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There has been abundant discussion regarding the utility of dividends. Many investment models rely on factors or other strategies in their attempt to increase returns or reduce volatility. These approaches generally focus on total returns and brush dividends aside. Some go further and argue specifically against dividends – occasionally likening dividend advocates to sacred-cow worshippers. The low dividend yields and strong capital appreciation we have observed in recent years has probably diminished the reputation of dividends as well. On balance, the art and science of dividends has largely been forsaken.

This is a pro-dividend article. While I acknowledge some issues with dividends (e.g., inefficiencies in how they return capital to shareholders), many investors and practitioners do not fully understand or appreciate some of the key attributes that can make dividends useful – especially in the context of retirement income.

This article discusses some pros and cons of dividends. I also weigh in on previously-discussed issues and share what are some new perspectives. Some of claims I revisit/challenge are:

  • Synthetic dividends are the same as real dividends;
  • Dividends are equivalent to buybacks when returning capital to shareholders; and
  • Dividends comprise the bulk of total returns investors experience.

As the title suggests, the primary goal of this article is to explain what makes dividends different. It is important to acknowledge the intrinsic fundamental nature of dividends. In particular, this creates a unique value proposition in that dividends can provide investors with a growing stream of income that is largely independent of market volatility.

On balance, dividends are a powerful financial planning tool many retirement models seem to neglect. Please stay tuned for my future article(s) were I will present a retirement income strategy that leverages some of the benefits discussed in this article.

Figure 1: Achieving the same result via different actions


Source: Aaron Brask Capital

Content summary

I first explain what a dividend is and highlight its fundamental (as opposed to market-based) nature – a critical notion that resonates throughout the rest of the article. I then discuss two key issues regarding how dividends may be an inefficient means of returning capital to shareholders. The following two sections challenge popular claims regarding dividends and how they are related to market returns and buybacks. The penultimate section (before my concluding remarks) discusses the relevance of calculating performance via total returns versus internal rates of return in different contexts and shares related empirical observations.

Figure 2: Executive summary


Source: Aaron Brask Capital

What is a dividend?

A dividend is a direct cash1 payment from a company to its shareholders. Of course, if you hold stocks and/or stock funds at a broker or custodian (e.g., Charles Schwab), then they will simply facilitate that payment by transferring the funds from the issuer to your account. In many cases, they will take your dividend and reinvest it by purchasing more shares of the stock via an automated DRIP (dividend reinvestment plan). A key point here is that dividends are paid directly from the operating business to shareholders. So they depend on the fundamental performance of the business and effectively bypass stock market volatility2.

Figure 3: Dividends bypass market volatility


Source: Aaron Brask Capital