Vanguard expert on total return vs. income producing

[ERD50]

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

... .

OK, thanks. I either misread or misinterpreted what you were saying then. I do have a vague recollection that open limit orders will be adjusted by the dividend, and that makes sense to me.

But I still don't think that the listing price is altered until a trade occurs, but maybe that isn't what you were talking about?

-ERD50

 

[Mulligan]

OK, thanks. I either misread or misinterpreted what you were saying then. I do have a vague recollection that open limit orders will be adjusted by the dividend, and that makes sense to me.



But I still don't think that the listing price is altered until a trade occurs, but maybe that isn't what you were talking about?



-ERD50

That has been the source of confusion, ERD. We have been referring to the stock price, while Mathjack has been referring to the open order of a stock. Jim58 is the one who has been expressing this all in a concise and accurate matter. Or at least to me you are Jim!


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[jim584672]

Some people try to capture dividends and sell shortly after the ex date with the hope the market prices the stock too high after the ex date.

 

[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. ...

Yes, on thinly traded stuff, the bid ask can have some crazy spreads.

Back when I was doing more options on individual stocks, I was able to get to something from my broker that showed the bid/ask prices further down (I forget the correct terms now). So you might see offers to sell @$110 with 400 shares on one side, and $111 would have 1000 shares offered. So you had some idea that if you were trying to buy 500 shares at $110, you might not get filled, and might need to go up to $111 for the remainder. Unless HFT changed all this!

-ERD50

 

[Mulligan]

Yes, on thinly traded stuff, the bid ask can have some crazy spreads.



Back when I was doing more options on individual stocks, I was able to get to something from my broker that showed the bid/ask prices further down (I forget the correct terms now). So you might see offers to sell @$110 with 400 shares on one side, and $111 would have 1000 shares offered. So you had some idea that if you were trying to buy 500 shares at $110, you might not get filled, and might need to go up to $111 for the remainder. Unless HFT changed all this!



-ERD50

That would be very interesting info to have and track. There is some interesting behind the scenes numbers I will be able to briefly view. A bid of 100 shares implying not much interest, but when it sells I may briefly see a 1000 order next in line bid only to see it vanish to 100 to align with the amount that is offered lowest as an ask price.
At times I will see a transaction occur above the ask price which doesn't make sense to me unless it is because a behind the front lines of the bid/ask there is a bigger allotment of Ask that matches the bigger Bid order to buy it and the bid person caves in to the price?


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[mathjak107]

OK, thanks. I either misread or misinterpreted what you were saying then. I do have a vague recollection that open limit orders will be adjusted by the dividend, and that makes sense to me.

But I still don't think that the listing price is altered until a trade occurs, but maybe that isn't what you were talking about?

-ERD50

it is the open orders that set the opening prices. when you reduce them all incoming prices follow .

 

[mathjak107]

interesting reading on the subject. i will post the link below .



What Really Happens To A Stock
Price On The Ex-Dividend Date?

It's commonly stated that the price of a stock is automatically adjusted down by the amount of the dividend on the ex-dividend date and while in practice it often looks as if that's what takes place, technically that's not really what happens. The only trade price that the exchange reduces by the exact amount of a dividend is the quote of the previous day's close, not any actual trade. But because the quote of the previous day's closing trade AND the bid and the ask of all outstanding orders are also reduced (unless placed with a Do Not Reduce restriction) by the exchange, plus the fact that the net asset value of the stock is now less (by the exact amount of the dividend), when trading begins on the ex-date the effect is usually a reduction in price approximating the size of the dividend, as traders are well aware of the reduction in the stock's net asset value.

Such an informal (though generally effective) reduction in stock price on the ex-dividend date is, of course, much more noticeable if the dividend is larger than the normal trading range of the stock. For example, if a stock has a normal daily trading range of, say, twenty five cents and the dividend is a few cents, the effect of a few cents' adjustment of the stock price may not be noticeable. However, if the dividend is two dollars, the price adjustment will nearly always be very noticeable, as it's well beyond a twenty five cent normal daily trading range.

