One thing I wish was more frequent on Seeking Alpha is a rebuttal article. In general, an alternative argument that is properly structured and directly linked to the original can only help to increase the level of discourse. More frequently, however, alternative viewpoints end up in the comments section of an article where they are either missed, get skipped, or are not fully developed into a cohesive argument. This article is a direct rebuttal to Greg Loehr's article entitled: Beware The False God Of The Dividend. While I appreciate Mr. Loehr's viewpoint, I felt compelled to provide an argument of my own as to why dividends represent a key part of any investing portfolio.
The Math of the Matter
Mr. Loehr's article was absolutely correct when it broke down what happens to a stock's price the moment it goes ex-dividend. You take money out of the company and its worth less than before. Big deal. If the story ended there though, I wouldn't have bothered with this eloquent rebuttal. The one part of Mr. Loehr's article that particularly ruffled my feathers was this bit:
In mathematical terms (tax implications aside), receiving a dividend really isn't much different from taking money out of savings and putting it into checking. Yet you still have the market risk of the stock.
So let's look at that math. One simple way to value an enterprise is through book value. According to Wikipedia:
Book value is used in the financial ratio price/book. It is a valuation metric that sets the floor for stock prices under a worst-case scenario. When a business is liquidated, the book value is what may be left over for the owners after all the debts are paid. Paying only a price/book = 1 means the investor will get all his investment back, assuming assets can be resold at their book value.
So when a company pays a dividend out of their cash coffers, their asset levels are reduced by that amount and therefore book value drops by that amount. I've listed three companies below to look at this in more detail.
Price to Book Value:
Now these three companies were chosen because they are all big old American manufacturers, not because of any recommendation one way or the other. You'll notice that Book Value is shown built into the Price to Book Value term. If all companies were only priced based on book value, the price to book value term would be 1 in all cases. Put differently, why do people pay some multiple of book value for a firm? There are a lot of answers to this but to put it succinctly, it comes down to future expectations of earnings. The world believes that over the long term, Caterpillar will do better than Ford which in turn will do better than GM. The flaw in Mr. Loehr's article is that he is assuming this:
Price = Book Value
When in actuality it is more like this:
Price = Book Value + (or -) Future Expectations of Earnings
Think about this for a minute. Imagine you purchased shares of Caterpillar at these rates. You have explicitly said that you are willing to pay 3.22x the value of CAT's book for ownership. Who cares if book value drops due to a dividend payout? Most of what you paid for is that future expectation of earnings.
To see where dividend investors really benefit, you have to take this one step further. What happens in the (un)likely event that future earnings are not what you hoped? Imagine a point 3 years down the road where GM and Caterpillar's prices have not appreciably changed because neither has been able to prosper. In the case of GM, you can sell your shares and get most of your money back. In the case of Caterpillar, you will have collected more than $6 per share in dividends to soften that blow.
I can't help but think that I'm preaching to the choir with this article. At the same time, I also think it's important to go through the process of reminding yourself why it is that you invest the way you do. For my part I value dividends because of what they signify in the company I own, because of what they let me do in raising cash without selling my ownership, and because they play an important role in long term valuation.