Do Dividends really pay

[OhNoNotimAgain]

What benefits do dividend payments and dividend yields convey? The answers may sometimes be overlooked as market participants seek equity income or the perceived safety of dividend strategies. In 1961, Merton Miller and Franco Modigliani (M&M) theorized that dividend policy is irrelevant to company value.[1] Of co

http://www.indexologyblog.com/2018/03/2 ... eally-pay/

[tjh290633]

If you define company value as the future value of all dividends to be received, plus the eventual return of the capital invested, discounted at an appropriate rate, then dividends have to be included in the cash flow. The time effect is significant.

TJH

[GeoffF100]

In theory, a company should not pay dividends if it can generate a return greater than the market as a whole by investing the money internally. Conversely, it should pay dividends if investing the money internally would generate a return less than the market as whole.

[Alaric]

In theory, a company should not pay dividends if it can generate a return greater than the market as a whole by investing the money internally.

Another way of looking at it, is that a Company seeking to raise money can do so either by loans/bonds or equity capital. From that viewpoint dividends are the cost of capital. It is cheaper than loans/bonds if the Company does badly and more expensive if the Company does well. Raising capital by shares makes shorter term financial problems easier to live through, since there isn't a loan to be called in, or bond to be defaulted on.

[DiamondEcho]

In theory, a company should not pay dividends if it can generate a return greater than the market as a whole by investing the money internally. Conversely, it should pay dividends if investing the money internally would generate a return less than the market as whole.

I think you see this in shares that pay Special Dividends, which can quite often be found in the insurance sector. Their projected working capital is according to their forecast market opportunity for the period ahead, it's relatively transparent in that way. If they have surplus capital to requirements for underwriting purposes, 'well it isn't their money' and they tend to return it in Special Divs. The flip-side being if their under-writing capital has taken a hit, then you can expect a lean period while they rebuild their capital.
I used to hold a very large position in 'infrastructure insurer' [rigs, airports, airplanes, etc] Lancashire Holdings Plc [LSE:LRE]. There were one or two exceedingly fat years - biggest dividend payments I will ever see, for sure. Then came Gulf of Mexico, then increased competition vying for smaller returns. I doubt it'll ever go back to what it was dividend-wise. Meanwhile my position is 1/10th of what it was at peak, but it still holds a frisson of the unpredictable. Probably not a sector/div method/or share for widows, orphans, or late-stage HYPers.
... It would be interesting to see such cyclical div payers vs the steady predictables compared over say 5, 10, 20 year periods - comparative returns - to see if the drama of those who you pay Specials when they can is worth the periodic seizure that comes from holding them.

[SalvorHardin]

Dividends may be irrelevant to the value of a company for the capital market theorists, but for investors who like to have a income they are essential. It isn't just crotchety private investors who want their dividends (because we live off them); many institutions such as charities, insurance companies and pension funds need a steady flow of income to pay their liabilities as they fall due (their regulators will throw a wobbly if they don't).

A lot of the "don't pay dividends" argument comes from managements who prefer earnings retention so as to buy back shares (often at inflated prices) or to reinvest, often at sub-par returns. Doing this makes it more likely that they will meet their targets for bonus schemes, many of which are based purely on earnings per share and make no allowance for buybacks.

Another wheeze is to hold the bought back shares in treasury so that they can be distributed under share option and bonus schemes, which helps to disguise the cost of these schemes.

Dividends are much less volatile than share prices. The idea of selling off shares to generate an income looks pretty silly when you're in the middle of a major stockmarket downturn (I'm thinking of something like 1973-74). Many investors don't want to have to sell shares in order to generate an "income" because of the transaction costs and the capital gains tax implications.

[Lootman]

Many investors don't want to have to sell shares in order to generate an "income" because of the transaction costs and the capital gains tax implications.

Transaction costs are fairly low these days, and especially for sales where there is no stamp duty consideration - the largest element of transaction costs for buys.

CGT may be an issue but then it is prudent to at least realise your annual CGT allowance, so in practice you will probably be doing some sales anyway. And basic-rate taxpayers might find the 10% rate of CGT barely more onerous than the 7.5% income tax on their dividends.

In my case, investment "income" is derived partly from dividends, partly from realised gains and partly from selling options. I find that to be better than relying on just one category of income.

[SalvorHardin]

Transaction costs are fairly low these days, and especially for sales where there is no stamp duty consideration - the largest element of transaction costs for buys.

CGT may be an issue but then it is prudent to at least realise your annual CGT allowance, so in practice you will probably be doing some sales anyway. And basic-rate taxpayers might find the 10% rate of CGT barely more onerous than the 7.5% income tax on their dividends.

The thing is that for some investors the term "transaction costs" includes the hassle of making a decision, then carrying it out, then having to deal with the tax consequences. Many investors wouldn't want the bother of making lots of small sales - not everyone is geared up to make regular sales online (both administratively and psychologicaly).

