Facts and fallacies about stock dividends
October 1, 2021 | View PDF
Some folks think stock dividends are a measurement for how well or poorly a company is doing. That is false.
Some folks think all companies pay dividends. That is false.
Some folks think dividends are not taxable. That is usually false.
Still, dividends remain an important factor in stock ownership.
What are dividends? One simplistic explanation often heard is that when a corporation has a profitable year, they share the profit with shareholders, in the form of dividends. But that’s not true. For when a corporation has a less profitable year, they do not reduce the dividend. And when a corporation has a year in which it loses money – it has no profit at all – the corporation seldom halts the dividend.
This is because if a dividend gets cut or eliminated, investors react by selling the stock, sending its price downward. To keep the stock price from plummeting, corporate bigwigs are loathe to cut or eliminate a dividend. Too often they care more about pleasing their investors than about fiscal responsibility.
About 20 years ago, I recall a telecommunications company going through hard times. It was losing money. When it came time to pay its dividend, this firm didn’t have the money. Rather than cut or eliminate the dividend, the company borrowed money solely for the purpose of paying its dividend.
ExxonMobil had a horrible year in 2020 – its losses exceeded two billion – that’s billion, not million – dollars. But it kept paying its full dividend. Fortunately, it had the cash reserves to do so, and its fortunes have since rebounded. Still, the oil industry was going through difficult times, and the stock price of Exxon (and of its competitors) dropped significantly.
Many stocks don’t pay dividends. Not paying dividends used to be unusual. But that changed significantly in the 1990s, which ended with a stock mania not seen since the 1920s; the dot-com bubble was expanding, and simply owning stocks seemed to promise investors future financial success.
But it was not to be. What goes up must come down, and the stock market is no exception. What made the dot-com bust more painful is that dot-com stocks did not pay dividends. These were, by and large, businesses without storefronts or factories. They conducted business entirely via computer. The first of them to post a profit – and it took quite a few years – was Amazon. Which still doesn’t pay dividends, despite its great wealth and success.
I recall the year 2000, when I bad-mouthed a stock because it didn’t pay dividends. A colleague looked at me in mock askance and said, “Dividends? How quaint. Does anybody still pay dividends?”In that colleague’s world of dot-com boom (and later bust), dividends were a non-factor. It was almost a sign of weakness to be paying dividends, at least in her view, because we were at the dawn of a new century and had advanced beyond mere dividends, and we now focused purely on stock price, etc. But I never stopped championing dividend-paying stocks.
Whether a stock goes up or down in price, you are much better off if that stock pays you dividends.
Often you may choose to reinvest the dividend, which means spending it to buy more of the stock in question. Or you can choose to receive your dividend check (electronically or on paper). Personally, I use a combination of the two. It’s nice to increase one’s stock holdings effortlessly by reinvesting a dividend. But it’s also nice to receive a check – income for which you haven’t lifted a finger in labor – every quarter.
Dividends, when in effect, are paid quarterly. If you try to time your purchase of stocks in anticipation of dividends shortly getting paid out, you won’t be doing yourself any favors. When a company pays a dividend, its stock price gets reduced correspondingly. That is one reason the dot-com stocks did not pay dividends. Those companies focused solely on the share price of their stock. The higher it went, the more its executives could puff their chests and perhaps collect bonuses. Many of those companies cared more about share price than turning a profit.
Some dividends are described as a percentage, such as “Company X is paying a 6% dividend,” which sounds great compared with bank interest. But I advise ignoring these percentages, which are calculated based on the momentary inverse relationship between a stock’s price and its per-share dividend. Because the stock price constantly fluctuates, this can be misleading. A very high dividend percentage could be a sign of a troubled, perhaps collapsing, company that just hasn’t gotten around yet to cutting its dividend.
Bonds also spin off dividends, but they’re a different ball game.
Arthur Vidro is an author and editor who worked for a decade in the stock industry.