So, while the market is free to trade the stock at any price on the ex-date, even at the open, much more often than not it trades lower by about the amount of the dividend. The only way to be sure whether any specific stock will or won't do so on its ex-date is to wait and see what happens.


What Really Happens To A Stock Price On The Ex-Dividend Date

 

[Mulligan]

I agree with you on what you are saying Mathjack, but it doesn't seem to back up what is happening with illiquids. The article above says the quote of the preceding day is reduced. But that is not happening. Just to give an example. On Fidelity stock website, AILLL is listed as last trade at $26.24. This last trade was July 7. It went exD July 9. Fidelity shows the last trade date next to price. The price remains $26.24 even though 2 trading days have since passed. Now I fully expect the next trade to be lower whenever it happens because it always gets bid up right before going ex.
It just appears to me based on my observations of illiquids that Jim's explanation is the only one that can make sense for this situation.


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[dallas27]

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.

Would be a study worth reading of anyone ever did that....



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[NW-Bound]

... Such an informal (though generally effective) reduction in stock price on the ex-dividend date is, of course, much more noticeable if the dividend is larger than the normal trading range of the stock. For example, if a stock has a normal daily trading range of, say, twenty five cents and the dividend is a few cents, the effect of a few cents' adjustment of the stock price may not be noticeable. However, if the dividend is two dollars, the price adjustment will nearly always be very noticeable, as it's well beyond a twenty five cent normal daily trading range...

+1

The effect of going ex-dividend on a single stock is generally masked out by the daily fluctuations because the quarterly dividend is minuscule nowadays.

But watch the MFs going ex-dividend once a year, and tell me that you do not see it.

 

[NW-Bound]

Occasionally, a stock may issue a special dividend that is huge or several percent of its price. It usually happens when the company holds too much cash, and shareholders beat that cash out of them. Ford did that once while I owned it. No way that such a big dividend would be missed in the stock price the next day.

 

[mathjak107]

I remember years ago fidelity magellan had a 20% distribution when they re- mapped the portfolio

 

[robertf57]

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


5330. Adjustment of Orders

Thanks you, but this is not setting a price. This is adjusting an order that has been entered for a transaction that is caught up in a dividend event. Not even close to the same.

 

[mathjak107]

as the article I posted above explains reducing the bids is effectively re-setting the price .


"because the quote of the previous day's closing trade AND the bid and the ask of all outstanding orders are also reduced (unless placed with a Do Not Reduce restriction) by the exchange, plus the fact that the net asset value of the stock is now less (by the exact amount of the dividend), when trading begins on the ex-date the effect is usually a reduction in price approximating the size of the dividend."

 

[robertf57]

as the article I posted above explains reducing the bids is effectively re-setting the price .


"because the quote of the previous day's closing trade AND the bid and the ask of all outstanding orders are also reduced (unless placed with a Do Not Reduce restriction) by the exchange, plus the fact that the net asset value of the stock is now less (by the exact amount of the dividend), when trading begins on the ex-date the effect is usually a reduction in price approximating the size of the dividend."

I appreciate what you are saying. However, I categorically reject that the price is being set. Each of those outstanding orders had their price set by the buyer and the respective seller. If the shares go ex-dividend while the order is in play, the seller is just receiving some of the purchase price agreed to via the dividend payment. It isn't anymore complicated than that. What happens with the resumption of trading is between willing sellers and buyers. The exchange doesn't set anything.

 

[Mulligan]

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

as the article I posted above explains reducing the bids is effectively re-setting the price .


"because the quote of the previous day's closing trade AND the bid and the ask of all outstanding orders are also reduced (unless placed with a Do Not Reduce restriction) by the exchange, plus the fact that the net asset value of the stock is now less (by the exact amount of the dividend), when trading begins on the ex-date the effect is usually a reduction in price approximating the size of the dividend."

