With interest rates so low from 2008 to 2021…less than 1% per year and sometimes negative…investors moved a significant amount of funds into stocks paying a high dividend yield…3% and more…and into so-called “income” funds. These are investors chasing cash…mentally, cash accountants: What could be better than a stock paying regular cash? Seems safe, doesn’t it?
But chapter 3 warned that cash is not necessarily value and more so in the case of dividends: On average the price of a stock drops by the amount of the dividend leaving the investor no better off. Technically, that is called the Miller and Modigliani dividend irrelevance principle after the two Nobel Laureates who developed it. It makes sense: How can a firm add value by just writing checks (or cheques!). If cash is paid out of a firm, the firm must be worth less and so must the investor’s interest in the firm.
There is another point: High dividend paying stocks can be riskier. This is always true, for reducing cash increases net debt and leverage (chapter 5) and that leverage might bite with particularly high payout. Consider the case of Global X SuperDividend ETF (what a name!). It yields an 11% dividend yield. Launched in 2011 at $75, it traded at $22 in September 2024. That’s a 70.7% drop. If you’d bought the ETF in 2011, you would have lost 9% after accounting for the dividends, according to a Wall Street Journal report on September 7, 2024. A company paying a gigantic dividend is likely to be damaging itself and so is an ETF buying those companies. That’s like paying interest by eroding the principal.