Debunking The 'Dividends Don't Add Shareholder Value' Myth

Includes: GE, JNJ, OII, PEP
by: Chuck Carnevale


There are simply two components of total return: capital appreciation and income.

Personally, I believe that it is undeniable that dividend income, if any, represents an important component of the total return provided to shareholders on any publicly traded company.

Every time the dividend investor receives and cashes a dividend check, they simultaneously take delivery of a return of - and on - their capital.


This article is primarily directed to the retired investor, or those investors that are close to retirement and/or to those investors that are planning for their portfolios to fund their future retirement. Moreover, for the purposes of this article, it makes no difference whether you are a self-directed investor or whether you have hired others to construct and manage your portfolios on your behalf. Additionally, the focal point of this article is on the equity portion of those portfolios. Regardless of your situation, I feel it is both imperative and of great value to possess a working knowledge of how investments work.

What I mean by how investments work refers to the relevant factors that drive and create long-term returns. Unfortunately, there seems to be both controversy and confusion about the generators of return and the relative importance of the components contributing to total return. There are simply two components of total return: capital appreciation and income. Dividend-paying stocks possess both of these components, while non-dividend paying stocks only possess the capital appreciation component. However, and this is of primary importance, both equity types generate total returns.

Even more disturbing to me is the notion that there is a conflict where I believe none, in truth, exists between equity investors focused on dividend income versus the so-called total return investor. No matter which type of investor you consider yourself to be, both of you will generate a calculable total return on your equity investments. Part of that total return will come from capital appreciation, and part of that total return will come from dividend income, if any, from the stocks invested in that pay a dividend.

Therefore, regardless of whether you focus more on one component over the other makes no difference. Both components will contribute to your long-term total return. The fact that you are more interested in one over the other does not negate the fact that the one you are not focused on exists. Therefore, why do we argue about it? The investor focused on total return that also invests in dividend stocks will receive an income component. Conversely, the dividend growth investor focused on dividend income will receive the capital appreciation component. Of course, in both cases, I am assuming some long-term capital appreciation manifests.

Debunking the Theory: Dividends Don't Add Shareholder Value

With the above said, the primary point that this article will address is the debunking of the "dividends don't matter myth." This myth is perpetuated by those who contend that dividends are irrelevant, because somehow in their mind's eye a company has become permanently (emphasis added is mine) less valuable by precisely the amount of the dividend that they paid out to shareholders. Moreover, they primarily base this judgment on the fact that a company's share price will be adjusted by the dividend amount on the ex-dividend date. To be fair, I submit that those that take this position are in some respects technically correct; however, as I will show later, there is also a practical side to this as well. Courtesy of the Securities and Exchange Commission, here is their explanation of ex-dividend dates:

Ex-Dividend Dates:
When Are You Entitled to Stock and Cash Dividends

Have you ever bought a stock only to find out later that you were not entitled to the next cash or stock dividend paid by the company? To determine whether you should get cash and most stock dividends, you need to look at two important dates. They are the "record date" or "date of record" and the "ex-dividend date" or "ex-date."

When a company declares a dividend, it sets a record date when you must be on the company's books as a shareholder to receive the dividend. Companies also use this date to determine who is sent proxy statements, financial reports, and other information.

Once the company sets the record date, the stock exchanges or the National Association of Securities Dealers, Inc. fix the ex-dividend date. The ex-dividend date is normally set for stocks two business days before the record date. If you purchase a stock on its ex-dividend date or after, you will not receive the next dividend payment. Instead, the seller gets the dividend. If you purchase before the ex-dividend date, you get the dividend."

Based on the above explanation, the fact that the dividend adjustment reduces the stock price is technically and mechanically correct. However, there is also the practical matter that needs to be considered and understood. Moreover, what is not precisely black and white is the notion that many hold that the payment of the dividend, theoretically at least, simultaneously reduces the earnings power and/or the intrinsic value of the company itself. In truth, this is only a theory that factually may or may not be true.

As an aside, let's see what the venerable Warren Buffett has to say on the subject of dividends from his 2012 letter to shareholders. Below are a few excerpts:


A number of Berkshire shareholders - including some of my good friends - would like Berkshire to pay a cash dividend. It puzzles them that we relish the dividends we receive from most of the stocks that Berkshire owns, but pay out nothing ourselves. So let's examine when dividends do and don't make sense for shareholders.

A profitable company can allocate its earnings in various ways (which are not mutually exclusive). A company's management should first examine reinvestment possibilities offered by its current business - projects to become more efficient, expand territorially, extend and improve product lines or to otherwise widen the economic moat separating the company from its competitors.

