# Why do companies pay dividends?



## Brendan Burgess (7 Aug 2013)

I found this great article which articulates what I have always believed Dumb idea: Dividends are good for you Incidentally the follow-on discussion shows how dumb people are in their love of dividends


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## Rory Gillen (7 Aug 2013)

Brendan,

Don't be too rash with your comments on the poor old dividend paying stocks; my own statistics highlight that buying the 15 stocks with the highest dividend yield from the FTSE 100 Index (with one stock from each industry) and recalibrating the portfolio once a year has delivered a compound per annum return of 11.5% since 1995 compared to 7.4% for the FTSE 100 Index, or your favoured vehicle; a FTSE 100 ETF. No taxes in a pension account so re-calibrating annually not penal for pension guys.

*Rory*


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## Brendan Burgess (7 Aug 2013)

Hi Rory

I think you are confusing causation and correlation there. 

There are many reports of high yielding stocks outperforming low-yielding stocks, but that is because good companies pay high dividends, not because paying high dividends makes companies good. 

Of course, if you have no other way of identifying good stocks, then using dividend yield might be valid. 

I have Ryanair shares, and I don't like when they announce a dividend.  But when they do, the share price usually rises. It should stay the same when it is announced and go down by the amount of the dividend when it goes ex-dividend.


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## Duke of Marmalade (7 Aug 2013)

_Boss_ I think that article has the tax angle wrong at least for Ireland.  If share buybacks made distributions almost tax free, they would all be at it.  From what I have Googled it is only in very rare circumstances that the CGT treatment applies.

You raise an interesting question on causation.  A dividend yield can be high for either of two reasons:

1) It is company policy to aggressively distribute.

2) The company's share price is low because the market does not like it, in which case a broadly normal dividend would look high in yield terms.

I have commented on Rory's algorithm before.  To me it just isn't statistically significant and without a supporting economic argument as to why his mechanocal algorithm should outperform I don't buy it.  

I am sure if I do enough backtesting I will find that, for example, a switch from oil stocks to utilities on the third Friday of very month and back again on the second Tuesday but only if it hasn't been raining has more than doubled the market performance.


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## DerKaiser (7 Aug 2013)

A few points:
1. A company that does not pay dividends will have to either keep large cash balances and constantly identify new investment opportunities.
2. If you invest in a pension or a savings policy with a pensions / insurance provider you are indifferent to whether you receive capital gains or income
3. The tax situation might be more complex dependent on total income and other gains / losses


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## Marc (7 Aug 2013)

If you read Modigliani and Miller what they argue is that dividend policy is irrelevant unless the company also changed its investment policy.

A dividend yield is sometimes but not always a manifestation of the risk of the company and more risky companies should have a higher expected return to an investor.

Our preferred metric is book to market as this tends to be more stable over time although in principle you can use several relevant measures over price which is all the dividend yield is really telling you.


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## Jim2007 (7 Aug 2013)

Marc said:


> If you read Modigliani and Miller what they argue is that dividend policy is irrelevant unless the company also changed its investment policy.



Marc, 30 years I concluded that the M&M Theorem was so full of assumptions as to render it useless, I have not changed my opinion in the intervening period!


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## Marc (7 Aug 2013)

Although Merton Miller did win a Nobel Prize for this work so I guess we shouldn't just dismiss it out of hand...


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## Jim2007 (7 Aug 2013)

Duke of Marmalade said:


> I have commented on Rory's algorithm before.  To me it just isn't statistically significant and without a supporting economic argument as to why his mechanocal algorithm should outperform I don't buy it.



Well it is just another version of the Dogs of the Dow, it has also been replicated on the SMI and a few other indexes as well, which I expect you already know..  

It is simply a value play on a selection of companies which one expects still to have some life in them, so I'm not really sure what kind of economic argument you are expecting...

One thing I do wonder about though, is the impact of one of the dogs falling of the index these days, as ETFs could have a serious impact on the pricing.  In the past although the price of such companies have fallen they usually have recovered enough to have only a limited impact on returns.  However today the impact of a very large number of ETFs dumping the stock might have a bigger impact that in past studies.


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## Jim2007 (7 Aug 2013)

Marc said:


> Although Merton Miller did win a Nobel Prize for this work so I guess we shouldn't just dismiss it out of hand...



I would not put much store by economists and Nobel Prizes, after all Black–Scholes–Merton got a Nobel Prize as well and look out that turned out for it's followers!


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## Monksfield (7 Aug 2013)

The evidence that investing with a distinct bias towards dividend tends to generate better outcomes is fairly overwhelming. The reason lies in human behaviour both on the part of investors and management.

Investors tend to overpay for the hope of high(er) growth and undervalue steady/boring.
Management sees a pile of cash as a way of building up a bigger company by way of acquisition - another mountain of evidence confirms that the majority of acquisitions destroy value for the acquirer's shareholders.

As an investor I love the idea that paying a meaty dividend places a substantial discipline on management to husband resources : it may seem like a trivial point but a substantial dividend reduces the likelihood of accounting tricks (or perhaps they are more likely to come to light?).


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## cremeegg (21 Aug 2013)

monksfield said:


> the evidence that investing with a distinct bias towards dividend tends to generate better outcomes is fairly overwhelming. The reason lies in human behaviour both on the part of investors and management.
> 
> Investors tend to overpay for the hope of high(er) growth and undervalue steady/boring.
> Management sees a pile of cash as a way of building up a bigger company by way of acquisition - another mountain of evidence confirms that the majority of acquisitions destroy value for the acquirer's shareholders.
> ...



+1


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## cremeegg (21 Aug 2013)

Marc said:


> Although Merton Miller did win a Nobel Prize for this work so I guess we shouldn't just dismiss it out of hand...



You completely misunderstand the point of academic research. Messers M & M didn't do their thing just so you could make money.

Their work extends and deepens our understanding of the rational market model. 

It does not tie that model any more closely to reality, in general or in relation to dividend policy.


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## Olivetti (22 Aug 2013)

*Dividends - Warren Buffett's View*

Warren Buffett has a very good (and as usual with him, clear and interesting) piece on why Berkshire Hathaway is delighted to receive dividends, but doesn't pay them, or plan to, in his most recent annual letter to shareholders.

It's available at the Berkshire Hathaway website (apologies I am not an experienced enough poster to be able to include a link, apparently, perhaps someone else might do the needful) - the piece on the dividend issue is at pages 19-21. Well worth a read.

{Off topic, there's another very worthwhile Buffett read floating around the internet too - a remarkably prescient report he wrote to the CEO of (I think) the Washington Post as far back as 1974 which effectively predicts the defined benefit pension investment crisis. Again, can't post a link.}


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## STEINER (23 Aug 2013)

Olivetti said:


> It's available at the Berkshire Hathaway website (apologies I am not an experienced enough poster to be able to include a link, apparently, perhaps someone else might do the needful) - the piece on the dividend issue is at pages 19-21. Well worth a read.
> 
> {Off topic,  predicts the defined benefit pension investment crisis. Again, can't post a link.}



http://www.berkshirehathaway.com/


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## tvman (23 Aug 2013)

The best reason to pay dividends is to get cash out of the hands of managers, who will inevitably waste it.


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