I hate dividends. There, I said it. There are so many reasons for their awfulness that I would need to write an entire book on the subject. In addition, an entire section would probably need to be devoted to accounting, so that the average Joe would be able to comprehend it.
But in any case, I don't want to get in too deep, because this problem has been studied by researchers for over 60 years under such names as "The Dividend Dilemma" and "The Dividend Irrelevance Theorem"; and so far, no real answer for why investors like dividends has been discovered. But when I suggest this issue to other investors, they all have the same argument: dividend-paying stocks return more than non-dividend paying stocks. Usually this is based on their review of how the Nasdaq (lower dividend yields) returned less than the Dow (higher dividend yields) over the past 10 years or so. There are numerous reasons this happened that are beyond the scope of this article, namely:
1. Nasdaq has smaller cap companies, which increases the risk and capitalization/discount rate for valuation formulas.
2. Nasdaq companies have more volatile earnings and higher costs of capital, which increase the capitalization/discount rate.
3. In the long-run the Nasdaq has returned more; but the arguer does not go far enough back.
4. The market has been dismal over the past 10 years; the fundamentals of Nasdaq companies are riskier and more volatile; therefore, the Nasdaq dropped more than the Dow
5. Dow and Nasdaq companies are apples and oranges.
As you see, none of these conclusions even consider the dividend. That's because the dividend is irrelevant to the company's value in the absence of transaction costs: cash is being pulled out of the company and placed in the investor's brokerage account; so, not taking into account the costs listed in items 1-6 below, the investor's personal wealth is the same whether he had received the dividend or not! The value of a company is derived from the income it produces (not the dividend). And in the case where a dividend is paid, the dividend actually reduces the value of the company. The reasons for this are as follows:
1. The investor must pay taxes on those dividends, which hurts his return.
2. The company cannot invest in other activities because it handed its capital back to its investors.
3. The investor must make a decision what to do with the dividend (when he entrusted his money with the company's management to invest for him in the first place!).
4. When he invests the dividend, he must pay commissions and other transaction costs. He also runs the risk of a lower return than if it had been left in the company.
5. The company has to pay a Registrar to handle the logistics of the dividend, which cuts into the investor's returns.
6. If the company is short on cash flow, they may still have an incentive to pay the dividend to appease investors and put itself in a liquidity glut.
What is interesting about all this is that most investors don't realize these ill effects that dividends produce. Here is why: they don't see all those 6 costs reduced from their dividend. If it were the case where the dividend landed in their brokerage account in an amount net of the taxes, the opportunity cost of keeping the money in the company, the commissions, the cost of the registrar, and the higher interest rates for having smaller liquidity ratios, these dividends would not be as appealing to the uninformed.