Friday, May 28, 2010

Dividend stocks ARE NOT a bargain

Cramer (and every other stock would-be pundit) is pushing high dividend stocks. The rational seems to be that you are locking in some profit if you collect the dividend. But I don't think that not-so-certain cash flow is worth the cost. Dividends are not free money.

I'm yet to see a convincing rational argument for preferring high dividend stocks to low dividend or no dividend stocks(unless you need the cash - like for retirement income). Tax-wise, dividends are taxed less than regular income, but at about the same level as capital gains.

If a company keeps the cash instead of paying a dividend, its stock price should be elevated by the value of that dividend. They have more cash in the kitty, so they're a more valuable company. As the stock price rises, you not only get the cap gains tax rate, but you get to defer those taxes till you actually sell the stock.

If the company is doing well and is growing, they probably need cash. They're probably borrowing money. They would be more profitable if they invested the money they're paying out as dividends. That would increase the price even more than just the cash value of the dividend, since it would save them on interest and (presumably) would allow the company to increase future earnings.

Companies pay taxes on dividends. That's after tax money. If they invested it in expansion or acquisition or something else, they would pay lower taxes (they would get depreciation on that investment).

SO: Just on a raw numbers kind of analysis, it seems to me that a company will make more money (and decrease their expenses -- and you will pay lower taxes) if the company does not pay the dividend.

If the company is not growing and has no use for more cash, it's probably not that great a stock to buy.

THAT SAID: If there's an industry you like (like Oil for example) that is awash in cash and has excess cash on top of their growth needs, then maybe dividends make sense. CVX/Chevron is a good example.

I have never read any analysis of actual market data that showed you make more money on high dividend stocks than you would on cap gains if they kept the money. Even after the tax rules changed to favor dividends, I haven't seen a study like that.

Also, conventional wisdom says dividend stocks are less volatile. People assume the stock can't go too low or people will jump in for the great dividend yield and bring the price back up. I think more often, if a company is doing badly and the stock price tanks, they will cut the dividend.

The reputation for dividend stocks being less volatile is probably because dividend stocks used to be sleepy utilities.

It's pretty typical for pundits to skip the homework part and just pontificate and advocate whatever the trend of the moment is. For pundits "the trend is your friend." If they're wrong, so was everyone else. If they're right, they'll baste themselves in that glory for years or even decades.

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