The Stock Market Is A Strange Place
Since I started investing 11 years ago, it has always concerned me that most people in the stock market have negative and complicated views toward dividends. Demanding that companies pay shareholders a reasonable income is met by aggressive arguments against dividends. People complain that dividends are not tax efficient, they can hinder future growth, they're inferior to stock buybacks, blah, blah, blah.
The strange thing is that I only hear these arguments when dealing with stock investors. When I talk to real estate investors, they love getting their taxable income each month from their tenants. As a real estate broker, it's difficult for me to sell properties that don't produce income. Real estate investors use the income from their properties to pay for vacations, their kids' education, car payments, entertainment, and other every day expenses. When I talk to private business owners, they need their businesses to generate income so they can make a living.
Outside of the stock market, everyone who owns cash-producing assets expect their assets to appreciate in value AND provide a steady stream of income. Stock investors have different expectations. We are often asked to choose between growth OR income. Growth that might never materialize, or income that is often low.
With the millions of dollars CEOs make, they should be able to create strategies that produce income and growth for shareholders.
Source of Hate Towards Dividends: Asset Managers and Company Management Teams
Where did this evil idea come from, where investors no longer expect to receive income from their cash-producing assets? Why do small investors reject sure dividends and accept flimsy promises from CEOs about future growth?
I define small investors as individual investors who buy and sell stocks in their personal brokerage accounts. I am a small investor.
Based on my observations, small investors are being deceived by asset managers, management teams, and the halo that is placed on these people's heads. I won’t mention any names in today's piece, but I always hear famous asset managers say dividends are not important and investors should focus on companies' ability to increase their future cash flows. Small investors have become mesmerized by these asset managers eloquent speech, status, and past returns, and they now believe that if Famous Investor X says dividends are irrelevant, then dividends must be irrelevant. The small investor believes that a company's value is the present value of its future cash flow, even if the cash flow never comes to us. We watch money flow into other people's pockets and pretend their cash flow is ours.
What is not highlighted enough by asset managers and the media is that the asset managers who downplay dividends for shareholders receive a regular dividend themselves when they collect their 1.5–2% taxable management fee. If they manage $500 million of assets, they make $7.5–$10 million from their investment activities. The management fee is their income, their dividend, so they don’t need to sell stocks to cover their expenses. Since their monthly expenses are covered by the management fee, asset managers are incentivized to focus on growth instead of company dividends because they get 15–20% of their portfolio's growth. They also attract clients when their portfolio grows more than their peers. Their incentives and structure are completely different from small investors, so we cannot use their playbook 100%.
Management teams believe distributing income to shareholders is optional, but they expect to receive their taxable salaries every month, and if they get fired, they expect a taxable exit package as well. Managers claim to be aligned with shareholders because their bonuses are dependent on hitting certain financial milestones, but the truth is, as long as shareholders are not getting paid an adequate income, the managers will never be aligned with us.
Dividend Yields Are A Joke
When companies decide to pay a dividend, the yield is so low that it doesn't reflect the level of risk we are taking.
In finance, investors demand an income return that compensates them for the risks they are taking. Right now, small investors are taking the most risk and getting the lowest income return. We have little access to management. We have little say in the direction of companies. We are the first to get wiped out when companies go bankrupt.
On February 1, 2024, Meta announced their first dividend with a yield of ~0.51%. On April 25, 2024, Google also announced their first dividend, with a yield of ~0.51%.
Just for reference, as of May 18, 2024
Meta’s 2027 bonds pay 4.8%
Google’s 2026 bonds pay 4.8%
The 10-year Treasury pays 4.4%
My savings account pays 4.25%
The S&P 500 pays 1.35%
The fact that Google and Meta announced a 0.5% dividend, and people were okay with it, shows me that something is broken in the stock market. Meta and Google's bondholders, who have more protections than shareholders, are getting paid 10x more. The financial principles people talk about every day should support the argument that small investors need way more than 0.50%– 1.35% for our money. Companies that follow Meta and Google's playbook of paying shareholders with small dividends are letting us know that they're the boss. Not us. We just give them our money when they IPO, help them pump up the stock price for their compensation, and get out of their way so they can empty the company coffers.
The Truth - Small Investors Are Owners Only In Name
Although small investors are called owners of the company, the truth is, we are treated like charity cases. Everyone involved with the company is getting paid a reasonable income, but we are told to be satisfied with stock buybacks and future growth. I grew up in the Bronx, and I also spent years as a real estate broker. The way management teams and asset managers talk to shareholders reminds me of the hustlers that I come across.
Buybacks Are Inferior To Dividends
In no way, shape, or form are stock buybacks comparable to dividends. This should not even be a debate. When shareholders receive a dividend, our risk is reduced because we get some of our money back. If we invest $10 and receive $1 in dividends, we get 10% of our money back. If the company goes bankrupt, we will only lose $9 instead of $10. We can also use the $1 of dividends to buy shares in other companies and diversify our portfolio.
With enough dividends, we can invest in private businesses outside the stock market. CEOs make it seem like they're the only ones who can find investment opportunities and allocate money in a tax efficient way.
Right now, my friend is expanding their small business, and they need a few dollars to buy more equipment. With enough dividends, I could invest in their business, which already generates high double-digit returns.
Buybacks do not reduce our risks the same way dividends can. Investors in companies that focus on buybacks will own more of a melting ice cube if the company declines. Also, if a non-dividend paying company goes bankrupt, shareholders are left with nothing, while the management team and board of directors walk away with the salaries and bonuses they collected over the years. Our risks are not reduced with buybacks.
In terms of taxes, I can own shares in a Roth IRA account and not pay taxes on the dividends I collect. Also, below certain income levels, investors pay 0% taxes on long-term dividends. CEOs are not the only ones who can allocate money.
Personal Examples of Why Dividends Are Important
Some dividend investors use charts and models to explain why dividends are important, but the only stats I need is my personal experience. When I first bought Intel, the dividends I received paid my phone bill. It was a great feeling to have my investment cover one of my expenses. Due to the company being mismanaged, the dividend got cut by 66%, and I can no longer use dividends to cover the phone bill. It was good while it lasted I guess..
I also remember when one of my people's owned a non-dividend paying stock for years, and the stock was going nowhere. They held onto it because they loved the company and management team. Eventually, the stock price shot up to the moon. One day the person needed money, but since the stock does not pay dividends, they had to get a margin loan. The stock price soon declined, and they got hit with a margin call. During the process, they had to decide between selling their beloved asset and miss out on the company's future growth, or get a margin loan. Long-term owners of cash-producing assets should not have to make these type of choices.
Small Investors Lack An Advocate
As small investors, we don't have anyone advocating for us. The terms we are being told to accept make it clear that we're on our own. Companies treating us like charity cases need to stop.
I'm putting together a little plan right now. I will get back to you with an update. Hopefully you'll join the movement.
Email me if you have any comments: ov@myinvestmentdreams.com
Stay strong, stay blessed, and God willing, I will see you next week.
"The Lord detests double standards; he is not pleased by dishonest scales."
Proverbs 20:23 NLT
Comments