5% dividended which you did not reinvest all you have for the market action to work on is 9500 bucks .

market action will compound your dollars invested . the fact you saw it retrace what it paid out is meaningless since if the stock went up 10% for the year , you earned 10% on 9500 not 10% on 10k


follow that ? just because it was absorbed in the action does not mean the compounding wouldn't have been greater in dollars if that dividend was reinvested or in a mathematical seance not paid out .

 

[Mulligan]

it did drop at the open , it has to , that is exchange law and done automatically before the open . so what ever balance you had the night before the deduct is starting out lower. there is no question .

from that point on for not just the day but the quarter , market action takes your balance to wherever it compounds to.

if you had 10k invested and got a 5% dividended which you did not reinvest all you have for the market action to work on is 9500 bucks .

market action will compound your dollars invested . the fact you saw it retrace what it paid out is meaningless since if the stock went up 10% for the year , you earned 10% on 9500 not 10% on 10k


follow that ? just because it was absorbed in the action does not mean the compounding wouldn't have been greater in dollars if that dividend was reinvested or in a mathematical seance not paid out .

Yes I follow, and once again I agree with you as I have. Your explanation isn't following my situation, but that is fine. It is just an obscure thought on my end. Ultimately in the illiquid markets, Bid/Ask spread, and Market makers have way more influence on a stock price than an ex dividend does.


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[mathjak107]

market action is the biggest part , but everything is still based on the amount you start off with in value at the opening bell. if it is even 1 dollar less than all compounding will be on 1 dollar less.

 

[Mulligan]

market action is the biggest part , but everything is still based on the amount you start off with in value at the opening bell. if it is even 1 dollar less than all compounding will be on 1 dollar less.

I am going to try to word it differently as I probably have been wording this poorly. But I would like your opinion on why this happened because it did this week as it interests me.
The stock was at $102. Which it has been since April 2014. It went ex D of $1.94. My vanguard account didn't even acknowledge the distribution and kept stock at $102. Fidelity changed it for one day then reinstated it back to $102 pre exD trading price. Keep in mind ZERO shares have traded during this time. Zero shares have traded. $9.70 of dividends have passed through without a trade. If the exchange has to lower the stock price by the dividend amount as you say and there is zero stock purchases the price would have to reflect downward movement without a trade. Yet it continuously pops back up to original pre ExD date without a trade to bring it back there.
If you give up, I understand, but I am trying my best to explain it.


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[mathjak107]

i follow what you are saying but my feeling is there are actually bids going on you are not aware of so it appears to not have budged after the payment .

but according the laws of the exchanges that would not be possible.

 

[jim584672]

Ex dividend pricing is set by the buyer and seller ultimately, they can't dictate a drop.

 

[robertf57]

I'm not aware of any law that would set a price on the open exchange.... And because of the continuous bid ask process, even if there was an instantaneous price set by statute, it would have no practical effect on prices that occur in the market. Too many other forces at play.


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[Danmar]

Yeah, I'm not saying a dividend approach is bad either. Dividends + gains in share prices may give the best overall return over lower dividend stocks, or maybe be close enough with a lower risk of loss. If I went for a dividend strategy I might lower my bond allocation.


What I'm saying, and I think the VG analyst is saying, is that just focusing on the income flow is a mistake, in our opinion. It might be analogous to the person who goes into a car dealer and says they want $XXX monthly payment on a car, not paying attention to the loan details and what it's actually costing you.

Agree and this is the point. Focussing solely on divs is not usually optimal for the reasons you cite. As you point out, dividend investing may well be a successful strategy if implemented well. This may not be a result of the fact they are paying divs though.
Also, once retired divs are a convenient way to obtain cash. Not magic, just convenient. Selling the right stock to obtain cash needed for living expenses can introduce another risk, ie you sell the wrong one and up it goes. Div paying stock are often less risky and have lower betas. I have often wondered if SWR can be higher for div paying stock? Probably.
In my case my CDn bank heavy, telco, and pipes portfolio has outperformed all benchmarks over the 18 years I ave been investing. Not likely because it is a div growth portfolio, but rather because the underlying businesses have performed well. Currently living off divs but at some point will liquidate some stock since it has appreciated quite a lot. Just gave DD a big chunk of stock for an eventual down payment on an overpriced house in Toronto.

