puzzled

by franco
(canada)

when a dividend is given, the stock price devaluates by the same amount. what is the advantage of that. I have difficulty understanding that part of it.

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Jan 11, 2020
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Dividend effect on stock price
by: Mike

Franco,

In many ways you are correct. On the ex-dividend date (the date you're entitled to the payment), the stock will drop by approximately the amount of the dividend. Therefore, in a perfectly rational world, there is no advantage to a dividend as it will effect your future capital gain. In fact, in this perfectly rational world, you are better off if your investment doesn't pay a dividend at all as you may well have to pay tax on that dividend and in many countries, dividends are taxed at a higher rate than capital gains. You can also choose when you'll pay your capital gains tax - you have no such control over dividend taxes.

This is one of the reason the likes of Berkshire Hathaway or Amazon DON'T pay dividends. They think they can reinvest their earnings at sufficiently attractive rates.

Every company and every investor is different though. From the company perspective, there is a risk that retained cash can promote ill-discipline and be squandered by management. This is one reason why stocks that pay dividends have traditionally outperformed. A lot of spare cash (especially other people's money) can go to the head of some people a little too easily!

From the investors perspective, the payment of dividends can help you ignore the (sometimes severe) fluctuations of the stock market. It gives you constant cash rewards for your investment and you might be able to reinvest that cash as you see fit. Remember that earnings made by a company are rightfully your earnings as a shareholder. Dividends at least give you more choice.

At the end of the day, you need to focus on TOTAL SHAREHOLDER RETURNS (that is dividends + capital gains + any other corporate action). If a company decides not to pay you a dividend and reinvests those earnings at a very high rate of return then this scenario could well be more favorable than a dividend paying company.

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