A recent column by Jeff Sommer in The New York Times (https://www.nytimes.com/2020/04/24/business/coronavirus-stocks-investing-dividends.html) highlights some of the challenges faced today by investors seeking income from their stock holdings. While the economic shutdown has certainly created an adverse environment for the public-company cashflows that have historically been paid out in dividends, income-seeking investors will want to consider a few additional perspectives beyond what is raised in the Times.
First, Sommer implies that because stock ownership has shifted from individuals a century or half century ago, to mutual funds, pension portfolios, and other institutional accounts now, that dividends are somehow less felt on Main Street. It is worth recalling that all mutual funds (and ETFs and index funds) regularly distribute the dividends that they receive. The real end customer—Grandma and Grandpa—are the same, even if there is an intermediary that may not have been there a century ago.
Second, the author reiterates an important point about the power of dividend reinvestment, and Wharton-Professor Jeremy Siegel is correctly cited in the article referencing “investor” returns as the beneficiary of dividend reinvestment. But product or market total returns and dividend reinvestment have nothing to do with one another. A fund’s total return is calculated on a daily basis and necessarily includes the dividend payment in that short period of time, if one is received. (That is why it is called “total” return.) Those brief-period returns are then geometrically linked over time to give you the annual or multi-year total returns that you see bandied about in the media or marketing literature. Whether or not the investor reinvests the dividend has an enormous impact on the value of any individual account—the investor’s return—but it has zero impact on the total return of the “market” or any specific investment product. For example, a single fund has two customers. One takes the distributions; the other reinvests them. At the end of five years, the fund has a single stated total return. But the two customers will have very different amounts in their accounts, because one has taken the dividends, and the other has reinvested them. This separation of the total return calculation from whether the investor reinvests dividends or not is needed because you would otherwise have great distortions in return figures anytime the investor added money to his or her account, or took out a lump sum.
The article highlights share buybacks as an alternative to dividends. Investors should realize that buybacks go to share sellers, not to shareholders. They do not benefit the income stream to Grandma or Grandpa one iota. And investors should carefully consider the assertion that dividends don’t or should not matter to investors, the argument of two academics, Miller & Modigliani, made in 1961. The M&M propositions, as they are known, are theoretical at best, and as I have argued at length elsewhere, are simply wrong more than a half-century later. Pointing to Warren Buffett’s disdain for dividends does not make the argument correct. He can be seen as the exception to the rule about how businesses should be judged, and he is very much at odds with Benjamin Graham’s original stated precepts about dividends.
Finally, the author suggests that dividends have weighed down companies over the past several decades and forced them to forego growth opportunities. That is one of the reasons he is “largely indifferent” to them. The questions for investors now, however, is about the future. What do those growth opportunities look like for the next 5, 10 or 50 years? If we expect the same level of growth as we’ve had in the past, he may well be correct. If growth is going to be lower, however, then payments to company owners in the form of dividends make even more sense than they might have in prior decades.
Investing in the stock market in a calm, business-like, long-term fashion is already challenging enough. And the recent shutdown of the economy has added to those challenges, as Sommer correctly observes. But these same circumstances give investors a chance to refresh their priorities. And for many investors, choosing investments that can reasonably be expected to deliver a cash stream in return for their capital can and should be one of those priorities. For investment managers, the crisis presents an opportunity to distinguish between those companies that can thrive over the next decade—and have distributable profits to show for it—and those that can’t.
Daniel Peris
April 27, 2020