I ask the managers of our subsidiaries to unendingly focus on moat-widening opportunities, and they find many that make economic sense. But sometimes our managers misfire. The usual cause of failure is that they start with the answer they want and then work backwards to find a supporting rationale. Of course, the process is subconscious; that's what makes it so dangerous."

At this point, Warren Buffett is telling us that not paying or paying a dividend to shareholders may or may not be beneficial to them or the company itself. Therefore, although in theory it might seem rational to believe that if the company did not pay out the dividend, they could grow faster or make their business more valuable longer term, in truth, this may or may not be the case; it all depends on the profit potential of the opportunities available to the respective business and/or its managers. Warren Buffett goes on to provide additional color on this subject as follows:

Your chairman has not been free of this sin. In Berkshire's 1986 annual report, I described how twenty years of management effort and capital improvements in our original textile business were an exercise in futility. I wanted the business to succeed and wished my way into a series of bad decisions. (I even bought another New England textile company.) But wishing makes dreams come true only in Disney movies; it's poison in business.

Despite such past miscues, our first priority with available funds will always be to examine whether they can be intelligently deployed in our various businesses. Our record $12.1 billion of fixed-asset investments and bolt on acquisitions in 2012 demonstrate that this is a fertile field for capital allocation at Berkshire. And here we have an advantage: Because we operate in so many areas of the economy, we enjoy a range of choices far wider than that open to most corporations. In deciding what to do, we can water the flowers and skip over the weeds."

Consequently, based on the above discussion, I contend that it is categorically incorrect to take the position that a dividend payment permanently reduces the value of a business. It may have some validity in theory, but not always, and certainly not absolutely. There are certain situations where paying the dividend when the cash is not needed to fund or facilitate future growth can actually enhance the future value of the business, as Warren Buffett described above. Conversely, it might actually hurt the business if appropriate and attractive investment opportunities are not readily available.

Theory may be useful in some academic settings, for example, as teaching points. However, in order to be useful, they must also apply in real-world situations. The above theory contending that dividends offer no true added value very often fails that test, as I will illustrate next.

Why I Tend To Shun Financial Analysis Based On Studies and Statistics

When attempting to debate the relevant benefit or lack thereof of receiving a dividend, advocates will quite often point to academic studies or papers supporting their thesis. Frankly, I have a lot of problems with basing investing principles on these so-called academic papers and/or studies. However, a comprehensive discussion of why I tend to eschew this kind of research is beyond the scope of this article. Therefore, I will simply attempt to offer a summary of a few of my greatest issues.

My biggest problems with studies and/or papers attempting to prove or disprove investing results or what generates them is the stereotypical nature with which they handle large sets of data. For example, when studying the question of whether dividends are relevant or not, they will include any and all stocks that pay dividends within their universe. Moreover, they are also likely to measure time frames that may or may not include aberrant price behavior. Simply stated, my problem is that putting all dividend-paying stocks into one basket, and then measuring the price performance of those stocks in the aggregate denies the reality that stocks, just like people, are unique entities.

In other words, if you measure the price action following a dividend declaration of low-growth, high-yield, dividend-paying stocks, such as utilities simultaneously with the price action of fast-growing, low-yield stocks simply seems counter-intuitive to me. My experience in specifically evaluating thousands of individual stocks has proven to me that their unique differences are great and distinct. Therefore, I find it hard to wrap my mind around painting them all with the same brush or characterization, such as "dividend-paying stocks". But most importantly, attempting to draw conclusions to prove a point among such disparate entities simply does not seem like a valid method to me.

Nevertheless, in the spirit of fairness, I provide this link to a paper written in December, 2005 by Thomas Henker of Bond University and Vyas Belasubramanyam of UBS Sydney that is often pointed to in order to support the theory that dividends do not provide value. I will let any interested reader read the full paper for themselves, as I did for myself, and draw their own personal conclusions. However, I also ask the reader to carefully consider the following conclusion, while asking themselves this simple question - does a one-month time frame provide conclusive evidence that dividends paid permanently reduce the long-term value or return of a business?

We also note a considerable dispersion about the mean for dividend drop ratios which suggest that the dividend event is often easily overwhelmed by the price impact of other events. Considering a longer event window we note price appreciation commensurate with the market prior to record day of a dividend and a notable underperformance of the market over the month after"

In my mind, this type of statistical analysis or research may be quite useful under certain scientific situations or areas. For example, certain areas of medical research may find great use and benefit from well-constructed statistical studies, where outcomes are based upon measurable and consistent behaviors of certain molecules in a controlled environment.