 

[ERD50]

....
The stock was at $102. Which it has been since April 2014. It went ex D of $1.94. My vanguard account didn't even acknowledge the distribution and kept stock at $102. ... Keep in mind ZERO shares have traded during this time. Zero shares have traded. $9.70 of dividends have passed through without a trade. ...

I am also not aware of any law/rule that the exchange is required to update the price.

AFAIK, the price shown is the last price it traded at. If there are active bid/asks, the mid-point of those might better reflect the implied price.

You see this with options all the time. Even on highly traded stocks, a particular option may not have any trading activity for a day or more, but might be close enough that people (computers?) are watching it. And if the underlying stock is moving, you can see the bid/ask on that option move with it. But the reported price on the option doesn't change over those days, it is the same as the last trade of that option.

It makes it tough to do any historical analysis on options, you need access to the bid/asks, the prices often don't move day to day.

-ERD50

 

[Mulligan]

I'm not aware of any law that would set a price on the open exchange.... And because of the continuous bid ask process, even if there was an instantaneous price set by statute, it would have no practical effect on prices that occur in the market. Too many other forces at play.


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I have always been under the impression that what Jim's and your post stated was the way it transpires. That would explain in my mind anyways why an ex D stock that doesn't trade does not have its price automatically lowered by said amount.


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[Mulligan]

I am also not aware of any law/rule that the exchange is required to update the price.



AFAIK, the price shown is the last price it traded at. If there are active bid/asks, the mid-point of those might better reflect the implied price.



You see this with options all the time. Even on highly traded stocks, a particular option may not have any trading activity for a day or more, but might be close enough that people (computers?) are watching it. And if the underlying stock is moving, you can see the bid/ask on that option move with it. But the reported price on the option doesn't change over those days, it is the same as the last trade of that option.



It makes it tough to do any historical analysis on options, you need access to the bid/asks, the prices often don't move day to day.



-ERD50

I agree. I was trying to keep bid/ask price out of the theoretical discussion because that was another can of worms! But since you brought it up.... I was sticking to last traded price of $102. But the bid price was $100 and ask was $175 and both were stagnant months on end. I got it bought at $108, but only a partial trade of 73 shares and that was it. I already knew this going in, but most will not even adjust the price unless a 100 share purchase occurred. So I instantly "lost" over $400. Unless I cite Yahoo finance who was the only website I found that adjusted the stock price to my purchase of $108.
Illiquids are crazy little creatures.

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[mathjak107]

I am also not aware of any law/rule that the exchange is required to update the price.

AFAIK, the price shown is the last price it traded at. If there are active bid/asks, the mid-point of those might better reflect the implied price.

You see this with options all the time. Even on highly traded stocks, a particular option may not have any trading activity for a day or more, but might be close enough that people (computers?) are watching it. And if the underlying stock is moving, you can see the bid/ask on that option move with it. But the reported price on the option doesn't change over those days, it is the same as the last trade of that option.

It makes it tough to do any historical analysis on options, you need access to the bid/asks, the prices often don't move day to day.

-ERD50

well now you are aware of it. see what you learn here . here is the finra rule requiring the offset .


