Dividend Irrelevance Myth Busted Again
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Busting the Dividend Irrelevance Myth… Yet Again!

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One of the most enduring investing myths to ever emerge on the scene is dividend irrelevance. In fact, this myth it is about as resilient as the infamous cockroach. Whenever the growth investing crowd and market prognosticators begin to get nervous about the economy/markets and their near-term return prospects, they resort to good old fear mongering and bust out a chorus of “dividend irrelevance” in a feeble attempt to scare everyday folks away from dividend-growth investing.

I guess in some twisted psychological way it somehow makes them feel better about themselves. In reality, I think it’s more a case of needing a pool of “bigger fools” to throw money into “growth” stocks so they have someone (aka a buyer) to sell their shares to while they still can.

Now, I have already debunked this myth in my article Do Dividends Matter? The Irrelevance Theory: Fact of Fiction? (which I highly recommend reading in conjunction with this one).

However, the topic seems to once again be reaching a crescendo and the noise from the bloviators is reaching a fevered pitch—trust me, it’s cyclical!

Recently, I came across a video from Levi Woods of Drawbridge Finance in which he was responding to a dividend irrelevance comment from a viewer. I’ll post the video (the portion in which he responds to the comment) at the end of this article; however, I wanted to focus on the comment because I think it epitomizes the misconceptions that have contributed to the enduring nature of this myth!

As we will once again see, there is a nugget of truth to the myth… however, this nugget is used to sell a broader falsehood. I’m taking the time to address this again because I believe this falsehood is (1) negatively impacting the investing decisions of good (but naïve) folks who don’t fully understand the intricacies of this myth and (2) causing them to make bad investing decisions.

Based on decades of investing, I am convinced of 3 things: (1) dividend-growth investing works, (2) it is the best path to long-term wealth building for the average retail investor, and (3) regardless of other investing strategies you may employ (and I use a lot of different approaches myself), DGI can and should serve as your foundational long-run retirement strategy.

However, this myth continues to unfortunately “convince” many ill-informed investors to avoid DGI—a tragic decision.

So, fasten your seatbelts as we dispel the dividend irrelevance myth… yet again!

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The Dividend Irrelevance Argument and Levi’s Response

The comment (shown below in its entirety) boils down to this:

Dividends are irrelevant because they are offset by an equal and opposite loss of capitalization.

Dividend Irrelevance Argument

Matt G’s argument is summed up in his second sentence. Specifically, he (like all proponents of the myth) reasons that:

The inconvenient fly in the ointment is that this myth assumes an equal and opposite capitalization loss… and you know what happens when you assume!

In essence, the dividend irrelevance argument contends that book value equals market value—a 100% false assumption.

Levi debunks this myth by comparing the price of dividend stocks over their dividend period (i.e., payout to payout).

His empirical evidence does support the case that this argument is a myth. However, it muddies the water by diluting the data with long periods of independent price action. I’m going to take a slightly different approach in this article.

But let’s be crystal clear about this up front… his response clearly shows that one entire dividend period later, the stocks he analyzed were trading higher, on average, 63% of the time. This refutes the claims that dividends are irrelevant.

However, as I noted, his data was impacted by the price action of the individual stocks and the broader market during those periods. In other words, it doesn’t necessarily isolate the impact of the dividend itself.

Let’s examine the dividend irrelevance case from a slightly different angle…

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Dividend Irrelevance: The Nugget of Truth

First, let’s identify the nugget of truth the lies hidden at the heart of the dividend irrelevance myth.

From a book-value (accounting) perspective, the proponents of dividend irrelevance are correct.

We know that the book value of a company is equal to its assets, less its liabilities.

I think we can all agree that cash and cash equivalents represent assets (current ones to be specific).

Next, I think we would all agree that when said company pays out a dividend, it is paying out cash.

So, if dividends (a cash asset) are distributed, then the assets and net value of the company musst decrease by an equal amount. Specifically, the book value of the company has, indeed, been reduced at that moment in time by the amount of the dividend.

We should all agree with this. That’s the nugget of truth—the whole nugget for what it’s worth.

And this is where proponents of this myth stop… however, this is where smart people keep going!