However, my experience garnered from studying literally thousands of companies over more than four decades leads me to believe that stock price movements do not qualify. The price movement of stocks is most often very unpredictable, especially in the shorter run. In other words, stock prices don't always act according to expectation. Consequently, drawing conclusions based on short-term and random movements of stock prices seems illogical to me. Consequently, I have never been able to embrace what I consider the academic hijacking of time-tested and proven sound investing principles.

When I first entered the financial industry, academic statistical theories were not ubiquitously embraced as they are today. Consequently, I am very grateful to my "old school" teachers and mentors that taught me the value of investing based on time-tested and unchangeable principles of business, economics and accounting. In other words, I was fortunate enough to have first been taught what I consider more practical aspects of sound investing. Things such as how to value a business based on earnings and cash flows, how to read and analyze balance sheets and income statements, etc.

The Practical Side and Benefit of Dividends

Personally, I believe that it is undeniable that dividend income, if any, represents an important component of the total return provided to shareholders of any publicly traded company. More importantly, I believe that the dividend received from a publicly traded company represents significant investment benefits.

First of all and practically speaking, once I receive a dividend from a company I own, I have less money at risk precisely proportionate to the amount of my dividend check. Therefore, I understand that I simultaneously have reduced the risk of owning that stock simply because I now have less money at risk. Moreover, I did not have to sell any shares to receive that cash back, therefore, my beneficial ownership interest in the company remains intact. More simply stated, I still have all my shares.

Moreover, I believe that the dividend I receive also represents a return bonus. This belief is based on the reality that the payment of the dividend does not reduce the amount of earnings that the company reported on its last financial statements. Therefore, my experience indicates that "Mr. Market" will continue to capitalize the company's future earnings in the aggregate, just as they always have and do. I have written extensively on the subject in the past - here are links to just two of my past articles. I stand by those articles and will let them elaborate on these last points.

Real-World Evidence and Examples of the Dividend Benefit

As I pointed out earlier, I tend to eschew basing my investment decisions on academic studies or papers in favor of examining specific individual companies instead. I believe that it is just as wrong to prejudge (be prejudiced against) individual businesses, as it is wrong to prejudge human beings based on esoteric attributes such as race, creed, gender or any other generalization. Furthermore, since I believe in building equity portfolios one company at a time, I concurrently believe in making my judgments about a business based on its unique individual merits.

To state this more clearly, I recognize that all dividend-paying stocks are not the same, nor are all non-dividend paying stocks the same. Therefore, it only makes sense to me to analyze the characteristics and attributes of each company I am interested in, independent of any generalized bias. Mere statistical inferences and/or generalizations have no place in my thought processes.

Therefore, I offer the following specific examples to provide evidence supporting the primary thesis of this article: Dividends are beneficial and add shareholder value. To accomplish this, I will provide real-world graphic illustrations courtesy of Standard & Poor's Capital IQ and the earnings and price-correlated F.A.S.T. Graphs™ research tool.

But before I do, I will add that time and space only allow me to present a few select examples. However, there is an unlimited number that I could produce if time and space permitted. I have examined many thousands of companies over many decades, and can emphatically state that I have never come across or seen a case where dividends were detrimental to shareholders or reduced the value of a business.

Oceaneering International, Inc. (NYSE:OII)

Oceaneering International, Inc., together with its subsidiaries, provides engineered services and products primarily to the offshore oil and gas industry, with a focus on deepwater applications worldwide. The company also serves the defense, entertainment and aerospace industries.

I specifically chose this first example because it represents a quintessential example of the primary points supporting the thesis of my article. With my first earnings and price-correlated graph, with dividends, we first see clear evidence that price (the black line) tracks earnings (the orange line), which generate the capital appreciation component of total return. Moreover, we see dividends starting in 2011 expressed by the light blue shaded area indicating after they've been paid out to shareholders, and by the pink line representing the dividend payout ratio prior to being paid out of earnings (the green shaded area).

Clearly, if the ex-dividend adjustment had a permanent impact, as some people contend, then the black stock price line should be significantly below the orange line (earnings) for the entire time that the company paid a dividend. Obviously, that is not the case. The stock price continues to track the full complement of earnings, and Mr. Market has made no permanent adjustment to the company's earnings-driven valuation. Instead, we see the normal day-to-day price volatility hovering around the company's total earnings. And most importantly, we see the added value of dividends when they are stacked above the orange line represented by the light blue shaded area.

This next earnings and price-correlated graph looks at the historical time period 1997-2011. This represents the time frame prior to Oceaneering International, Inc. paying dividends. Consequently, this was also a time when the total return of shareholders in this company was exclusively generated from capital appreciation.

