Those who champion dividend growth investing liken it to planting a money tree--once you have planted it (purchased the stocks), the fruit is there for the picking (dividends are paid regularly) and increases as time goes on. The stock that pays you a $3.00 dividend this year may pay you $3.10 next year (or it may pay less if business is not good).
Last week I read an blog post (and I wish I had bookmarked it) in which the author eschewed dividend growth investing, stating that generally when dividends were declared, the value of the shares dropped the same amount, giving you a zero-sum game, except that you had to pay taxes on the dividends. Something about that statement didn't sound right to me, so I did some math.
Disclaimer: The last time I took a standardized test, my verbal skills were in the 99th percentile, and my math skills, dead average. Make of it what you will.
Trying to figure out what WILL happen in the stock market is, at best, an educated guess and it isn't very useful for comparison purposes.
The shares of a particular company pay increase or decrease in price due to factors unique to that company. In other words, if a company has a great new invention that "everyone" wants to buy, investors may bid up the price of the stock in that company. In the same way, if something happens so that the company's future prospects look bad, investors may seek to sell off the stock and the and the price per share will drop,
On the other hand, sometimes the price of stocks will change, sometimes substantially, not because of anything good or bad that happened to the company but because the market as a whole has moved and they get caught up in it.
In other words, while the price of a company's stock is, to some extent, a reflection of the current and expected profits of the company, there are times that prices of shares of stock in a particular company may drop for reasons that have little to nothing to do with the company.
Dividends, on the other hand, are a reflection of earnings. If a company isn't making a profit, the only way it can pay a dividend is to use savings, and no company can do that long-term.
So, back to the question, is it better to own stock in a company that pays a dividend, or a company that does not, assuming the same rate of growth?
I did the following math:
Since I know the average stock market return over the long haul is about 7%, I used random.org to randomize numbers between -10 and 20 to come up with a string of numbers that my eyeball estimate told me averaged close to that. Actually I ended up with numbers that average a little over 5% and decided to stick with them.
I used those numbers as the percent increase in the stock price in a given year. I started with 500 shares of stock that cost $100 each. Each year I assumed the growth rate was my random number and figured out how much I would have at the end of the year. Here is the chart I got:
|Year||Return||no of shares||open price/share||end price per share||total value end|
I never took any money out of this account and at the end of eight years I had $74,305.06. But what if this had been a dividend paying stock? Would it make any difference? My guess before I did the math, was that it wouldn't make a diffence in the accumulation phase. I was almost right.
I used the same return rates on the second chart. The difference is that I assumed that this stock paid a $3,00 per share dividend on the last day of the year, and that the stock then fell in price by 3.00. In other words, if the stock sold for $98 on the last day of the year, I opened it the next year at $95 rather than $98. However, I used that $3.00 per share to buy more stock at that opening price. At the end of the year, I computed the value by multiplying the number of shares from the beginning of the year by the post-dividend price, and then adding the dividends paid.
|Year||Return||# of shares||open price/share||pre-dividend close||$3 dividend||post div close||total end value|
What About During Withdrawals?
I redid the first chart, only this time, after computing the value on the last day of the year, I withdrew $5,000, which reduced the number of shares with which I started the next year. Here are my results:
|Year||Return||no of shares||open price/share||end price per share||pre-withdrawal value||post withdrawal value|
I then re-did the chart, assuming that after the dividend had been paid, I used it as part of the $5,000 I withdrew. I thought the dividend payer would come out ahead.
|Year||Return||# of Shares||Price per share||pre-dividend close||$3 dividend||post div close||pre-withdrawal||post withdrawal|
Well, you can tell I write these posts on the fly because obviously, there is no difference (or at least no significant difference) between getting dividends and having the price of the stock increase, whether you are trying to accumulate more stock or whether you are trying to generate cash to spend.
That conclusion, of course, assumes that there is no difference in the stocks, which is something that rarely happens. In general, companies that are profitable and growing at a slow but steady pace, if at all, pay dividends. Companies that are re-investing everything they have into growing the companies do not pay dividends, but hopefully the price of the stock will increase in the long run. Of course if they overbuild, then the stock can crash for that reason.
Are you a dividend investor? If so, has my little exercise made you reconsider your stance? Why or why not?