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Dividends are Dead!

April 16, 2024




                                                                                                               


What investors don’t realize: today there is a lot of information about the value of dividends and dividend investing that is obsolete. Dividends are at their lowest point in history. Where are dividend yields going from here?  Up or down. What should you do next? I am the CEO and Senior Portfolio Manager for Thriving Asset Management. For over 30 years I’ve helped clients like you navigate the financial markets. Let’s dive in.

  • DIVIDENDS AND CORPORATE SHARE BUYBACKS.
  • A HISTORICAL PERSPECTIVE ON DIVIDENDS AND SHARE BUYBACKS.
  • THE IMPACT OF DIVIDENDS AND SHARE BUYBACKS ON INDIVIDUAL SHAREHOLDERS
  • WHAT DOES THIS MEAN FOR YOU?
  • IN CONCLUSION, THE NUMBERS DO NOT LIE

What is a dividend? For those of you not exactly sure how dividends work, we will focus on the most common form and use of dividends.

Remember that it is possible to purchase ownership into a company by buying 1 or more shares of its stock. This stock, or shares in companies, is sold to the public on regulated public exchanges. Exchanges are where buyers and sellers of the company’s stock agree upon price and exchange the share of stock for money. 

For example, The New York Stock Exchange is where buyers and sellers go to exchange stock for cash and bring their cash to buy stock, which is similar to the farmer’s market in your town. The buyers go to the market with cash to buy and the sellers go to the market to sell their stock for cash.

Once you own a share of stock, you are a part owner of the company. A company can often have 1 billion or more shares of stock available for sale. Owning one share would be a very small piece of the company. However, as an owner, you would be entitled to your share of the profits of the company if there were any profits.

If the company makes a profit – more cash coming in than cash going out to pay expenses – the company can share this cash with the owners of the shares of stock or it can keep the cash and use the cash for the company’s business needs.

There are a limited number of things that a business can do with its profits.

  1. The money can be either returned to shareholders, or
  2. The money can be invested for the shareholders’ benefit.

                                                              

DIVIDENDS AND CORPORATE SHARE BUYBACKS.

To return profits to the shareholders, the company will either pay a dividend or buy back its own shares. This purchasing of its own shares is done with the intention of raising the price (value) of the shares. When a company buys back its own shares, it is called a “share buyback.

If the company sends the shareowners cash as their portion of the profits, this is called a dividend.

These public companies must be organized as corporations. Corporations are managed by a board of directors. The board of directors is in charge of the company and chooses the senior leadership who will run the day-to-day operations of the company, like the Chief Executive Officer (CEO) and/or President of the company. The board of directors also decides if profits will be shared with the shareholders in the form of cash payments or if the cash will be kept in the company for business needs.

Since the 1990s, publicly traded companies started to change focus from paying dividends to the shareholders to the value of the stock price. They then tied that share price to the compensation of the management team. For example, the CEO would receive compensation based on the increased value of the stock price over the year or quarter rather than on the profits of the company. This mistaken belief fits the board of directors’ purposes but did not and does not address the long-term health of the corporation or individual investors like you.

For instance, the Chairman of the board of directors at Microsoft. who is also the CEO had a total annual compensation of $54.9 million in 2022 *CRN Magazine. He does not need more income, in my opinion. He is also responsible for deciding what sort of income Microsoft will pay to the shareholders in the form of a dividend.

A buyback is a share repurchase plan approved by the board of directors and is a transaction where a company buys back its own stock on the open market.  As opposed to stock dividends, share buybacks use corporate cash. The shares that are bought back from the open market were previously issued to the public and now become what is known as treasury stock. These shares will no longer be considered for dividends, voting, or computing earnings per share.

Interestingly, Microsoft had the 4th largest buyback in terms of dollars spent on repurchasing its own shares in 2023, *Insider Monkey 5 Stocks with the Biggest Buybacks using over $21 billion of its cash to buy back its own shares.

The current dividend on Microsoft is 0.71% (0.0071). I think that amount is nothing compared to the revenue Microsoft produces.  

This is not a statement as to whether Microsoft is a valuable investment or not. There is no doubt about Microsoft’s business decisions. It is an excellent company.   However, as an investor you must be aware that there is no reason for Microsoft to increase its dividend and, it could be argued, that the CEO / Chairman of the board does not entirely understand how beneficial it is to his shareholders to share the profits of the corporation in the form of providing them a steady dividend.  

          We will look at the total number of shares outstanding of Microsoft as well as the total amount of money Microsoft used to buy back its own shares. Then we will review the change of value of Microsoft stock from the beginning of the year. Let’s take a closer look:

  • Microsoft has about 7.5 billion shares outstanding. (That is billion with a “B.”)
  • For the calendar year 2023, Microsoft bought back $21.5 billion worth of stock using its cash on hand.
  • During that same period of time, Microsoft stock rose by $200 per share.

