The Myth Of Dividends

by: George Acs

I very recently created a bit of a fuss over my recent article, "I Don't Understand Dividends." Based upon comments received in some earlier articles about Apple (NASDAQ:AAPL), it appears that it would be a terrible idea -- in terms of personal safety -- to ever write an article suggesting that Apple should discontinue its dividend. The response would truly be a good example of compounding, which apparently is something that I'm said to not understand.

But then again, can any of us truly understand a miracle?

In the recent article about dividends, the intent was to demonstrate a technique that may sometimes be used to exploit an inefficiency in option premium pricing. That inefficiency can serve to offset some of the share price drop that accompanies the distribution of a dividend. My opinion is that dividends themselves are simply illusory benefits, rather than real added value. You simply take value from one pocket to another, pay taxes and then hope that shares will appreciate to offset the price drop they sustained.

As was frequently said during the recent Presidential campaign, "Hope is not a strategy."

The comments made were many and often fairly passionate. Among the common refrains were the assertions that dividend payments prevent corporate management from squandering profits on ego stroking acquisitions, and that dividend paying companies outperform their non-dividend paying counterparts.

Of course, paying a dividend didn't stop Time Warner (NYSE:TWX) from making its ill-fated "merger of equals" with AOL (NYSE:AOL). It did, however, directly result in a cessation of the dividend for a number of years and cause a sustained depression of share price. In fact, I don't think the dividend offset the $150 or so price drop once the deal was closed. Can you imagine how an unshackled management team would have been spending in a wild frenzy? I wonder if they had to borrow from the capital markets to get some of the funds that weren't available because they were lining the pockets of shareholders.?

More recently, paying in excess of $1 billion in dividends didn't seem to make the management at Hewlett-Packard (NYSE:HPQ) any more vigilant when doing due diligence in its purchase of Autonomy, if allegations are found to be true. In terms that are easy to standardize, the $8 billion in fraud is the equivalent of eight years worth of dividend payments at Hewlett-Packard.

If paying a dividend is a means to keep management from recklessly spending "other people's money," I think I can offer to do it for only $500 million.

But what has intrigued me is the unflinching belief that dividend paying companies are simply better than the rest. The evidence to suggest that is really the case is quite tenuous, as the analytical methodology is lacking. Simply comparing the performance of dividend paying companies to non-dividend paying companies is a worthless exercise, as it is devoid of the controls necessary for comparisons of study groups.

In fact, what should be assessed is the performance of dividend paying companies to themselves, prior to initiating a dividend and then during their dividend paying years. Additionally, further comparisons may be made to companies that are capable of paying dividends, but have chosen to not do so. More critically stratifying companies on the basis of dividend yield or payout ratios would be even more compelling.

But forget it if you think that I'm going to be the one to undertake the study. If anecdotes are good enough to prove a point for some, they are at least good enough to illustrate the fact that not all is black and white.

Obviously, the poster child for either of those two study approaches is Apple, although it has been an exceedingly short period of time that the company has most recently been paying a dividend for such comparisons to be truly meaningful.

But since people tend to interpolate their anecdotes, this is a good place to start.

Since Apple paid its first dividend in August 2012, shares have decreased 7.8%. Looking at the four months prior to dividend initiation, shares were 6.7% higher.

Obviously, not enough time to make an observation, much less a generalization, but let's look at Apple at a few different periods of its life. From December 1980 to May 1987, just before Apple made its first ever dividend payment, shares appreciated by 138%. In the nearly nine-year period that Apple paid that dividend, its shares appreciated only 16%, including its dividend payments.

In the event that one wants to suggest that the comparison periods should be identical, then let's simply shave the last 22 months off of the latter dividend paying observation period, before Apple had to discontinue its dividend, despite the fact that management was presumably shackled from making bad decisions due to the allure of retained profits. In that case, shares actually fell about 15%.

I'll take "No Dividends" for 138%.

How about Microsoft (NASDAQ:MSFT)? You know, that company that now pays a dividend, yet it is constantly referred to as being the place that money goes to die. You know, the company that is roundly criticized for the way in which it squanders money, despite the fact that a dividend payment should be preventing such happenings.

In the 17 years Microsoft had traded as a public company before initiating a dividend payment in 2003, its shares appreciated 26,200% after adjusting for splits. In the years it has offered a dividend? 43% and Skype.

But just to be fair, let's forget about such behemoths and instead, look at mere mortal companies that are going ex-dividend this week and have started paying dividends in just the past 10 years or less.

Lorillard (NYSE:LO) has been paying a dividend since 2008. In that time, it has distributed $20.23, with its current yield at 5%. During its dividend paying period, it has risen an adjusted 107%. Not bad, although not quite the 213% of the 54 months prior to initiating its dividend. Want to improve the numbers by ignoring the market drops during 2007-2009? Looking from March 2009 and forward, Lorillard returned 148%.

Need another example from this week's dividend players? In the six years that AAON (NASDAQ:AAON) has been paying its dividend, its shares have appreciated 119% after adjustments. The previous 78 months, it returned a more than respectable 292%

You can also look no further than Sinclair Broadcast Group (NASDAQ:SBGI) and see that for its initial period of paying a dividend from 2004 to 2008, it posted a loss of 52%. However, the 54-month period prior to paying that dividend it didn't set the world ablaze, but it did gain 1.2%. Meanwhile, when it stopped paying a dividend in 2008 until restarting in 2010, shares gained 162% while proceeding to gain only 51% once the dividend was reinstated.

For those interested, there's also Joy Global (NYSE:JOY) paying a dividend this week. You probably know how that story went.

The likely response to these examples is that you expect greater returns from companies that are experiencing growth than more mature companies. That's difficult to argue with, but one has to wonder why anyone would want to compromise growth opportunities by depriving management of the cash necessary, due to the need to pay dividends.

In what many have referred to as a lost decade of stocks, the idea that simply investing in a dividend paying company and counting your future dollars as being essentially guaranteed is a shaky premise.

Just as my few examples do not prove a point, there should be enough reason to have a small bit of skepticism when anyone loudly thumps their chest to proclaim that dividend investing is a panacea and foolproof approach to investing.

The reality isn't quite as consistently on the side of the individual investor and as most ads loudly proclaim, "past performance is not a guarantee of future results."

Disclosure: I am long MSFT. 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.