Thursday, January 8, 2015

The Dumbest Argument for Dividend Paying Stocks

This article’s title is a play on the title of a recent article by Dividend Growth Investor, “The dumbest argument against dividend paying stocks.” In it the writer uses a straw man argument to misrepresent criticisms of dividend investors who ignore past “solid dividend-paying stocks” that subsequently performed poorly or went bankrupt.

I won’t repeat DGI’s points here, but will point out two mistakes that many (but not all) dividend investors make when they ignore the existence of past solid dividend-paying stocks that faltered.

1. Too many dividend investors own far too few stocks.

In Canada, many people who consider themselves dividend investors own nothing but a few of the big bank stocks. This worked well in the past, but is risky for the future. The failure of just one of their holdings would be very harmful to their portfolios.

One of the problems here is the stories we hear occasionally about an elderly person who became rich holding onto just one stock. Concentrated portfolios will always give both the best and worst results. We rarely hear stories of the many investors who hold a single stock for decades and eventually lose most of their money. It’s the rare few who happened to hold a long-time winner that make better stories.

2. Many dividend investors look at the past long-term track record of their current holdings and conclude that their investing approach is superior to other forms of investing.

This is an extreme case of survivorship bias. By looking only at companies with no blemishes for decades, you’re necessarily excluding those companies that faltered. When we screen for good dividend stocks today and imagine having held them since the distant past, we are using recent information that wasn’t available back at the time we imagine having invested the money. This creates unrealistic expectations for future returns.

If we were to go back 50 years and create a dividend portfolio based on only the information available back then, many of the stocks we selected would have had problems in later years. Of course, all other strategies will pick some losers as well. All this doesn’t make dividend investing bad; it just means that dividend investing is not superior to other forms of investing such as index investing.

It’s certainly possible to get acceptable results from dividend investing. The key is to be adequately diversified and to not to have unreasonably high expectations. If all dividend stocks continued their exceptional performance indefinitely, then a dividend-based portfolio would certainly outperform. But investors can’t count on this. The reality is that some of their beloved stocks will falter. The likelihood of outperforming the market over the long-term is very small.

23 comments:

  1. The following thought comment from Paul seems to have disappeared somehow, so I'm posting it again:

    As usual I like your point of view. I think you have a detached fair way of looking at investing and you give unbiased advise.

    I think there is more to the story then you have pointed out here. When I look at other blog sites, particularly "Dividend themed" ones, I see sites more designed to create the owners of the site income rather then give impartial good advice. The ones that become popular have a vested interest to stay on their message (right or wrong) as they are able to generate a lot of income from the site. So much at times that it becomes their full time job.

    Anyone who tries to question their message is rebuked or comments just get deleted. Also the number of start-up less popular sites that leech onto popular blog sites with overly positive messages to promote themselves because of the large traffic on them. "Oh Dividend -insert name here" your the best, smartest, good for you"... "Oh I agree, I just wrote about that on my site..." and so it goes. They try to build traction off of one another. It becomes more like a popularity contest rather than investing advice.

    You may find this article interesting. A disagreement between a popular index author and a Dividend blogger.To be fair, I enjoy reading both of their works :

    http://theconservativeincomeinvestor.com/2014/11/30/myth-everything-is-priced-into-the-stock/

    Dan was not aware of the post, and I made him aware of it. There was a good exchange of comments between them. I also commented and it did not suit the site owners message and it was deleted. I have to say I was shocked as it was a fair clean comment. (a little along the lines of what you wrote above) It just proves what I have said here. For some bloggers you don't want to mess with their golden goose. They have almost cult like followers, and it is sad, some of the truly intelligent bloggers, don't get near the traffic they deserve compared to the ones that "play the game" better.

    That's my take on this topic. I also agree with your points above.

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    1. @Paul: It sounds like you've been following dividend blogs more closely than I have. Your remarks are consistent with my observations generally, but I can never pick out a particular blogger and say "you're just in it for the blog income" or to a particular dividend investor "you've drunk the koolaid."

