To paraphrase Einstein, “matter cannot be created or destroyed,” yet this fundamental tenet seems to be ignored when discussing dividends. Despite the popularity of dividend-paying stocks, serious analysis dictates that dividends are a net drain of company enterprise value. Why are we so confused about dividends? There seems to be a misunderstanding of enterprise value and tax-effect because dividend payments by their very nature have a negative expected return.
If a company has just paid $10 million in dividends then its enterprise value has decreased by a corresponding $10 million dollars. No value has been created in the dividend payment, but investors are quick to praise the merits of a dividend-paying stock.
I believe the flawed logic of this problem is ingrained in the dogma of investing. I was sitting beside an economist on a flight to New York City while writing this article and I asked the question, “How much money do you have if a $10 stock pays you $1 dividend?” He said, “$11, the $10 stock plus the $1 in dividend.” In actuality, you still have $10 because the price of stock declines by the value of the dividend to create a net neutral transaction. That is, until you get your tax bill and that $1 dividend turns into $0.85. So in reality, the dividend payment turned your $10 into $9.85. That doesn’t sound like smart financial strategy to me but it is the basis of dividend-paying stocks. ....