5330. Adjustment of Orders

(a) A member holding an open order from a customer or another broker-dealer shall, prior to executing or permitting the order to be executed, reduce, increase, or adjust the price and/or number of shares of such order by an amount equal to the dividend, payment, or distribution on the day that the security is quoted ex-dividend, ex-rights, ex-distribution, or ex-interest, except where a cash dividend or distribution is less than one cent ($0.01), as follows:
(1) Cash Dividends: Unless marked "Do Not Reduce," open order prices shall be first reduced by the dollar amount of the dividend, and the resulting price will then be rounded down to the next lower minimum quotation variation.
(2) Stock Dividends and Stock Splits: Open order prices shall be determined by first rounding up the dollar value of the stock dividend or split to the next higher minimum quotation variation. The resulting amount shall then be subtracted from the price of the order. Unless marked "Do Not Increase," the size of the order shall be increased by first (A) multiplying the size of the original order by the numerator of the ratio of the dividend or split, then (B) dividing the result by the denominator of the ratio of the dividend or split, then (C) rounding the result to the next lowest share.
(3) Dividends Payable in Either Cash or Securities at the Option of the Stockholder: Open order prices shall be reduced by the dollar value of the cash or securities, whichever is greater. The dollar value of the cash shall be determined using the formula in subparagraph (1) above, while the dollar value of the securities shall be determined using the formula in subparagraph (2) above. If the stockholder opts to receive securities, the size of the order shall be increased pursuant to the formula in subparagraph (2) above.
(4) Combined Cash and Stock Dividends/Split: In the case of a combined cash dividend and stock split/dividend, the cash dividend portion shall be calculated first as per subparagraph (1) above, and the stock portion thereafter pursuant to subparagraph (2) above.

 

[mathjak107]

I have always been under the impression that what Jim's and your post stated was the way it transpires. That would explain in my mind anyways why an ex D stock that doesn't trade does not have its price automatically lowered by said amount.


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well you were wrong about that . they certainly are adjusted automatically .

 

[MichaelB]

well now you are aware of it. see what you learn here here is the finra rule requiring the offset .

If you're going to quote a source, please provide a link (see here for more detail)

 

[mathjak107]

the finra manual

FINRA Manual - FINRA Rules - 5000. SECURITIES OFFERING AND TRADING STANDARDS AND PRACTICES - 5300. HANDLING OF CUSTOMER ORDERS - 5330. Adjustment of Orders

 

[MooreBonds]

Finance theory

• agency problem: managers with excess cash will spend it on poor investments just to make the firm larger when they should be returning it to shareholders.
• signaling: management knows that cutting the dividend is received negatively by investors. so a manager that establishes a dividend is signaling that the firm has good prospects and won't need to cut the div

I'm sure there are academic studies that support these theories. Probably an equal number that don't support it.

I don't disagree with that line of thinking, what I'm asking is, 1) does it play out in a meaningful way in real life? 2) Is the delta significant enough for me to change my investment strategy? 3) If so, at what point is it noticed and arbitraged away?

Answering my first two questions requires data. If an equal number of studies were to dispute/support the idea, there probably isn't anything significant there.

-ERD50

Another thing to keep in mind: Dividends don't typically have wild swings. However, as we all know, both dividend-payers and non dividend-payers have (sometimes) wild swings in stock prices, based on the fickle short-term mentality of Wall Street. When do you sell small positions to pay your bills and fund retirement? Timing when to sell those shares can be a big impact on your "total return". However, if you are able to largely live off of just the dividends, then you don't have to worry about "well, they just came out with earnings that displeased the street, and the stock dropped 10%, and I need to sell X shares - do I sell now? Wait 1 month? 2 months?".

So while I agree in principle that "Total Return" is what is important....the reality and mechanics of it leads me to tilt more towards "Total Cash Flow" metrics rather than straight-up "Total Return".

 

[jim584672]

Adjustment of orders refers to open limit orders and stop limit orders. Do not confuse adjustment of orders with setting a price. Market order pricing is set by buyer and seller. The market sets the price at all times. There is no mechanical means by which an ex div price is set, other than by the market adjusting itself.

 

[Mulligan]

well you were wrong about that . they certainly are adjusted automatically .

According to your link, it does not refute my statement or make it in error. Your link if I am reading it correctly reduces OPEN orders of a stock automatically. It did not mention it reduced the actual quoted stock price by the dividend. Which gets back to my original point ( and keep in mind this is a minor amusing observation to me, not a who is right or wrong debate) that the stock price is not adjusted at ExD.
If I understand your link correctly it adjusts open orders. Which would actually support my observation since because I currently have 2 stocks that have not moved from their last traded price despite going ExD. But both though have had their bids dropped accordingly by same price of dividend. I just assumed the buyer did it. The exchange did it. So I actually learned something there.


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