      I took a look at the link you gave. I don't think it's necessary to settle the questions of whether stock prices reflect all information or whether markets are efficient. Each investor needs to look at himself or herself and decide "am I one of the rare investors who can see a company's future enough better than professional investors that I can beat them at their own game by enough to cover the extra costs of active stock picking?" If we're being honest with ourselves, the vast majority of us would have to say no.

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    2. I'm not sure what's going on today, but the following comment from Bet Crooks seems to have disappeared as well:

      re: "can I see a company's future enough better than"
      Especially since the person has to use only publicly available information about a company to decide what that's company's future is. I've seen from the inside that what goes into and gets left out of annual/quarterly reports can be the result of bloody protracted battles inside companies. While some issues like sales and inventories and such are very straightforward and reported accurately, there are often murkier issues that don't get dragged out and displayed in reports.

      For ex. How many people outside of the geological or petroleum engineering field reading an annual report from a shale-producing oil/gas company would know instinctively how much to write into the liability side of the ledger for the almost inevitable lawsuits when the frac'cing destroys the local groundwater 10 years+ into the future? Now compound that issue by having several small producers taken over by a larger oil company and a few of the original joint ventures' partners (shared production projects) of the original small producers going bankrupt. When the lawsuits start, where will the lawyers look for the money to pay the fines: the bankrupt small partners? the now-liquidated small producers? or the big oil company that generates zillions in revenue from its other assets that took over a few of the small producers?

      Every type of company has these undocumented risks and liabilities. Telecomms and Banks are always at risk of mass and class action lawsuits, anti-combines fines etc.

      There are all kinds of those risks and future costs that are never mentioned in reports that the average investor won't even be considering when they tap on the keyboard and order their 500 shares.

      And, Paul, it's very interesting to read about your experiences with "for profit" personal financial websites. I've been able to easily spot some that are in the business of pushing credit cards but I hadn't noticed this other kind. I'll keep an eye out for it. (I push Tangerine on my site, but I also call them out on problems like the new transfer out fees for registered products. I like the occasional referral fee but not enough to lie about my problems with their products.)

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    3. @Bet Crooks: You're right about the turmoil that goes on below the tidy surface of every company. I came to understand some of this stuff for some companies during my days as a stock picker.

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    4. @Paul - that's an interesting theory about the dividend bloggers doing it for the income but it's a bit far-fetched considering that most blogs don't make much income from their sites - certainly not enough to make it a full-time gig. I'd say it's more to do with having a lot of peers and readers agreeing with the strategy and confirming each others ideas. That was a danger in announcing on the blog that I was switching to indexing - losing long term readership who, as it turned out, might have only followed my blog because I took a dividend approach to investing (even though I haven't written about dividends for quite some time).

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    5. @Robb: To be honest I don't know much about how much money bloggers make from their sites. My 2014 blog income amounted to less than one day's pay at my day job. I assume others fare at least somewhat better than I do in blog income. If you're right that other bloggers don't tend to make much either, then your assertion that like-minded people reinforce the group's investing opinions seems dominant here.

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    6. One day's pay? Truly a labour of love, then. I used to read a blog (now defunct) that criticized people who called blogging income "passive", since writing a blog is a lot of work, not passive at all.

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    7. @Gene: It's in part a labour of love in the sense that I like explaining things and expressing opinions. The biggest payoff for me has been the process of learning to invest in a way that makes me more money, takes less work, and makes me less vulnerable to pitches from those who are more interested in taking my money than helping me prosper.

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    8. More trouble with comments getting posted. Here's another from Paul:

      @ Robb

      I could point out a few quite quickly. They even clearly itemize their blogging income right on their sites. That's great that they do as well, as we all like disclosure. Many plainly write about their meetings at bloggers conferences and discuss the best ways to "monetize their sites". At some point the "labour of love" as Gene so nicely states above, becomes a business.