How did Microsoft do in total dollar terms?

  • The Value of Microsoft Stock increased by $1.5 trillion from January 2023 to December 2023.
  • Buying $21.5 billion of its own stock during 2023, that money went to pay for the shares it bought.

What if Microsoft paid out the $21.5 billion as a dividend:

  • The dividend would have been $2.86 per share, 7.5 billion shares divided by $21.5 billion.
  • This is $200 in gain per share the shareholders would have received.
  • We will never know at what the share price would have ended in 2023 because Microsoft did not pay the dividend. It is fair to say that the increase in share price would have been less with the dividend than with the buyback.

This is just an illustration of what happened in 2023 and what alternative the board of directors could have taken.

 

     With the illustration above, we can see that the share buyback is intended to raise the price of the shares and that a prudent investor would now be wise to start a program of sales of stock to generate the revenue they need. It is also a much more tax-efficient way for investors to receive cash from their investments. Though you as the investor need to sell your shares. Just like the CEO’s do.  

 

If we are expecting revenue from owning Microsoft in the form of dividends, this is not a stock where we can expect cash dividends. That does not mean the value of the investment won’t go up. We will assume that Microsoft is putting its cash to good use. And it is. Microsoft is spending down its cash and reinvesting into its business operations as well as share buybacks.

                                                                                               

What investors don’t realize is that the game of investing in dividends has changed and investors’ attitudes need to change with the new rules, which require that a portion of the shares need to be sold to create income from the stock. You have to act like the CEO.

If one needs income, the portfolio dividends will not be enough. The current strategy of Microsoft and other companies is consistent with raising your net worth not your income.  If one does not solely want to increase their net worth by retiring and living well and never running out of money, don’t wait for dividends. Take revenue from the portfolio by selling some of your shares. Just like the CEOs do.   

                                                                                               

Companies can pay dividends in a variety of ways. Cash can be distributed to shareholders as a regular dividend, a special dividend, or a liquidating dividend.  Public corporations pay dividends from corporate earnings. Earnings are the profits of the corporation.

                                                                                                                   

In the early 80s, stock dividends were 5 times larger than the value of stock buybacks. By the late 90s:  “For several years in the bull market of the late 1990s the value of share repurchases was greater than the value of cash dividends in the United States.”

From an accounting perspective, this share buyback is the same as a dividend – instead of giving the cash out to the shareholders, the cash is spent buying the shares back.  There is much debate about the long-term value of the buybacks.

What are areas of concern and possible overuse and misuse of share buybacks? Horse sense (something even a horse would tell you): if you have to buy the shares on the open market, you are competing against other new buyers and this buying drives up the price of the shares temporarily.  

                                                                                                               

       It would be like the farmer who owns the farm and after a banner year of profits takes his profits and goes to the farmers market where he has a tomato stand and buys his own tomatoes. He could have given the money to his partners who work the stand, but instead, he buys the tomatoes, thus increasing the price of the tomatoes.  

          This practice of buybacks can get worse in 2 ways. A CEO who gets a bonus when the share price goes up can buy back shares just to get a bigger bonus. Or a company can go to a lender and borrow money and use this borrowed money to raise the price of the shares.

If you think that a company borrowing money to buy its own shares is not allowed, then you are wrong. It is allowed. Corporations borrow money and buy back their own shares.


                                                                                    


The board of directors run companies and serves their clients the shareholders. The way the shareholders provide feedback to the board of directors is through elections called proxy votes and shareholder meetings. The shareholder meeting is held once a year and the elections are held once a year.

The board of directors knows there is 2 types of shareholders. There are institutional shareholders that are companies, mostly mutual fund or extracted fund companies. Then there are individual investors who own shares in the company.

The board of directors is elected by the shareholders and the majority of individual investors do not vote. The board of directors knows that almost all of the institutional investors vote. Guess on whom the board of directors focuses? The institutional investors. The board does nothing to upset the institutional investors and makes sure the institutional investors’ needs are met. This is the “Clientele Effect.” The Clientele Effect, in other words, is exactly as it sounds. The client in this case is the institutional investors The board of directors serves their clientele, thus creating this clientele effect.  The CEOs and board of directors appeal to their clientele.

Whoever votes the shares are the ones who get the most attention. Those who want a dividend distribution can only influence the board if they vote their shares. If the shareholders don’t ask for a dividend, then they won’t get one. 

The reason there are so few individual shareholders compared to institutional shareholders is because we have overused Exchange-Traded Funds (ETF) and other types of funds.  We have moved the clientele from the individual shareholders to the institutions, the institutions have the power, instead of the individual shareholder’s and the individuals’ preferences.

The dividend distribution rate for stocks is approaching its lowest point ever! This is not because corporations are making less money. They are not;  2023 was the all-time high in corporate profits.

