AIM stocks, dividend coverage, dividend yield, Expecting Value, income/dividend bubble, pitch books, REIT/MLP sector, Richard Beddard, Stockopedia, survivorship bias, tax, tax-free compounding, The Reformed Broker, UK Value Investor
There’s been a lot of good dividend commentary & debate in the UK blogosphere recently. Stockopedia seems to have ignited the debate:
Expecting Value & UK Value Investor chimed in with these:
Finally (apologies, I may have missed a blogger or two), Richard Beddard posts up a storm on the subject, beginning here (so scroll through his more recent related posts also):
Time to add my 5%, I guess…
Or should I say my 2.5%, I’m not sure I’ll actually add something new considering the debate to date. But I do ponder the dividend dilemma regularly, so it’s time to do a bit of a brain dump & move on!
- So, what’s all the fuss about anyway?! I’m no enemy, but I can’t say I’m a particular fan of dividends myself [Look back through my stock write-ups, have I ever really homed in on a dividend yield?]
Let’s tackle the tax angle first:
- Double taxation – i.e. income tax on corporate profits and dividends. This is sometimes explained away as the price you pay for shareholder’s limited liability. You’re f**king kidding me?! Imagine what government’s tax take would look like if there was no limited liability – we’d probably still be back in the bloody Middle Ages. This is simply an opportunistic & egregious abuse of government’s taxing authority, which far too few investors ever cotton on to (as hoped).
- Especially as it’s really triple taxation, in all too many cases. Remember, i) you paid income tax on the salary/earnings that originally funded your equity investment, ii) the company then paid income tax on the earnings from your investment, and iii) you finally paid income tax again on your (paid) share of the earnings from your investment.
- But wait… You might want to buy a bottle of whiskey or two to drown out the pain of this taxation trifecta. Yup, time for another hit…over 50% of the cost is simply more taxes (VAT & duty)! Of course, then you suffer inflation – far too often, it’s just another government ‘sponsored‘ tax on its citizens & creditors. And to add final insult to injury: If you’re unfortunate enough to live in certain (cough…most?!) countries, the government will lie to you about the actual rate of inflation!
- Incidentally, governments will always treat creditors (i.e. fixed-income investors) even more atrociously, via financial repression and inflation (or both!). You can’t fight that, so equities are inevitably the best choice vs. bonds as an investing vehicle.
- The relative tax treatment just adds to the pain for many investors. The sale of shares (in the open market, or into a buyback) attracts capital gains tax, while dividends incur income tax. Generally, with minor exceptions, income tax rates match capital gains tax rates at best, and are often far higher. Therefore, share price appreciation’s clearly preferable to dividend returns.
- Investing on a tax-free basis is an appealing alternative. But in most instances tax-free doesn’t mean tax-free at all..! It simply means tax-deferred, you just pay coming out the far end. Don’t knock it, though. I’m sure I don’t have to post tables (or Buffett quotes) to convince you of the significant out-performance to be gained from tax-free compounding! But do you really need to endure all the potential limitations, fees & hassle of tax-deferred investing when you can target & enjoy the v same compounding effect with low/zero dividend yield stocks?
Next, let’s cover some misconceptions & hype:
- We’ve all seen the studies that demonstrate a significant portion of long-term stock returns comes from dividends. So? I could also posit a significant portion of reality show returns comes from dumb, slutty & possibly mentally ill nobodies… So which is the more obvious statement?!
- This is really just a case of ‘healthy dog, healthy tail‘. Share buybacks are a relatively new phenomenon so, throughout history, dividends have obviously been the main conduit of corporate cash to shareholders. Stock indices are, by definition, always weighted towards the large/mature/successful blue chip companies. These are the consistent dividend payers, and generally exhibit higher dividend payout ratios. I haven’t even mentioned survivorship bias. Put all this together, and are you surprised at the study conclusions? Healthy dogs have the healthiest tails!
- But forget all that, I’ve the utmost faith in the investment bankers, brokers & fund managers. To sell the public on whatever they think the public thinks they want… Got that?! I’m sorry, did you think it was about investment performance, not sales? Just like cigarettes are about mellow pleasure?
- C’mon, seriously, why on earth do people still persist in buying billions of high fee/poorly performing investment products (yes, I mean mutual funds)? It’s all down to advertising & sales incentives, of course! Josh Brown says the financial sector outspends the beer/liquor industry seven times over! That ratio’s a little hard to believe, but even if it’s partly true, it explains a hell of a lot… [Take a look at Josh's new book 'Backstage Wall Street' for a dead-on/snarky look into the industry!]
- And what does the great unwashed public really want right now? Certainly not equities, it seems – they’re terrified of them, and of potential losses. And it’s not just a buying strike, they’re still actively selling equity funds. Trouble is, the bulk of the fees are in equities & equity products… So what’s the answer for the ‘advisers‘? Well, that old chestnut – sell dividends, of course!
- And boy, are they selling the hell out of them now! After all, these days, if they promise you stock gains, all you can think of is stock losses… But if they sell you dividends, well then you’re just two v prudent investors going down the pub for a pint & a natter about dividend yields. All v cosy - throw in a few assorted pictures of mountains, sailboats, grandchildren & the like and everybody feels even better.
- But no financial advertising/pitch is complete without a sexy table/chart, or two. Think they can come up with a few charts that prove, beyond a shadow of a doubt, that i) dividends, not growth, contributes most of your return, ii) blue chip dividend payers are the best thing since sliced bread, and ii) you can never lose¹ by investing in a basket of those stocks? Course they can! Not suggesting they lie, they just need to slice & dice long enough to come up with something good – after all, greed is the mother of invention.
- btw Don’t believe me? Well, if you’re unfortunate enough to suffer investment banks, save their pitch books. Do a transaction, wait a few years, and then welcome them back. Now compare the old & new pitch books – notice anything? V interesting ideas, detailed data, compelling charts, all triple-checked, and only a small window of opportunity to do the deal. Except…it appears the new pitch presents the exact opposite data, conclusion & transaction vs. the old pitch book!? It’s even more fun if you do this comparison when the bankers are in the room. Oh, and direct all your questions to the lowly analyst who’s clearly been warned not to speak – that’s always fun too.
- It’s all much worse in the US, of course. They’re further along in the current cycle, so investors are far more desperate for low risk & high dividends. Trouble is, US company management/sponsors are a lot more flexible in identifying & delivering whatever story investors think they want to hear [yes, UK AIM cowboys aren't any better, especially in the natural resources patch - but the figures are far larger in the US]. Just look at valuations in the listed US REIT/MLP sector – those guys really pander to/abuse dividend investors – they’re already looking crazy. But that’s just the bleeding edge, I think there’s plenty more exploitation & idiocy to come in the form of a monster income/dividend bubble, spreading from the US to Europe.
¹ Oh Gawd! You’re one of those people who actually reads the footnotes..? You probably wanted to read all those CDO prospectuses too? OK, OK: ‘Disclaimer: Let’s assume you never sell, and you have no mark-to-market, it is therefore easily proved you can never lose’.