      I just find it strange for example by just pointing out one or two simple things : The dividend payout reduces the security's share price by an equal amount on the payout date (It's not like a bonus on top - not everyone clearly understands that) -or- If a dividend investor has 50-60 stocks which you could very closely but not exactly replicate with an ETF, why take the time to do all the research? Does that not almost label you a "closet indexer" anyway? If you ask question's about that, sometimes you get some "interesting" replies...My suggesting using ETF's in a Dividend blogger's website then becomes a distraction to them?

      I feel that some investing blog sites are akin to a show like the Kardashians but they actually attach some useful content. (I won't watch that show or anything like it just for the record) The investing information is almost a sideline to a personal diary of the bloggers life. If people are flocking to the site clicking on adds etc. The person has made it into a business. I mean good for them, but is the info presented always the best for a beginner stumbling on the website? Like a very positive well written article on Exxon Mobile and how investing $10,000. in 1970 would make you a millionaire today? It's easy to pick that today in retrospect. But can you or any of us pick the next Exxon in its infancy in 2015? I know I can't.

      I can also understand if you are bringing in $750.00 + a month (there are a few people in the USA that do this, and some exceed that amount). At that point you then have to protect your brand and your message to protect your income, as well as keep your followers interested and bring in more new ones. I just have found that some dividend focused bloggers take it quite personally when you don't seem to fall in line with their investing choice or you question their post.

      I have had this discussion with others as well and there to a degree IS some agreement in my view. Not as far fetched as you think. I don't want to single any one blogger out or pick on any in particular, I was just really stating that this could be another reason to add to the two above.

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  2. I had to comment :)

    Survivorship bias is real and it happens across all financial products and companies. It's too bad the author didn't call that out. Oh well.

    Recency is also a bias, but I think the biggest issue here with the author, DGI, is the illusion of control. You would need to own dozens of stocks for decades and benchmark it to an index, to see if your selections were an act of skill or luck or a combination.

    I've certainly never thought of dividend investing as a superior way of investing, it can be great but greatness comes with risks. There can be great calls and great falls.

    That said, I have no intention of selling the 20+ stocks I own in Canada. They seem to make money year after year but there are never guarantees of this. I hope to make indexing at least 50% of my portfolio in the coming years. Indexing just makes too much sense not to follow, more, for me.

    Mark

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    1. @Mark: Having 20 stocks in only a sub-part of an otherwise indexed portfolio sounds like a safe level of diversification to me. I'd wish you good luck, but you'll probably be fine with that approach even if your luck is somewhat less then good.

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  3. Dividend paying stocks have outperformed non-dividend payers, as documented by academic research e.g. see Tweedy Browne's What Has Worked in Investing (http://www.tweedy.com/research/papers_speeches.php). That doesn't mean anything with the label dividend investing works equally well and individual investors having their own versions of such strategies won't succeed equally well either, some likely doing worse than broad-market cap-weight indexing.

    Re the banks, it's pretty darn suspicious that all the banks in Canada have seen decades of outperformance. Barring some radical changes in the way our laws, regulations and business practices operate I am betting with some of my money that this will continue.

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    1. @Canadian Investor: The advantage of dividend stocks over the long term comes from a value tilt. Investors who believe dividend stocks will outperform should consider a indexed approach with over-weighting of value stocks.

      My point about Canadian banks was avoiding unsafe portfolio concentration. Almost every Canadian investor owns Canadian bank stocks, as do I. The question is whether it is safe to be 100% in bank stocks. I'm quite certain that it isn't.

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  4. Michael, one of the other interesting mistakes people make about dividend stocks is treating the yield as a valuation measure. While yield is suitable for valuing bonds, it is of no use for stocks. There is nothing wrong with picking from a subset of stocks that pay a dividend, or have consistently grown their dividend, but an investor still has to determine how much the business is worth. TB

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    1. @Tom: Yes, if a company increases its payout ratio (dividend/profit), investors who try to value the stock based on the dividend yield will overvalue the stock. I agree that valuation is key, but sadly too many dividend investors see dividend growth history as the end of their analysis.