I am only splitting hairs here because you have backed off your initial statement saying I "was wrong about that" when I said the closing stock price was not automatically adjusted down. Your statement above also says "usually" and "approximating" not automatically. And now you have changed the words to "effectively" instead of "adjusted automatically"
Everyone knows there will be automatic downward pressure on an ExD stock. Its the mechanics we were discussing.
FWIW- The book is now closed on my AILLL example. Last trade July 7 at $26.24, with last Bid 25.95. Went exD July 9. Bid and Ask price as your article mentioned did reset bid/ask both. Bid price went down to 25.55 and ask was 25.85 Price went unchanged 3 trading days at $26.24 until a 400 share transaction occurred today at $25.75.
So it did not immediately adjust... Bid/ask immediately adjusted but not to the price that sold. As I stated, nobody is debating downward pressure, but in relation to the actual previous closing price Jim's analysis was correct. Your article is speaking in more general terms, but in my interpretation it supports Jim's explanation. He just used more technical terms that the writer did not want to use.


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[Danmar]

What happens with the resumption of trading is between willing sellers and buyers. The exchange doesn't set anything.

This is certainly my understanding. I had 20 years in the industry. Exchanges generally don't set prices but facilitate buyers and sellers. You might be able to debate what the word "set" means. But I would say it was the buyers and sellers who "set" the price. Anyway, sounds like we have a little too much time on our hands?

 

[Mulligan]

This is certainly my understanding. I had 20 years in the industry. Exchanges generally don't set prices but facilitate buyers and sellers. You might be able to debate what the word "set" means. But I would say it was the buyers and sellers who "set" the price. Anyway, sounds like we have a little too much time on our hands?

I plead guilty as charged and beg leniency from the court! I have been "under the weather" the past few days and I have been confined to the couch. My GF wont even come visit. I am hoping to get more of a life tomorrow assuming I feel better and round out a foursome on the course. The issue has been close to debating over whether it is 110 degrees outside or 111 degrees.


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[samclem]

The issue has been close to debating over whether it is 110 degrees outside or 111 degrees.

I would like to nominate the previous "what happens ex-dividend" messages as the least interesting exchange of information of 2015--peppered with the most unexpected and ironic passion.

 

[Mulligan]

I would like to nominate the previous "what happens ex-dividend" messages as the least interesting exchange of information of 2015--peppered with the most unexpected and ironic passion.

My shameful passion has been from watching how my illiquid preferreds trade which is very unusual. I guarantee you one thing, Sam, if the title of this thread was started in certain other website's Income and Investing section (and it has repeatedly); the endless debate would never have devolved into this as the heated argument would have remained on task.


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[clifp]

M* Dividend Investor newsletter.

This month's M* Dividend Investor Newsletter had very good article about dividend investing. This is snippet of the cover article. My apologies for the formatting. You can read the whole thing here and sign up for a free trail.

Given the various practical advantages associated
with dividends, it would not be unreasonable for
equity investors to accept lower total returns than the
market average in order to get them. However, history
tells a different story: The aggregated virtues of high yielding
stocks have led them to outperform low- and
no-yield stocks over time.

Though this observation has been demonstrated in
numerous academic studies, lately I’ve started
to evaluating raw data myself. Among the data sets
made available by Dartmouth professor Kenneth R.
French (best known for the Fama-French asset
pricing model) are returns for U.S. stocks based on
their dividend yields at one-year intervals. This
treasure trove of data and many others is available
free at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html,
and I’m still coming up with ways to evaluate the past performance
of dividend-paying stocks. But it’s not too early
to share a few of the strongest conclusions
Invested at the average return of the U.S. stock
market, a dollar at the end of 1927 became $3,013 by
the end of 2014—an average annualized return of
9.6% a year. That in itself isn’t surprising, but those
who consider dividends the province of has-beens
should note the positive relationship between relative to the standard deviation of returns—provides
a good yardstick for considering risk-adjusted performance.
The higher the Sharpe ratio, the higher the
return that is earned relative to the volatility involved.

