@Cameron I have long thought dividends are irrelevant and largely a signal that the company has given up trying to grow. I wonder if dividend irrelevance theory also applies to buybacks or not - whatâre your thoughts?
I completely agree but in this case I am offering very serious reasons why the two are casually linked.
Higher capital efficiency, fewer and less risky ventures and cash flow focus and discipline.
Also, I was not aware that Apple and Microsoft had given up growing?
Well most their EPS growth is from buybacks if iâm not mistaken? If iâm honest i almost have a bigger problem with buybacks than dividends.
I think distribution of cash is relevant (whether it comes from dividends or buybacks is irrelevant). You could make a meaningful argument about dividends + buybacks combined, although individually they are both equally irrelevant.
The reason for this is that excessive distribution reduces the cash available for future growth and insufficient distribution means the company is sitting on large amounts of money they are not producing growth (effectively under-leveraging your investment).
So yes to total distribution, no to either of the individual distribution mechanisms. I think buybacks get less attention is because they tend to less consistent, so a company doesnât get shackled to them and fewer investors are making investment strategies around buybacks because they often get less visibility.
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Because of their exposure to the quality, value and volatility factors.
Historically in bear markets, lower volatility and higher quality stocks have tended to outperform the overall market and those stocks with higher volatility and lower quality (Ung & Luk, 2016). Given the factor exposures, it is expected that indices in the dividend growers and yield/quality blend categories would fare better than indices in the higher-yielding category during bear markets. This is largely consistent with what was observed during the Tech Bust and GFC.
These factors arenât some random mysterious thing that a company either does or does not have. Dividends are part of the puzzle when examining those factors.
So letâs take volatility for example. Where does that lower beta come from? Perhaps, cash flow management and fewer and generally less risky ventures. This is the kind of discipline which dividend payment instils. A need to push for stable earnings and less aggressive, but steady, growth in order to maintain moats and ensure dividend payments.
To be clear I am obviously not saying that any dividend payer would outperform any non-dividend payer that is obviously nonsense. I am saying that there is intangible value which a company instils from dividend payments.
The more efficient realisation of capital and the removal of the need to sacrifice future cash flow make dividends far from âirrelevantâ.
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I get what you are saying, but I donât see any evidence that suggests that dividend policy does change managementâs approach (except limiting the scope of future investment). No CEO wants to preside over a massive failure, dividends or not. Ultimately management will behave inline with their individual incentives, which are hopefully are well constructed to align with total return for investors (although clearly there are big departures from this in reality).
If I want stable earnings, less aggressive and steady growth I would look at that directly (in volatility or quality) rather than using dividends as a proxy. Dividends do provide factor exposure, but they do so imperfectly because (for example):
- Not all low volatility stocks will pay a dividend
- Not all dividends payers will be low volatility
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If an investment opportunity was so amazing the bond market exists for a reason.
There are numerous studies which have demonstrated that companies which pay dividends to be more efficient at allocating capital and that companies which retain large amounts of earnings tend to overpay for acquisitions. New CEOs often buy something to show they are a force for change and having a dividend policy means they have to borrow the funds or cut the dividend forcing management to really consider the consequences.
I also think there is a fraud aspect, it is much harder to manipulate your finances if you are obliged to pay a dividend.
Iâm not using a dividend as a proxy for quality and low volatility I am saying they partly explain that.
Despite all the points I have made I think largely that they are all inconsequential compared to one. Dividends allow an investor to realise cash flow now without forgoing future earnings. Whereas selling shares forces you to forgo future earnings. As there is little quantitative evidence to suggest that the average investor would pick non-dividend paying companies which would outperform those which do pay dividends (given the historical outperformance of the latter), how do you argue away this point?
Iâm big into mining stocks. Retained earnings have seen massive expansions and buyouts and destroyed billions in shareholder value. Paying out large dividends helps to prevent this and makes me more comfortable than in 2014-2015 for example.
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Direct Line shares have jumped to almost pre covid levels after they announced resumption of dividend payments. According to the Dividend Irrelevance theory it shouldnât have moved the price in either direction.
Rightly or wrongly most investors see dividends as relevant. And share prices are driven by investor sentiment.
According to the Dividend Irrelevance theory it shouldnât have moved the price
Wrong. It doesnât say any such thing.
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Why not? If dividends are not relevant why would the price move before itâs paid?
What is different about the company now than before they announced dividends would resume? The valuation has gone up
The earnings call.
The consensus forecast for adjusted EPS stands at 22.67p, rising to 27.2p in 2021.
BP rose over 7% the day they announced the cut to their dividend! What should we conclude from that? (nothing).
But profits were down significantly. I donât believe they would have had that price rise without the dividend announcement.
I understand the maths and why they should be irrelevant. But markets and valuations arenât driven by mathematical formulae. They are driven by Investor sentiment and human behavior. If enough people think they are relevant then they are relevant
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The market must have anticipated a bigger reduction in profits or worse forward projections for them.I donât think itâs fair to attribute the movement to irrationality. Direct Line themselves presumably are somewhat more confident in the future and their ability to fund the dividend.
I do agree that stocks can trade irrationally for some time, but we shouldnât expect them to do so for ever. If we think the market is already irrationally overvaluing dividend paying stocks then that would be a reason to avoid them as we would expect future returns to be lower. I think in general betting on market irrationality is starting a game of the âgreater foolâ, which does have itâs winners but I donât think itâs a good game to get involved in.
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I didnât say it was irrational. Investors assign some value to companies that payout regularly. Not all companies have room to spend all their free cash on growth, large utilities, banks, and insurance companies are examples. They make loads of cash but the market is somewhat saturated. It makes sense for them to pay a dividend rather than just sit on a cash pile.
It make much less sense in fast growing tech companies
Personally I think the ones âbetting on irrationalityâ are the ones buying Tesla shares, but they seem to be doing alright out of it so far 
That post seems to be more of an argument against share buybacks than dividends. Also not all companies have enough investment opportunities that offer value for money in order to spend their profits and itâs better to return some money to shareholders than to invest in something that wonât offer good returns for the sake of it.
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Today itâs Admiral thatâs reinstated the dividend and jumped 7%
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