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  5. Hi Michael,

    You are correct, the two major arguments that you have stated against dividend investing are dumb. You seem to be biased against dividend investing, and using your own made up beliefs to justify your own biases. The reason I am saying this, is because you have no factual evidence supporting claims 1 and 2.

    As for me using a straw man argument, this is incorrect. I used to post articles on Seeking Alpha, and used to spend time reading comments under articles on Seeking Alpha. I have read comments which discussed how dividend investing is bad, and those comments were using Eastman Kodak and GM as examples of how dividend growth investors are following a losing strategy.

    I don't care whether you post it this comment or not. I just wanted to let you know, and if you are smart, you will try to look at things objectively. Do not let your preconceived beliefs cloud your judgement.

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    1. @Dividend Growth Investor: Just ask financial advisors who have examined numerous self-directed accounts and they'll tell you that there are many people who have the bulk of their holdings in just a few dividend stocks (often Canadian banks).

      Your article is a very good example of a straw man argument. The existence of dividend stocks that later fail is exactly why dividend investing does not give the outperformance that it seems to give when you look only at past winners.

      Your repeated claims that I'm biased, not objective, and letting preconceived beliefs cloud my judgement are laughable. I've read your blog for some time now. You should examine your own biases.

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    2. MJ,

      Of course you are biased. Your example that most dividend investor portfolios are not diversified is not based on a factual study. You are asking a financial advisor whether investors should invest on their own – what do you think they will tell you? What are their incentives? Why would you ask a barber if you need a haircut? You do not have a study that proves your point. Rather, you provide some piece of anecdotal evidence, that you might have read on some newspaper, and then you are posting it as a “fact”. This is called confirmation bias, and you are providing it in your article. If you are blind to see this specific example as a logical flaw, then that is your problem, not mine.

      But this is the reason why I called you biased in the first place - because you made a claim, without really having a study to back up your claim. You are giving me even more examples with your comments. Most dividend investors do not succumb to survivorship bias folly – some do, I don’t. But you have no body of evidence to support your claim.

      You keep talking about outperformance of dividend stocks, yet you have no factual study to back up your point that dividend growth stocks underperform anything You made up your mind, and you have no factual evidence to support your thesis. I can say this behind a lot of the points you try to make. This is an example of someone who is biased in my book. You remind me of a quote by Charlie Munger : “The human mind is a lot like the human egg, in that the human egg has a shut-off device”

      The one thing that works in your favor, is that you seem to have realized your limitations and invest the way you invest. Thats important. I have my limits, and I invest my money the way I invest them in dividend growth companies because of that.
      However, you cannot simply say that you read my site, and that I am biased. You need to provide specific evidence that proves this point. I have my own strategy, that fits my goals and objectives. If you disagree with me, that’s fine with me. I am not here to make friends with everyone, but to make money. You exhibit the same amount of hatred for dividend investing, as if this was a religion you opposed to for whatever reason. Don’t be that way. Also, understand that differnet investors have different goals and objectives than you.


      I am not sure why my example is a straw man. Do you even know what a straw man is? Here is what Wikipedia tells you “A straw man is a common type of argument and is an informal fallacy based on the misrepresentation of an opponent's argument” What did my opponent say – they say that dividend investing is not good, and they offer an example with an Eastman Kodak or GM, and make the conclusion that the strategy is bad. I have already provided an explanation behind this, where the idea came from etc. If you choose to ignore what I tell you, that’s fine with me. But it means we cannot have an intelligent discussion.

      Either way, I wish you good luck. You won’t be seeing more of me here however, since the type of conversations where someone talks about sports team/religion are not really helpful at all.

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    3. @Dividend Growth Investor: You continue to misrepresent my arguments. I saad that too many people who consider themselves dividend investors own too few stocks. I never said it was true of most of them.

      I never said dividend stocks underperform. My claim is that many dividend investors count on their stocks outperforming to achieve the goals they describe. That is true, particularly for you.