My next earnings and price-correlated graph, with dividends, covers the time frame 2011 to 2013. This represents the period of time since Oceaneering International, Inc. started paying a dividend. If you examine this graph closely, you can see that price tracked earnings generating the capital appreciation component, and dividends, the light blue shaded area on top of the orange earnings justified valuation line represents the second component of total return-dividend income.

But most importantly, the performance associated with the above graph shows that the capital appreciation component (30.7%) is functionally related to the company's earnings growth rate (25.6%). Additionally, we see that dividend income added an additional $331.67, which expanded the total return from 30.7% to 31.9%.

With my next graph generated courtesy of Standard & Poor's Capital IQ, I present share pricing only from April 2013-current. My objective is simply to illustrate the random and erratic nature of stock price movements in the short run. Common sense would indicate that the intrinsic value of this company cannot possibly have fallen from approximately $86 a share in November 2013 to $68 by February 2014. In other words, Mr. Market does not always efficiently price stocks. But more importantly, volatility such as this clearly counteracts any minor price adjustment due to a dividend payment.

To illustrate this point more fully, I offer this next graph covering the same time frame as the previous graph, however, I have added annotations on the graph and circled those that represent the company's ex-dividend date. A close examination of this graph provides evidence of the fact that the ex-dividend adjustment is not only temporary, but also has little relevance to the company's future stock pricing over time.

Additional Ex-Dividend Date Examples

The following examples are offered in order to provide additional evidence relevant to individual companies illustrating the lack of any long-term effect that the ex-dividend date adjustment has on the pricing of an individual stock. As you review the ex-dividend graphs, notice how sometimes the stock price rises almost immediately after the ex-dividend date, and sometimes it falls. In other words, post ex-dividend date pricing is more random, than affected by the ex-dividend date.

I am not alone on this position. In his excellent and newly released book titled "Top 40 Dividend Growth Stocks For 2014", author and fellow Seeking Alpha contributor David Van Knapp has this to say on the subject.

Because of this price adjustment, shareholders who owned the stock before the ex-dividend date, and who hold on straight through, see the price of their stock momentarily lowered by the amount of the dividend. In practice, as soon as trading opens on the ex-dividend date, market participants establish the actual price of the stock. The exchange's price adjustment is usually hard to detect after an hour or two of trading. There certainly is no long-term impairment to the price of the stock.

For the sake of brevity, I will let the reader examine the following examples on their own. However, the careful study of what is presented with these examples should establish the reality and truth that the ex-dividend adjustment has little long-term bearing on a dividend-paying stock's past, present or future total return.

PepsiCo Inc. (NYSE:PEP)

Johnson & Johnson (NYSE:JNJ)

General Electric Company (NYSE:GE)

Summary and Conclusions

Even though the dividend growth investor might be focused on dividend income, they are naturally going to get total return as well. If they own a well-selected blue-chip dividend growth stock that was bought at fair value, their total return will inevitably be a function of the company's future earnings growth rate, once Mr. Market inevitably decides to behave rationally. Consequently, it doesn't matter whether they focus on it or not, dividend growth investors can, and do, enjoy very attractive total returns.

But even more importantly, most of the best-of-breed dividend growth stocks, such as Standard & Poor's Dividend Aristocrats or David Fish's Dividend Champions, Contenders or Challengers have earned their status as a result of above-average operating performance. Therefore, as long as the investor is careful to invest in these dividend-paying blue-chips at sound or reasonable valuations, the odds are highly in their favor that superior, above-average capital appreciation, coupled with a consistently increasing dividend income stream will lead to above-average total returns.

Consequently, the intelligent dividend growth investor can focus on the dividend income stream, while simultaneously trusting that above-average capital appreciation, and yes, above-average total return, is highly likely to follow along with their rising dividend income stream. Accordingly, they don't need to worry about total return, because whether by intuition or knowledge, they can be confident that it will manifest.

Moreover, the reality that dividends provide important benefits to shareholders is clear and observable to anyone who's reviewed the evidence or that applies common sense. In my last article, I referenced that I was stating the obvious. To me, the reality that dividends are beneficial is readily apparent. Not only are they a component of total return that does not reduce the value of the business, they also represent significant risk-mitigation.

Every time the dividend investor receives and cashes a dividend check, then simultaneously they take delivery of a return of their capital, as well as on their capital, and therefore, their net capital at risk has been reduced. Dividends are in fact beneficial, and in my opinion, it doesn't get any more obvious than that. To me, anyone attempting to deny this simple truth is simply engaging in intellectual snobbery.

Disclosure: Long PEP, JNJ, GE at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

Disclosure: I am long PEP, JNJ, GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.