My tax return is complicated enough already without having to make sales solely to generate cash to live on. UK dividend tax is irrelevant for me because my foreign withholding tax is always going to exceed it so I won't have to pay anything (unless the rate is raised to something like 70%). But CGT is a major factor for me because I pay CGT every year.

So I'd be looking at 20% CGT on the gains from shares sold for income, but 0% income tax on dividends. ISAs aren't of much use for me because most of my holdings are outside ISAs and the holdings inside ISAs are not ones I'd particularly want to sell.

Partial sales greatly increases the amount of record keeping for CGT purposes. No doubt at some time in the future the pooling rules on CGT will change; then people without detailed purchase and sales histories will have a problem.

If I had to move to selling shares because I didn't own any dividend paying shares, I'd prefer to keep a year or two's worth of living expenses in my current account and make one share sale every year to replenish it.

[johnhemming]

It would be interesting to study the impact on the tax changes since say 1960 on the balance between dividends and other capital returns. Lots of changes have happened which will impact on what happens.

[johnhemming]

There is also the issue of the removal of ACT and its effects. I think now there is no tax difference for the company between a share buy-back and a dividend.

[PinkDalek]

... Roy Jenkins, then Labour, raised the higher tax rate to 136% in 1968 - earn £1, owe £1.36 to the taxman! ...

I've seen you mention this more times than I can remember but wasn't it retrospective, applicable for one tax year only (1967-68) and a "special charge". rather than a (higher) tax rate?

Plus the word earn was not in the legislation, if I've found the correct Finance Act, as it related to investment income:

Finance Act 1968 (as it was originally enacted)
http://www.legislation.gov.uk/ukpga/196 ... 41/enacted [26th July 1968]

41 The special charge
(1) In the case of an individual whose aggregate investment income for the year 1967-68 exceeded £3,000 plus the amount of his surtax personal allowances, there shall be made in accordance with the provisions of this Part of this Act a special charge in accordance with the following Table—

Table

For every pound of

the first thousand pounds of the excess 2 shillings
the next thousand pounds of the excess 3 shillings
the next three thousand pounds of the excess 6 shillings
the remainder of the excess 9 shillings.


It might be of interest if anyone can dig up a link to the press at the time and any workings that explain the calculations for the 136% (I have seen the John Whiting quotes).

[tjh290633]

Finance Act 1968 (as it was originally enacted)
http://www.legislation.gov.uk/ukpga/196 ... 41/enacted [26th July 1968]

41 The special charge
(1) In the case of an individual whose aggregate investment income for the year 1967-68 exceeded £3,000 plus the amount of his surtax personal allowances, there shall be made in accordance with the provisions of this Part of this Act a special charge in accordance with the following Table—

Table

For every pound of

the first thousand pounds of the excess 2 shillings
the next thousand pounds of the excess 3 shillings
the next three thousand pounds of the excess 6 shillings
the remainder of the excess 9 shillings.


It might be of interest if anyone can dig up a link to the press at the time and any workings that explain the calculations for the 136% (I have seen the John Whiting quotes).

Well, 9 bob was £0.45 so if you add that on to income tax and surtax, which was about 90%, you will get a marginal rate of about 136% at the top end.

Somehow I managed to keep out of surtax, probably because we had the benefit of Marriage Allowance, Children's Allowance, Mortgage relief, etc. in those days. There was also unearned income surcharge of about 15% if my memory serves me correctly. The top rate of Income Tax was 8/3d or 42.5% in today's money. I think surtax was 10/= (50%) and somehow it got up to about 98%. I have a feeling that the rates above were the unearned income surcharge.

Isn't it nice only having to pay 20% these days, despite losing all those allowances.

TJH

[scotia]

Isn't it nice only having to pay 20% these days, despite losing all those allowances

.
Yes - its nice for us oldies, but I do remember in my youth, when tax rates were much higher, that I got a grant to attend university, and of course, my fees were also paid out of general taxation. OK - I have paid a bit back through the higher rate band, but possibly the youth of today feel that we should be contributing more. Up in Scotland we are making some steps in this direction, although much of the recent tax rate changes have been implemented to score worthless political points (a £2,000 band at 19%). However there is a lower higher tax threshold, and an increased higher tax rate (as compared to England), neither of which I object to. But I believe that the Dividend and Interest taxation remains as for the UK, so my tax calculation is going to be a lot more complicated - particularly when my income reduces to a level around the higher tax threshold(s).

[johnhemming]

There is also the issue of capital taxes (which are relevant to buy backs) and the impact on the companies taxation (viz the removal of ACT).

I think from the companies perspective that buybacks and dividends are treated the same way now, but that has not always been the case.