Who killed the dividends then? We did, by letting our 401k plan, mutual funds, and ETFs run our money for us. Relatively few investors own individual stocks anymore. Did you know that your ETF company votes your shares for you? It does not sit out the election and let whatever happens happen. It pools all the shares that it owns, paid for by you, and votes your shares any way it sees fit. Guess what they don’t vote for? They don’t vote for dividends.

A HISTORICAL PERSPECTIVE ON DIVIDENDS AND SHARE BUYBACKS.

                                                                  

Dividend Yields Since 1870,5.5% down to 1.44% today.

So what, you say? So what… The shareholders decide the dividends paid by the company. The board of directors sets the dividends to be paid out for the company. The shareholders vote for the board of directors. Guess what the board of directors doesn’t need? It doesn’t need income. As mentioned above. we can question if the board of directors has a real understanding of that which everyday hardworking Americans face.

The ETF companies do not care who pays dividends. They are not in that business. They just vote in whatever way the board of directors wants them to vote.

Do you see where this is going? There is no one driving the bus. The fancy word for this is no accountability when it comes to the needs of the individual shareholder.

THE IMPACT OF DIVIDENDS AND SHARE BUYBACKS ON INDIVIDUAL SHAREHOLDERS

Okay, Okay … how do we fix it?

First, there needs to be taken a serious look at corporate buybacks. Why are corporations allowed to buy back their own shares if the CEO is compensated for the increased value of the share. How does that increase shareholder value? As an example, it is the same as if someone takes $100 out of their left pocket and puts it in their right pocket. They get paid a percentage of what is in the right pocket. That in and of itself does not add to their value. They still have $100 in their pocket.  It does not make any sense. The corporation is supposed to use the money to make new and better products or pass the money out to the owners, who are the shareholders.

Second, there needs to be a huge push to educate the shareholders, increasing the value of the shareholder’s meeting to encourage individuals to go to the meeting by offering a bottle of wine, or giving away baseball tickets, or gifting something. Anything to make it worth their time to make the meeting and read the material.

They also should have a simple way to communicate with the corporation if they don’t understand something or if they just have a question.  Someone at the company has to pick up a real phone with a real person answering a real question from somewhere inside the 50 United States. This will allow individual shareholders to have the clarity they need to vote for their shares and thus get a management team that is listening to shareholders’ interests. If you have a question now, and don’t have someone like me or an attorney, – I wish you good luck getting an answer. It won’t happen.

                                                                                         

Third, there needs to be a carrot-and-stick approach using taxes and tax breaks to keep corporations moving forward and keeping a long view toward the health of the economy. An example is taxing a behavior of corporations that is not conducive to the overall economy, as well as providing tax breaks for the behavior of corporations that is conducive to the overall economy. Or, initiating new taxes on behaviors that are to be discouraged and giving tax breaks for behaviors that are to be encouraged.

To illustrate the point: By providing tax breaks for corporations and shareholders around dividends would encourage corporations to pay dividends. The amount of cash that corporations are keeping in their accounts is staggering.

For example, since 2000 corporate cash on hand has gone from $1.6 trillion to $6.9 trillion (Harvard Business Review and Kellogg School of Management) All of this money is sitting, doing nothing. Corporations are not investing this money into their business. The money is not earning interest of any real substance. The corporation is just hoarding the cash.

Just to give you an idea of how much $6.9 trillion is, it is like $20,000 for every man, woman, and child in the United States of America.  

If, and this is a big “If,” the government was thinking it could use a short-term discount in the capital gain tax for corporations, allowing corporations to sell old assets at a low tax rate. At the same time give a tax break to the corporation to pay dividends to shareholders. Also, at the same time increase the tax on the money corporations is holding that is sitting for a prolonged period of time. Say 36 months, for instance.

Finally, get the money that is held by US companies outside the United States and move it back to the United States. This could be done by getting a few of the retired CEOs, the good ones, of some of the largest non-bank corporations and put them in a room. Let them think of different ways to incentivize corporations to improve the whole system. Then, every 3 – 5 years, do it again.

You might say, great idea but how do we do it?  It is simply by educating the shareholders and incentivizing the board of directors. We have lost our way a bit by not taking the time to educate ourselves and our kids.

                                                                                                     

WHAT DOES THIS MEAN FOR YOU?

What does this mean for you? Just that we must find alternative sources of income other than waiting for dividend yields to increase. The concept of buying dividends was a great idea 10 years ago, though they have changed the game. Corporations are keeping their cash. In general, if you can, you need to add individual stocks to your portfolio. Even if you don’t vote your shares, you can. It is available to you.

                                                                                                                    

While at the University of San Diego, we had an extensive core accounting requirement. My Accounting II professor, a retired CPA, had explained to the class that the best way to change a company was by owning shares. He would often buy a small number of shares in a company he did not like just so he could go to the shareholders’ meeting and express his displeasure and recommend change.


