The darlings of the stock market…
Why might you ask?
Maybe it is because they “pay you to wait” or you get a check in the mail (or a debit deposited into your online brokerage account) every quarter…it’s free money, right?
Even some hedge funds, endowment funds, pension funds, and individual investors have mandates to never own any stock or asset unless it pays them a dividend. For these reasons and much more, Wall Street cannot seem to get enough of dividend stocks.
Look at Shark Tank judge and hedge fund manager Kevin O’Leary. He loves dividend stocks and does not invest a single penny of his or his investors’ money in any assets unless they pay him a dividend.
While we cannot argue that dividend stocks are a great way to reduce your cost basis over time and an even better way to generate cash from your investments, they might not be as rosy as everyone and their mother thinks they are. You see, sometimes things that look too good to be true are in fact too good to be true.
We are not going to lecture you and try to convince you that dividends and investing in dividend stocks are something you should avoid. We just want to go a little bit underneath the surface. Remember, Wall Street does not want you to dig deep into anything and would rather you A) give them your money or B) just keep buying stock.
There do happen to be a few things about dividend stocks that we do not think you are aware of that we would like to discuss. Here we go, the three lies Wall Street won’t tell you about their baby, the dividend stock.
Lie #1 – Dividends Add To The Price of The Stock
Apple is a company that hopefully you have heard of. If not, it is the company that makes the cell phone that every driver is texting on while they are behind the wheel. The myth that Wall Street tells us here is simple. Apple currently has a $2.52 dividend.
Every quarter, they will pay out one-fourth of that to their shareholders either in the form of a check sent to the investors home or in the form of a debit of cash into their online brokerage account. This means that for every share of Apple someone out their owns, every quarter they will receive $0.63 per share (0.41%). If we hold 100 shares of Apple, this would mean we would get a quarterly dividend payment of $63 and a total of $252 over the course of a year.
Wall Street would say, “You get the gains of Apple over the course of the year PLUS the dividend”. Unfortunately, that is not true. Let me explain.
Dividends occur on something called ex dividend day. In the case of Apple, they do not just willy nilly throw an extra $0.63 per share at you out of thin air. That money needs to come from somewhere, right?
The dividend is removed from the price of the stock in order to pay out the cash to shareholders. If Apple were trading for a cool $150.00 the night before the ex dividend date and was going to open up the next morning completely flat (up $0.00), what would the price of Apple actually open up at?
Nope, not $150.63. Apple would open at $149.34!
The reason it would open up lower is again, they have to get the money from somewhere!
The reason for the adjustment is that the amount paid out in dividends no longer belongs to the company and this is reflected by a reduction in the company’s market cap. Thus, we have a reduced price to reflect the ex dividend payment.
So no, the dividend doesn’t add value to the price of the stock, it removes value from the price of the stock.
Lie #2 – All Dividends Are Created Equal
Sorry to be the bearer of bad news. But not all dividends and dividend stocks are created equal.
But in order to figure out which ones are best for you, we have to go back to what Wall Street says about this. And it has to do directly with your bottom line.
One of the big pitches Wall Street makes to investors about the reasons to invest in dividend stocks is because they say dividends are taxed at capital gains. Capital gains are gains that are not taxed as normal ordinary income and are taxed at a much lower rate of roughly 20%.
But, as you could tell by now, not all dividends are able to be taxed at capital gains rates. And for this, we will have to learn a little bit about qualified and non qualified dividends.
Qualified dividends are those that do get taxed at capital gains rates, which again, is typically lower than normal ordinary income and usually is taxed around 20%. In order to qualify for a qualified dividend, according to Investopedia, one must
- The dividend must have been paid by an American company or a qualifying foreign company.
- The dividends are not listed with the IRS as those that do not qualify.
- The required dividend holding period has been met.
Only if one of those three is hit do you receive a qualified dividend.
However, on the flip side, there are a decent amount of high paying dividend stocks that do not see their dividends be taxed at capital gains. These dividends are called non qualified dividends and can be seen in high dividend paying stocks such as REIT’s.
In order to be a REIT, the company must pay out 90% of its profits or more to its investors in the form of non qualified dividends. These are dividends that are not set in stone ahead of time like they are for Apple above. Apple will always pay out $2.52 for the year (until it changes). Unless Apple pays a one-time special dividend (which is a non qualified dividend), that dividend will be taxed at the capital gains rate.
However, the dividend payments from a REIT are seen as distributions from a company and are non qualified. This means those payments are to be taxed as normal income.
This is why we see REIT’stypicallyy have larger payouts for dividends because they are taxed at double the rate of a qualified dividend.
Lie #3 – Great Companies Pay Dividends
You got it! They are all great companies!
But what else do they have in common?
Yes. Right again! They are hyper growth companies!
But what else???
You nailed it! They reinvest all of their money back into their respective businesses!
They do not pay dividends!
Wall Street says time and time again that only the best companies with the strongest balance sheets pay dividends.
And do you know what these three companies say about that?
|Stock||3 Year PnL|
I’m sorry what did you say your name was Mr. Dividend? Oh, that’s right, we don’t have time for you.
The truth is, companies can do whatever they want with their money. They can buy other companies, they can hire employees, they can grow the business, or if all else doesn’t look too promising, they can pay a dividend.
In short, a dividend is the last resort for a company that cannot find any other way to attract shareholders.
A company, like Tesla, brings investors to the table because they are growing the business and being innovative. Apple, on the other hand, brings investors to the table because they are paying them to do so. Big difference.
If we actually want to make any money investing, we want to be invested in companies that walk the walk. They don’t pay a dividend because they feel they can create massive amounts of shareholder value by reinvesting their profits back into the business, rather than just paying you.
Wrapping Up the Lies About Dividend Stocks
There you go folks, the three lies Wall Street tells you about dividend stocks.
And for those of you that simply scrolled to the bottom of the page, here are the cliff notes
1) Lie #1 – Dividends Add To The Price of The Stock
Wrong. On the day of the dividend payment, the amount of the dividend is removed from the price of the stock as the stock is ex dividend. On dividend day, if the price of Apple is to open up at $150, it will open up at the price of $150 minus the amount of dividend.
2) Lie #2 – All Dividends Are Created Equal
Wrong. Only qualified dividends are taxed at capital gains. Dividends from companies like REIT’s or one-time special dividends are not qualified dividends and are taxed as normal income.
3) Lie #3 – Great Companies Pay Dividends
Wrong. Amazon, Google, Netflix, and Facebook do not pay dividends. They are excellent companies. They simply choose to spend their money reinvesting in their businesses instead of paying people to own the stock.
Again, we are not saying to stay away from dividend stocks. If you love Apple go for it. However, think twice before you think they are the greatest thing since sliced bread.