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In a rather controversial article written last month, SA author Greg Loehr characterized dividends as a "false god." While some of what Mr. Loehr had to say about dividends was demonstrably true -- specifically, that a stock's price is adjusted lower on the ex-dividend date to compensate for the pending payment -- I believe his basic conclusion was off the mark.

Mr. Loehr states that "a dividend is a return of your money, not a return on your money." I couldn't disagree more. A dividend, in actuality, is a realized portion of corporate profit conveniently paid to shareholders on an ongoing basis. If a company has or is growing a profit ,or has or is growing shareholder equity, the dividend should be perceived as a return on your investment. The beauty of dividend paying stocks is that this realized profit can never be taken away.

On the other hand, if a company's profits are faltering to the point where the dividend payment consistently exceeds profit or shareholder equity is in decline, that's when we could concede that a dividend payment, in essence, becomes a return of shareholder money. Usually, a company curtails or suspends payments before those dividends might start being considered a return of capital, however.

Further, Mr. Loehr contends that the dividend is meaningless to your net worth, or potentially detrimental when taxes are taken into account. I would concur that taxation is a negative aspect of the concept of dividends, and certainly, the fiscal cliff has brought this notion further to light. But I wholeheartedly disagree with him that a dividend is meaningless to your net worth.

To counter Loehr's contention, I refer back to the idea that a dividend is a realized profit payment. When comparing two stocks with exacting price percentage movement, an investor paid a dividend holds a total return advantage and therefore, a realized net worth advantage over the investor in a stock that does not, all things being equal.

For example, take a look at this five-year Procter and Gamble (PG) stock chart:

(click to enlarge)

If an investor bought shares of PG at about $70 in January of '08 and did not reinvest dividends, his or her price appreciation has been basically nil. However, this investor has received 20 dividend payments over the past five years totaling $9.43, which equates to an approximately 13.5% total return based on the $70 per share price. In real-world terms, an investment in 2008 of $100,000 in PG returned $13,500 in cash payments over five years, hardly a meaningless sum. The investor's net worth has grown $13,500 simply because PG paid a dividend.

In another world where PG paid no dividend, the total return would be zero. The hypothetical $100,000 investment is still worth $100,000, but with no added return. Mr. Loehr and others might argue that if PG paid no dividend, the stock chart would skew higher because the dividend distributed cash was retained in the company, creating increased equity and better market capitalization of perhaps better than 13.5 percent. That could be true. However, given the company's questionable performance over the past five years, one might equally argue that the stock price would have skewed lower due to bad managerial decisions with the extra cash hoard. So minus Nostradamus-like capability, we have no clue what would have really happened if PG had not paid a dividend over the past five years.

From this perspective, it's hard to argue that a dividend is meaningless to your net worth. Whether the stock price goes up or down, an investor receives cash. Cash that can be banked or reinvested, cash that can be put under your mattress, or cash that you can gamble away at the casino of your choice. Dividends are tangible, dividends are real, and dividends can never be taken back from you, unlike unrealized paper gains which can (and sometimes do) evaporate overnight.

But Are Dividends A Bonus?

SA contributor Chuck Carnevale composed a thought-provoking article over the summer arguing that dividend paying stocks provide a "return bonus" compared to non-payers with like characteristics. While similar to the discussion above that dividend payers provide a return advantage in a price sense, his argument centers more on stocks with comparative growth rates, not necessarily similar pricing movement. Carnevale's argument is compelling, and he provides instances that show that dividend-paying companies outperform non-payers with similar earnings growth characteristics over equal time periods.

However, as I stated above with regard to PG, it's impossible to conclusively say that the decision to return cash to shareholders is always the best total return strategy for a company to employ over the long run. While near-term dividend payments may improve investor total return, who can definitively say that the cash couldn't have been put to better use by the company in some alternative fashion, with better total return results? Capital or outside investments, stock buybacks, personnel decisions -- there are always options outside of dividends for company cash. And while hindsight may be 20/20, foresight never is.

The Road Not Taken

I would like to advance the thought that the decision to start paying a dividend is a cataclysmic event in a corporate lifecycle. Picture Robert Frost's poem, "The Road Not Taken". Once a company decides to start paying a dividend, the way in which the company becomes managed and valued/perceived by the market becomes substantively different. Dependability of near-term performance begins to take precedence over risk taking, and a more conservative operational format gradually replaces a more liberal growth platform. Sometimes this may work to the long-term benefit of shareholders, sometimes it may not.

What if Hewlett Packard (HPQ) had decided not to pay billions of dollars in dividends to shareholders over the past decade? Would it have avoided its recent death spiral? Has McDonald's (MCD) done a masterful job of balancing dividends and growth for shareholders over the past decade? Is Apple's (AAPL) decision to start paying a dividend the best long-term total return move for investors?

Given this perspective, I would contend that we can say with no definitive resolve that dividend paying stocks provide a conclusive long-term ownership advantage to shareholders. All we can say with clarity is that the company has shifted gears, has become an entirely new animal, and in my opinion, probably shouldn't be compared with a non-dividend paying company at all.

To conclude, I feel dividends are meaningful payments made to shareholders that exemplify ongoing, tangible, realized profit from equity investments. Though the payment may or may not necessarily represent a bonus as compared to similar non-dividend paying brethren, in virtually all cases, it represents a periodic return on your money, not of your money. With the preceding thoughts in mind, it would seem to me that the dividend is something neither to be considered false, nor something to be worshipped like a god. Instead, it should be considered and viewed as a component of equity distribution and return that has innate practicality, wisdom, and purpose for both pure income and total return investors alike.

Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.

Source: Behold The Wisdom Of Dividend Stock Ownership