Exhibit 2: Returns and Risk by Yield
Column 1 Total Return Percentage
Column 2 Standard Deviation %
Column 3 Sharpe Ratio

Entire Market 9.6 18.8 0.33

Non-Payers 8.5 30.1 0.17

Lowest 30% 9.1 19.8 0.28

Middle 40% 10.4 17.9 0.38

Highest 30% 11.1 20.0 0.38

Quintiles by Yield

Lowest (non-zero) 9.1 20.6 0.27

Quintile 2 10.0 18.4 0.35

Quintile 3 9.7 18.7 0.33

Quintile 4 11.6 18.7 0.44

Highest Yields 10.9 20.9 0.35

*Monthly data from Dec. 1927 through Dec. 2014. Total returns and standard deviations are annualized. Source: Kenneth R. French, Morningstar analysis.

Here we see that the highest 30% of stocks by yield
provides higher total returns than the middle 40%,
the middle beats the lowest 30%, and all the dividend
payers top the nonpayers—a slightly expanded
version of the outcomes graphed in Exhibit 1. The
nonpayers also had the highest standard deviation of
returns, which isn’t much of a surprise. However, the
highest yielders also have a standard deviation (20.0%
annualized) that is slightly above the market average.
The Sharpe ratio suggests this additional volatility
is worth taking, but the least volatile segment—the
middle 40% of yields—offers a similar risk/reward
trade-off (a lower annualized return than the high
yielders, but less volatility too).


There is a bunch more info for the data loving folks. For the rest of us dividends mean higher returns and less volatility. If you are in the accumulation phase the lower volatility may not be that important in the withdrawal phase I think it is very important.

So what about DVY and other dividend oriented funds. I guess my answer is that aren't particularly good funds. For instance, I've never understand the rational for DVY.
To me a far better dividend fund is Wellington.

The M* dividend investor newsletter has been around for 10 years and the real money portfolio is up 1.8% per (as of Jan 2015) over the S&P more importantly the Beta of the portfolio is .73. My portfolio (which relies heavily on Josh Peter picks) has had similar performance. Despite the drag of my large Intel holding.

 

[FIREd]

T
The M* dividend investor newsletter has been around for 10 years and the real money portfolio is up 1.8% per (as of Jan 2015) over the S&P more importantly the Beta of the portfolio is .73. My portfolio (which relies heavily on Josh Peter picks) has had similar performance. Despite the drag of my large Intel holding.

Josh has admitted to having made some mistakes along the way, like going into the 2008 crash with a healthy dose of financial-sector equities that ended up cutting their dividend aggressively and yet he still came out ahead. So I think it is a testament to the strength of this strategy. Of course, back in 2008, the indexes were also heavily invested in the financial sector, so Josh may have not been outsmarted by the market after all.

Still, I wonder. The core of my US large cap equity allocation is composed of dividend-paying stocks. Low interest rates have boosted the appeal of dividend-paying stocks, so it is perhaps no surprise that they have outperformed in recent years. With that in mind, I have started redirecting new funds to a plain US equity index fund over the past year.


On another note, I really dislike this often black and white debate between income investors and total return investors. There is a huge grey area in between. My dividend-producing portfolio is sitting on huge unrealized capital gains, so I not only get income, I get growth too. And plenty of total return investors live solely on the income produced by their portfolio.

It seems like the main argument against dividend investing is that price matters more than income. It is hard to disagree with that. I don't think that KO for example is a buy at any price. But I don't see a lot of index investors worry about price much. In fact, discussions about market valuation are often DOA unless one wants to be labeled a dirty market timer. In a few decades, the story goes, price won't matter anymore because the market will be much higher, so tune the noise out and keep buying. If maximizing total return is truly the goal, shouldn't price be the number one concern for non-income investors?

 

[ERD50]

... So what about DVY and other dividend oriented funds. I guess my answer is that aren't particularly good funds. For instance, I've never understand the rational for DVY.

To me a far better dividend fund is Wellington. ...

