Two myths and one truth about dividends – 03/21/2023 – From Grain to Grain

When researching stocks on the internet, one subject stands out: dividends. The fact of receiving an amount in the account without doing anything is very attractive. The problem is that myths end up appearing that are not supported when simulated in a spreadsheet. But since no one takes the time to verify, it ends up becoming true by simple repetition. I comment on two myths that circulate about dividends and one truth.

I have already written a few times that income is more important than dividends.

But what is income? Yield, or total return is the sum of two rates of return:
I – Capital gain, which is the price variation; It is
II – Return by dividends.

Don’t make the mistake of considering too many of them.

Many believe that because they think they will keep an asset forever, they should only consider the dividend gain. This is a mistake.

This type of error usually occurs at times like the current one when the market has been negative for the last three years. To justify the error, many investors consider only the dividend yield. However, it’s not about this behavioral failure that I’m going to talk about, but two other myths that I’ve seen more often.

Both myths are related to your ability to have more resources in the future when a stock pays dividends. This is not true.

First Myth: With the power of compounding dividends by reinvesting them, the return of a dividend-paying stock will be greater than one that does not pay dividends.

Second Myth: With the reinvestment of dividends, you buy more shares of the same asset, therefore, your final equity is greater.

These are two lies.

This can be proven with a spreadsheet simulation. Attached to this link is the spreadsheet that simulated the results.

The figure above depicts the evolution of the initial purchase of 1000 quantities of two shares whose initial quotation is R$10.00 and which have the same total return:
Stock C in the top frame is the dividend stock; It is
Stock S is the stock without dividends, that is, that does not distribute dividends.

The simulation can be performed for various dividend and total yield rates. In any simulation, final equity is the same for the case with and without dividend payments.

Yes, when a stock pays dividends, you can reinvest and buy back more shares. In the end, you will have a larger amount of shares in the case of the stock that pays dividends. However, the share price is adjusted when it pays dividends. Therefore, the share price will be lower.

It is also true that as time goes by and with reinvestment, the volume of dividends is greater, but this is because the share price rises and you have a greater number of shares. However, this does not change the total equity.

Note that in all years, the equity is the same in the case of the stock with and without dividends.

Therefore, investing in dividend stocks does not result in higher returns. What you should aim for is total yield. This alone results in greater equity.

It is not true that the total yield, that is, dividend plus capital gain, of dividend-paying stocks is always greater. This is proven when evaluating long-term international indices focused on dividends and other factors such as the MSCI in the figure above.

Note that the 10-year total return of the MSCI Dividend Index is the third worst factor. It loses overall MSCI and other factors such as growth, quality and minimal volatility. These indices present the total return considering the reinvestment of dividends.

The only truth that exists in dividends is that they are exempt from income tax. At least for a while.

Therefore, while this benefit exists, there is a small advantage in the final profit after IR. However, it is important to consider whether this benefit can be lost by choosing assets that present a worse total return.

Michael Viriato is an investment advisor and founding partner of Investor House.

Talk directly to me via email.

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