Why Dividends?

One of the main focal points of our model ETF portfolios are dividend paying stocks. I see it as a twofer … not only does it offer attractive potential returns, but it’s also my version of socially responsible investing.

Lance Roberts at RIA has an excellent article that helps explain:

“Beating Estimates” – How Companies Win In Earnings Season

A couple quotes:

“As shown, for companies to win the “beat the estimate game,” they need the bar lowered far enough to ensure they can clear it. If not for these downward revisions in analysts’ estimates, the majority of companies would miss, rather than beat, estimates. Such would obviously weigh on stock price performance which directly impacts executive compensation due to the now standard practice of using stock options.”

“There is an inherent conflict between Wall Street, corporate executives, and individual investors. As stated, there are billions at stake for executives and Wall Street, and the “beat the Wall Street estimate” game is critical in keeping corporate stock prices elevated. Unfortunately, this leads to a wide variety of gimmicks to boost bottom-line profitability, which is not necessarily in the best interest of long-term profitability or shareholders.”

This isn’t just a heads up for investors … it’s a picture of systemic corruption. The argument for share buybacks is that they’re an efficient means of returning capital to shareholders. But it’s confined only to those shareholders that sell. Including the insiders that got options. Until the 1980’s most buybacks were illegal, a prohibited stock price manipulation scheme. At the time, stocks had been through a secular bear market and were arguably too cheap, so relaxing the rules may have been justifiable. But the pendulum has swung the other way.

Insiders who receive stock option compensation benefit disproportionately. Options are cheap, involve leverage, and if their options are underwater, they can be repriced. And earnings announcements and share buybacks can be used to manipulate stock prices at no more cost than clever accounting and PR. Coupled with skillful management of earnings releases and stock option compensation, clever use of buybacks can work as a net transfer from the general public shareholder to corporate management. This is only made possible by promoting focus on earnings. Earnings are not real to the shareholder. Dividends, in contrast, benefit all shareholders equally, and are hard to fake.

Earnings are when management tells you how much you’ve made.

Dividends are when they actually send you the money.

It goes even deeper than that though. In a fundamental way, dividends are the real earnings. If management is telling you the company is retaining profits to grow, but in fact retaining profits is required for the company just to maintain its competitive position, then are they even profits in the first place? Or a cost of doing business?

On an individual company level, retaining earnings may indeed fund growth. This is how small companies get to become big companies. But economy wide? And once the company is big? Real growth would be seen in broadly improving living standards. But aside from having snazzier toys, there has been no broad improvement in American living standards in decades. The reverse can even be argued … where a few decades ago one earner could buy a home, a car, and support a family, it now takes two. More work for the same stuff is a setback.

So in the aggregate, there has been no real growth. All of those retained profits have bought nothing.

So in the aggregate, the only earnings that are real are in dividends.

We have yet more evidence:

Making Stock Market History

Here we showed that, over the long term, in terms of gold, investors have received virtually no return from price appreciation. Using real money to price stocks shows that price appreciation has been a figment of a declining pricing unit. The real returns have all come from dividends.