“Dividends will have their day again,” says the WSJ. So will business investors.

Happy to have this Dividends will have their day again call out from the Wall Street Journal, but it is worth filling out the story a bit.

Distributable profits are the most natural, logical way of generating return for minority shareholders in an on-going, for-profit enterprise. If that enterprise happens to be publicly traded they are called dividends. It is a form of business ownership.  Successful businesses that do not distribute their excess cashflow to company owners can be owned as stocks, and stocks only. Their only cash return comes from going into the market place and selling a stake–hopefully at a higher price than what was paid. That’s a rather odd way of benefitting from business ownership–by selling it down. The dictionary calls that speculation, but that is neither here nor there. So while business owners in the stock market have missed out on the tech highflyers mentioned by Jakab, they are not really part of the investable universe for business owners in the stock market. From an investment perspective, non-cash distributing assets can be considered a distinct asset class, one that warrants a separate asset allocation decision.

The role of dividends in the market’s total return continues to be woefully misunderstood. In the standard narrative, dividend yield represents about 40% of the market’s overall return for the past century or so, with the rest coming from capital appreciation. But share price gains are themselves just a function of dividend growth and valuation differentials. Throw in dividend growth, and the dividend accounts for about 90% of total return over longer time periods. The only reason it is not 100% is that the market has gotten more expensive over time, with a current measly yield of 1.6%.

And it is worth reminding investors and market commentators that total return calculations include the dividend in the period it is paid. There is no “reinvestment” benefit to total return for a given investment.  It is already included. That is, the total return of a stock (or portfolio) is the same whether or not the owner is taking the dividends or reinvesting them.  The amount of money in a specific customer account will, of course, depend on reinvestment (as well as flows in or out), but that is not part of the total return calculation. It is stunning the number of investors and commentators who do not realize this.

Jakab makes one particular observation about dividend investing that is really important to highlight in the current period. As minority shareholders downstream from imperial, all-powerful CEO, investors face high agency costs. In that context high payout ratios  “leads managers to avoid bad investments. They are better stewards of investors’ capital because they have to spend it more judiciously.” Amen.

Even with all these edits, thank you Spencer Jakab.