The Irrelevance of Dividends

Summary

In this video, Ben Felix debunks the popular belief that dividends are a key indicator of future stock performance. He explains that dividends, while an important part of total returns, do not have any special predictive value for stock performance. Citing academic research and empirical data, Felix shows that dividends are irrelevant when it comes to stock selection, as factors like value, profitability, and investment drive returns. He also highlights the risks of dividend-focused investing and explains why low-cost index funds are the most reliable choice for most investors.

Takeaways

• 😀 Dividends are irrelevant in determining which stocks have good future returns, according to academic research and empirical evidence.
• 😀 Dividends are an important part of total returns, but they do not predict stock performance or future returns.
• 😀 The 1961 paper by Merton Miller and Franco Modigliani shows that investors should be indifferent between receiving $1 in dividends or selling $1 worth of shares, as both reduce the stock price equally.
• 😀 Stocks with similar exposure to factors like size, value, profitability, and investment tend to have similar returns, whether or not they pay dividends.
• 😀 Dividend stocks' outperformance is primarily due to their exposure to risk factors like value, profitability, and investment—not because of the dividends themselves.
• 😀 There is no evidence that a company's dividend policy leads to better long-term results for investors, and dividend-paying stocks do not systematically offer superior returns.
• 😀 Comparing two companies, one that pays dividends and one that does not, with equal book value and profitability, leads to the same expected return, illustrating that dividends don't impact returns.
• 😀 Dividend investing reduces your opportunity set by limiting you to stocks that pay dividends, which cuts your diversification in half and introduces more risk.
• 😀 Picking dividend stocks is just another form of stock picking, and does not provide any systematic advantage over other types of stocks, despite the large-cap value tilt of dividend growth stocks.
• 😀 While Canadian dividends are taxed more favorably than other forms of income in some countries, this advantage is temporary, and taxes on capital gains from selling shares can be lower, especially if the capital gains are not realized until later.
• 😀 Warren Buffett does not prioritize dividends in his investment strategy; instead, he focuses on buying companies at low prices, often finding high yields in undervalued stocks, but this does not mean he values dividends over other factors.

Q & A

What does Ben Felix mean when he says that dividends are irrelevant?

Ben Felix argues that while dividends are an important component of total returns, they are irrelevant when it comes to determining which stocks will perform well in the future. He emphasizes that factors like size, value, profitability, and investment have more bearing on stock performance than dividends.

Why does Ben Felix claim that dividend stocks are not better for long-term returns?

Felix points out that dividend growth stocks tend to outperform the market not because of their dividends but due to their exposure to other factors like value, profitability, and investment. He suggests that dividends themselves do not offer any predictive value for stock performance.

What does the paper by Miller and Modigliani (1961) explain about dividends?

The paper by Merton Miller and Franco Modigliani explains that in a world without frictions like trading costs and taxes, investors should be indifferent between receiving $1 in dividends (which causes a drop in stock price) or selling shares to create their own income. This theory suggests that dividends do not impact the overall return of an investment.

What is the key argument against the idea that dividend-paying companies are better managed?

Felix argues that there is no evidence supporting the notion that companies with strong dividend policies are better managed or have superior long-term outcomes. He states that for this idea to hold true, the market would need to misprice stocks with good dividend policies, which he believes is unlikely.

Why does Ben Felix use an example of two companies, one paying dividends and the other not?

Felix uses the example of two companies, one paying dividends and the other not, to demonstrate that, under the assumption of equal profitability and other factors, the expected returns for both companies will be the same. He shows that receiving dividends does not create a superior financial outcome compared to selling shares for income.

What is the difference between receiving dividends and selling shares for cash?

Receiving dividends and selling shares for cash are financially equivalent in terms of their impact on the stock price. In both cases, the value of the company drops by the dividend amount, and investors can use either method to generate income. The key difference is that selling shares gives the investor more flexibility in managing their tax liabilities and investment strategy.

How does Ben Felix compare the Vanguard Dividend Appreciation ETF (VIG) to Dimensional Fund Advisors (DFA) funds?

Felix compares the Vanguard Dividend Appreciation ETF (VIG) to two Dimensional Fund Advisors (DFA) funds to show that two portfolios with similar exposure to risk factors will produce similar returns, regardless of their focus on dividends. He highlights that VIG, which focuses on dividend growth, has a lower return and higher risk-adjusted returns compared to a DFA portfolio with similar factor exposure.

What does Felix mean by 'dividends do not explain future returns'?

Felix asserts that dividends do not play a significant role in determining future stock returns. Instead, factors such as exposure to size, value, profitability, and investment risks are the key drivers of stock performance, as shown by empirical research and factor models.

What is the downside of focusing only on dividend-paying stocks, according to Ben Felix?

Felix warns that focusing only on dividend-paying stocks reduces diversification, as approximately half of global stocks do not pay dividends. This limitation increases the risk of the portfolio due to less diversification and potentially higher volatility, leading to less reliable investment outcomes.

Why does Ben Felix argue that dividend investing can be seen as 'stock picking'?

Felix argues that dividend investing is essentially a form of stock picking because it involves selecting individual stocks based on dividend policies, which introduces specific risks. He points out that even though dividend stocks may tend to be larger, more profitable companies, this approach still exposes investors to significant company-specific risks, much like any other form of stock picking.