But if a general broad based fund/ETF, which has as its stated purpose to hold dividend stocks (DVY) can't be used as a proxy for this strategy, then I think we are deep into cherry-picking season. I could just as well say that BRK/A is a better rep than SPY, as it pays zero divs (and beats them all in total return).

Wellington is 35% bonds. And actively managed.

Equity component: Fundamental research identifies high-quality large- and mid-capitalization companies in out-of-favor industries. These stocks typically offer above-average dividend yields, low valuation multiples, and improving fundamentals.

It sounds like divs are an product of their choices, rather than what they seek out?

...
It seems like the main argument against dividend investing is that price matters more than income. ... If maximizing total return is truly the goal, shouldn't price be the number one concern for non-income investors?

I can only speak for myself, but to me total return (and some efficient way to invest in it and be diversified) is everything. Price? BRK-A and BRK-B are priced very differently, but are essentially twins.

Did you mean valuations? OK, but that's getting into timing, which is a different discussion.

edit/add: And to be clear, and again, only speaking for myself, I'm not arguing against dividends, I'm just asking if they really outperform in recent times in a broad based, diversified fund that I can easily invest in.

-ERD50

 

[FIREd]

Did you mean valuations? OK, but that's getting into timing, which is a different discussion.

edit/add: And to be clear, and again, only speaking for myself, I'm not arguing against dividends, I'm just asking if they really outperform in recent times in a broad based, diversified fund that I can easily invest in.

-ERD50

Price and valuation are connected through earnings (correct me if I am wrong), so I mean both.

I am not trying to argue for dividends either or convince anyone. As my post shows, I am not sure what strategy is going to be superior in the future and I am hedging my bets. But I dispute the assertion that I am making a "costly mistake" (as per the webcast) by building my portfolio around a core of dividend paying stocks. As always, time will tell. Since many of the stocks I own form the core for forum favorites, Vanguard's Wellington and Wellesley funds, I won't be the only one going down.

 

[clifp]

But if a general broad based fund/ETF, which has as its stated purpose to hold dividend stocks (DVY) can't be used as a proxy for this strategy, then I think we are deep into cherry-picking season. I could just as well say that BRK/A is a better rep than SPY, as it pays zero divs (and beats them all in total return).

Wellington is 35% bonds. And actively managed.

I think the problem is that DVY algorithm is a lousy one.
Here is what M* says about it.

While its yield is attractive, this fund isn’t pretty.

IShares Select Dividend DVY offers an attractive yield but can’t overcome its awkward methodology, bulky size, and high expense ratio. This exchange-traded fund tracks 100 high-yielding U.S. stocks and weights them by dividend per share, resulting in mid-cap and deep-value tilts. Despite the higher yield, the fund has underperformed both the mid-cap value Morningstar Category and the S&P 500 since its 2003 inception. The fund is best used as a satellite holding to boost the yield of a core portfolio.

It seems me that more algorithmic approach you use for ETF the more you get into potential trouble. IMO these strange ETF that rely on momentum, data mining or whatever, actually combine the worse feature of active and passive management. The inflexibility of an index fund, with the likelihood of a bad programming/criteria.

Morningstar did an interesting analysis between the mostly passive ETF Dividend Appreciation ETF VIG and the actively managed Dividend Growth VDIGX. VIG has a lower expense ratio .1% vs .31%. And have basically the same philosophy buy stocks of companies with growing dividends, but on virtually every measure the actively managed did better. VDIGX also beat the S&P 500 over 10 and 15 years periods and do so with significant lower volatility, with a sharpe ratio of .38 the same as Josh Peters findings.

The manager for VDIGX is also part of the Wellington Group and has >$1 million of his own money in the fund. Turns out one of the best ways to find out if active fund will one of the 25% that beat the index funds is if has two criteria.
1. Expenses in the bottom quartile
2. The fund manager has lots of their own money invested in the fund.

I'm not sure why it is cherry picking. Buy stocks that pay dividends but don't buy the ones with the highest yield, because they often are trouble.