Dividend Irrelevance Problem #1

If we accept the myth and that this is indeed the end of the story, then we are left in an awkward position:

Every time a dividend was paid out, the company’s book value would continue to decrease—until they hit insolvency???

I mean that must be true if you are going to argue dividends are a complete wash—meaning a dividend-growth investor loses an amount of capitalization equal to the dividends they gained (i.e., a net-zero return)?

This is what that would look like from a book value perspective:

However, we know that can’t be the case. But why? Because we are talking about companies that create value—they produce cash flow!

If you go back to that basic accounting approach and look at what is really going on with book value, this is what you find:

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In other words, while the book value does drop when a dividend is paid out, it necessarily returns to the same level by the next dividend payment—assuming a dividend pay-out ratio less than 100% and zero growth.

In a zero-growth system, the company’s book value will be exactly the same just prior to each dividend payment—and not one inch closer to insolvency!

The corollary to this is that the dividend-growth investor just made a real return equal to the yield of the dividend—completely busting the dividend irrelevance myth!

This is what the book value actually looks like:

Book Value and Actual Dividend Gain

And remember, this assumes zero growth. If you are investing in dividend-growth companies, then the book value will actually increase over each dividend period—producing a total return equal to the dividend yield plus the growth!

For the dividend irrelevance myth to be valid, the company would have to be one that creates zero value (aka cash flow). In other words, it is just liquidating its assets and distributing them to shareholders via dividends.

However, if the company generates value (cash flow), then the myth is busted.

Remember, balance sheets provide a snapshot of financials at a given point in time. You can’t simply look at one point in time (as the dividend irrelevance proponents do), you must look at snapshots from the beginning and end of the period being examined—to see the net change. When you do this, the drop in book value evaporates and there is no net change over the dividend period.

Of course, if there is growth with the company than there will be a net change—but it will be positive!

Dividend Irrelevance Problem #2

The second problem with the dividend irrelevance myth is that is assumes the market value of a stock equals its book value.

This couldn’t be further from the truth and is, again, a fundamental misconception inherent in this myth.

Based on problem #1, we would expect a stocks price to slowly recover over the dividend period. However, as Levi aptly notes, most dividend stocks recover very quickly… why?

They recover very quickly (sometimes within 30 minutes of the market open) because market price doesn’t equal book value!

Market price is what the aggregate market is willing to pay for a share at any given point in time.

Furthermore, this price is typically predicated on some form of intrinsic valuation—almost always tied to future cash flows.

In other words, what a buyer is willing to pay for a share (market price) is not based on the book value of the company but, rather, what they feel the company’s future cash flows are worth to them today!

The reality is that it makes no difference what amount of dividend a company pays today. If the future cash flows are the same, then the intrinsic value of the company is the same. Why would I pay less for it?

The moment that dividend is paid, time has moved forward and we are now discounting a new series of future cash flows. If those are expected to be the same, then the intrinsic value of the company will be the same—regardless of the now past dividend payment.

Again, if company earnings are expected to grow, then the new intrinsic value will also continue to rise.

This is a perfect check against the book value argument made in the first section—and it perfectly validates it.

Market Value and Actual Dividend Gain

In a zero-growth environment, the intrinsic (and therefore market) value of a stock will remain steady—regardless of the short-term oscillations of book value (and price-to-book ratio). Myth busted!

Now, this doesn’t mean the market is perfectly efficient. To the contrary, the market will overreact in both directions to short-term catalysts. These moments provide opportunities to long-term value and dividend-growth investors—known as time arbitrage.

Dividend Irrelevance - Dividends/Buy-Backs Are Just the Same as Appreciation?

Having proven the dividend irrelevance myth to be a bust… there will be those who argue something entirely different: that dividends are simply the same as buy-backs, which are simply the same as capital appreciation. In other words, they are irrelevant because you would have the same return without them.

Again, there is always a kernel of truth in every myth. Yes, if a dividend was not paid out, the book value would increase (in this case, at a rate equal to the previous dividend yield).

However, you would only have an “unrealized” gain. With the dividend, you have that gain in your hand to use or invest as you see fit—a realized (cash) gain.

