Why Investors Love Them And CEOs Should Not
Martin, our money man and main investing partner, emailed us last night and said simply "I've pretty much lost it all". It was mostly financial stocks that cut payouts. First, dividends do matter in terms of returns from shares. But people who have truly relied on dividends for income may have to face a sad truth. While investment trust dividends depend on their underlying investments, they are a number of other factors to consider.
Of course, it is possible to keep income low enough to avoid taxes on dividends and long-term capital gains Live in a state with no income tax and you may avoid taxes on dividends entirely But numerous income streams can foil those plans, sending your taxable income north of the magic number of about $75,000 for couples (half that for singles) including Social Security Income, withdrawals from tax deferred accounts, unanticipated blog income, and yes, dividends themselves.
For the US share market, it has been found that higher dividend payouts lead to higher earnings growth1. It's important that dividend imputation is not weakened in Australia to ensure dividends are not taxed twice. While I do some individual stock investing myself, I really can't recommend it to others unless they have both the time to invest†and the contrarian attitude.
I look at dividend stocks as a kind of diversity. When a company cuts its dividend, its share price usually goes with it, and no CEO likes that. Not only did shareholders never see another dividend, they lost all their capital as well. The FCF can be used for several purposes, including paying a dividend, buying back stock, lowering debt, or saving for future acquisitions.
The chart below shows the total return for a sample of ASX-listed stocks around the dividend ex-date (day 0), with interim dividends shown in black and final dividends shown in red. Once the portfolio's objectives and stock and bond allocation are determined, you can figure out how to get the cash flow out of it, whether it's through asset sales, interest payments, dividends, or something else.
The latter group is more than happy to sell shares if they need cash from their portfolios. Dividend-focused funds though, typically invest in companies that have higher payouts, which means that there's still money left over for unitholders after those expenses are paid.
Value stocks tend to be more likely to pay a dividend as compared to growth stocks, and I own Vanguard's small cap and mid cap indexes in my Roth IRA. The purpose of the income asset allocation of an investment portfolio is the production of income in an Passive income amount large enough to assure: annual growth of income producing capital and annual growth of income production.