      Now you are guilty of another common fallacy: ad hominem attacks. You accuse me of "bias", "hatred", not knowing the definition of "straw man," and not knowing that different investors have different goals. All nonsense.

      I've read a great deal of your web site. The advantages you repeatedly describe for dividend investing depend on picking stocks that outperform the market. It's certainly possible to get acceptable results through dividend investing without necessarily beating the market. But the wide range of great advantages you describe will only come if you beat the market.

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    4. I guess you now have had a crash course yourself in "upsetting a dividend investor". Over the past 10 years I have read dozens of articles that state a simple stat. 85% of all forms of active stock investing do not beat the indexes. It seems many think they have a "system" that falls in that 15% group and gives them an edge.

      Are you familiar with Norm Rothery and his "Beat the TSX" Strategy? Once a year he posts 8 or 10 dividend stocks in Moneysaver magazine that you buy at a certain time and sell at a certain time. His method seems to have paid off over a very long period of time. Generally these are few and far between. For every handful of successful stories unfortunately there are many more that aren't.

      Again I don't think the disagreement between your thoughts and Mike's in this context are really helpful. The way you invest is in the end what your comfortable with and what you can risk and finally, controlling your fee's. Time will tell if one style will beat the other.

      Starting out, I liked dividend stock investing or dividend ETF investing because of the illusion of getting that reward every month or quarter. For an investor starting out getting $0.03cents from their bank account, then for example only, going into an ETF like CPD (which is used in many core investment strategies), getting that 6 cents per share every month might might give them some confidence to then learn more and embrace investing in general instead of fearing it. Even the TD couch potato TDB900 fund pays out a divided in December. If you have XIU as part of your index strategy aren't you getting the best of both worlds anyway?

      I also think the amount of money available for investors to invest every month year is a factor as well. If you have very little and a loss affects you greatly, a simple index strategy would be the best. For those that have maybe a backup plan, my earlier comment of getting an 8% return vs 9% over 30 years won't really make a big difference when all is said and done. Maybe I could easily invest $2000.00 a month maybe only $200.00, think of the long term impact of that difference. I would have a big cushion in being a little wrong with the former.

      Also some questions : Do you really want to spend your time going over stock reports? Always keeping on top of world events in case you need to get out of a stock. Setting / moving stops? Remembering to sell on the right date every year if you follow someones system? What happens if the blogger you follow for your strategy passes away or closes shop, retires? There a lot of if's and unnecessary worries there.

      I'm with Mark above. I have a core index strategy, but for almost fun I have picked a few individual stocks/ETF's as well. Some have done really well others not so well. I am in a position to be able to do this. I however would not recommend what I do to anyone else. My risk, my gain or loss.

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    5. @Paul: I wouldn't want to paint all dividend investors with the same brush, but this exchange is part of a pattern I've noticed, and apparently you have too.

      The percentage of active stock pickers who beat the average actually declines rapidly with the period of time considered.

      I've read read some of Norm Rothery's writing, but I haven't followed his stock picks.

      You're right that the disagreement hasn't been helpful. The part that amazes me is controversy over my assertion that for dividend investing to have the wonderful properties many investors claim, it has to be that their dividend stocks will outperform the index.

      I also decided I didn't want to spend my time poring over financial statements. But to each his or her own.

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  6. It's always nice when someone comes along and proves your points for you... I don't think this is a we vs. them situation. People have different investing styles. If after 20 years one has a 9% return the other 8.1% is it worth arguing over.
    I'm also going to guest this poster is Mike from his moneytised website "dividend stocks rock" ?

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    1. @Paul: It's certainly true that there are many approaches to investing that can work satisfactorily. However, there are many ways to get yourself into trouble as well. Most approaches that are diversified and have low turnover can give decent results over the long term. Well-executed dividend investing can fit in here. Where some investors get themselves into trouble even with a good investing approach is when they come to believe that their way of investing is best and they count on getting superior results.

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