In my previous article busting this myth, I address a lot of the flawed arguments related to this different claim. However, this is beyond the scope of this follow-up article. I encourage you to read it if you want to learn more about why this myth is so fundamentally flawed.

For example, there is the question of the efficiency at which that capital can be deployed by a company. I would rather be in control of how that capital is deployed in my portfolio—I have a track record of being able to do it with a very high degree of efficiency.

The article highlights a plethora of directly and indirectly related reasons why dividends actually matter—and matter a lot.

For now, it is sufficive to say that with capital appreciation (1) you are at the mercy of the market to actually capture (realize) that gain and (2) it will require surrendering an income-producing asset. Remember, the second shareholders start to try and capture that appreciation (by selling), it will exert downward pressure on price.

It’s like musical chairs. To fully capture your unrealized gains from capital appreciation, you need a bigger fool out there to buy your shares from you! This is easy during a powerful bull market… not so easy during a bear market or major correction (which might be precisely when you need to reap some actual cash!).

With dividends, you are not dependent on market timing to capture your return. You steadily earn your income regardless of short-run market movements—and still can benefit from the additional capital appreciation when and if you someday decide to sell.

In other words, (1) you get the same gain—all of it—with the bonus of steady passive income (which you can use or redeploy efficiently yourself) and (2) you’re never forced to surrender your income-producing asset to convert it to cash. You capture a portion of the available total return and keep right on capturing more!

With dividends, you are simply banking a portion of your total return each dividend period (generating passive income) rather than waiting for some glorious day when you manage to time things perfectly and capture it in a lump-sum payment (hope that works out for you). And, again, thanks to your own higher-degree of capital efficiency, you actually produce a higher total return over the long run!

Dividend irrelevancy is busted again.

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Conclusion

The dividend irrelevance argument is a myth—one that is thoroughly busted.

While it contains a nugget of truth (dividends do reduce book value), it ignores the broader context or picture—including how markets work and the net changes that occur over a dividend period.

Ceteris paribus (all other things held constant), you have a real gain when you receive a dividend payment equal to the dividend yield. Period. End of story. Myth busted.

Note: Two critical “other” things that may not remain constant are (1) the performance of the underlying company and (2) the performance of the broader industry/market.

However, you can not use the impact of these outside variables on the short-run performance of a stock to support the argument that dividends are irrelevant.

Always remember:

If you’re interested in dividend growth investing—you’re in the right place! We focus exclusively on helping others be as successful as possible with this approach and we hope you’ll continue to return to our site to learn, grow, sharpen your skills, and find effective and positive ideas and motivation!

Soak it all in, take and use what you want, modify it to fit your unique situation, and keep building that portfolio with a solid process and winning mindset!

The key to investing is always learning and always improving your craft. Be equipped so you can identify and avoid investing myths—myths that will only serve to derail your long-term financial goals!

Finally, if you’re interested in starting a dividend-growth portfolio, we highly recommend using M1 Finance (we listed the numerous reasons for this in many of our other articles!).

If you decide to pull the trigger, please consider using our M1 referral link https://mbsy.co/sZVS3 and we’ll both get some free cash!

That’s just one more reason to start your dividend growth investing today! It’s never too soon to start working towards your financial freedom!

Here’s the video from Levi. He puts out some great content related to dividend investing, I encourage you to check him out and subscribe to his channel if you find his content useful:

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Doug

Doug is the founder of Wicked Capital. He holds an MBA, BBA (Summa Cum Laude), and AAcc from Liberty University and has over 20-years of corporate finance, accounting, and operations management experience--spanning the public, private and nonprofit sectors. He is a member of Sigma Beta Delta International Honor Society in Business Management and Administration, Delta Mu Delta International Honor Society in Business, and Tau Sigma Academic Honor Society. He is also proud to have served his country as a member of the 82nd Airborne Division. His professional wheelhouse is corporate financial reporting, analysis, and forecasting—buoyed by his passion for fundamental analysis and valuation. Doug has been actively engaged in trading and investing for several decades, with a focus on value and dividend-growth investing. He has authored several books and, when he's not busy living the corporate dream, trading and managing investment portfolios, he enjoys playing the drums and spending time with family--especially in the Outer Banks of NC.

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