                                                                                                   

 His advice to us, with which I agree, was to own at least some individual shares of stock if you can.  Just as a first step. The company knows exactly how many shares of stock are in individual investor’s hands. The more shares that are in individuals’ hands the more the board of directors of the company will take steps for the benefit of the individual investor. (The Clientele Effect) You will become the clientele.

 They also know how many shares are in institutional hands.  What is “institutional?” For example, Vanguard is an institution, and it is the largest shareholder of Microsoft. Vanguard will always vote the way the Microsoft board of directors chooses to vote. It means that Microsoft does not have to concern itself with individual investors.  The next biggest investor in Microsoft is BlackRock. The third largest investor is State Street Bank.  All three of the largest investors in Microsoft are institutions.

The dividends at Microsoft or any other company are not going up any time soon. You have to change your strategy for the current reality.


                                                                                                  

 IN CONCLUSION, THE NUMBERS DO NOT LIE

         The numbers do not lie. According to the Financial Industry Regulatory Authority (FINRA) which self-regulates the securities industry – “Typically, somewhere between a quarter and a third of retail investors participate in shareholder voting, as opposed to around 90 percent of institutional investors.”

The corporations know this. That equates to 30% of the voting shares that are institutional and will vote with the board of directors and a maximum of 20% of the voting shares owned by the individual shareholders will vote. Even if all the individual shareholders who vote voted the same way, it is never enough to outvote the institutions.  This disparity in voting is yet another reason to think that dividends are staying at the level they are, or even going lower.

                                                                                                  

We have seen in the beginning of 2024 a healthy contest between the board of directors of Disney and the shareholders of Disney. Shareholders of Disney are pushing the board of directors and forcing Disney’s board to reach out to individual shareholders and communicate what is taking place. I think it is great. If there is an issue with how a company is run, bring it to the board. Make the board listen.

                                                                                                                 

Remember, more investment mistakes are made in an attempt to avoid paying taxes than in bad investment decisions. Don’t let your tax bill cloud your investment decisions. Until we see a trend of corporations starting to pay dividends or increase their dividends, no corporation will. One day it will happen. Corporations will realize the desire of shareholders and the taxes will move to advantage the paying of dividends. One company will start to pay dividends and will see its dividends attract investors. This will force other corporations to follow them to stay competitive. But, until then, we can’t afford to wait.

In conclusion, what does this all mean for you? You have to adapt to the current reality. Gone are the days when PG&E, a utility company, paid a 4% dividend. It pays 0.239% today. That is less than the average and less than a technology company. This is unheard of. Dividends are not going up anytime soon and they very well may go down further.

                                                                                                                         

We can’t worry about what we don’t control. In the short to near term, there is no control over the dividend. Let’s not expect that people will find the time and interest to get involved in voting their shares. Let’s not expect them to get involved if they don’t want to do so.

The present situation is that companies do not pay dividends like in the past. Income is important to everyone’s portfolio, for a variety of reasons and for a healthy portfolio. Even if one is not retired, we want to have a steady source of income coming into an investment portfolio.

Income or cash will do 3 things:

  1. Allow the portfolio to be reallocated as the new cash is invested.
  2. Raise a level of cash to take advantage of investment opportunities that arise in the future.
  3. Create a buffer. Whether for an emergency or an experience, have a source of cash to pull from if a purchase or expense pops up unforeseen.

One needs fresh cash coming into the portfolio to buy the next great opportunity. Life is unpredictable; we need the portfolio to be ready.

Income is the cornerstone of a portfolio because everyone needs some level of passive income, though for different reasons. There are ways to get income into the portfolio to replace the traditional cash flow that dividends used to provide.

Obviously, during retirement, a higher amount of income is needed because the income from our current job goes to zero. One needs an alternative stream of income to cover expenses. There is a lesser amount of income needed for investors who are still working. Working investors need less income because they are still getting income from their current employer.

                                                                                                                       

Just like the rest of the world, investments are constantly evolving and your portfolio needs to evolve also. The portfolio is there for you to use for the goals you set out for and the objective you would like to achieve.  “Check in so you can check out” is a catch-all phrase. It means checking in with your investments and putting your portfolio in the hands of an experienced intelligent advisor so you can follow your passions and interests.

Hope this is useful to you in some way. If you find this article valuable and you are interested in strategies to take advantage of the current dividend environment, share this article, or reach out by clicking the link below and get your free one-page financial review and our newsletter if you are not a client already.

Thank you for spending the time reading this article. It is a joy to share knowledge and provide you with some tools to help you make good investment decisions for you and your portfolio. Questions and comments are always encouraged as well as recommendations for topics of which you would like to see more.

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"The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Private Wealth Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation."