People are Wrong about Dividend Stocks. Here’s why

Summary

In this insightful video, Matt Derron addresses common misconceptions about dividend investments, countering the idea that dividends are not 'free money'. He illustrates that dividends represent an investor's ability to choose how to allocate profits. Whether investing in dividend-paying stocks or growth stocks, each has its unique merits. By comparing dividend and growth investing strategies, Derron emphasizes the importance of personal investment goals and risk tolerance. Ultimately, he advocates for a diversified approach for a balanced investment portfolio.

Highlights

• Dividends are not just free money; they represent a slice of profits returned to investors. 📊
• Investors have the option to reinvest dividends or use them as income, offering flexibility. 💪
• Dividend stocks provide consistent cash flow, beneficial for planning and emotional stability. 💵
• While growth stocks may offer higher returns, they're also subject to market fluctuations. 📉📈
• Both dividend and growth stocks have their place, depending on investment goals. 🏆

Key Takeaways

• Dividends are not free money; they come from the company's profits and offer investors flexibility. 📈
• Investing goes beyond simple math; it involves strategic decisions on profit allocation. 🔍
• Dividend-paying companies may display strong, stable business models. 🔄
• It's crucial to balance growth stocks with dividends to minimize emotional decision-making. 🤔
• Each investment strategy has unique advantages, depending on individual goals and timelines. 🎯

Overview

Dividend stocks often get a bad rap for seemingly offering "free money" that comes out of the stock price, but there's more to it. Matt Derron breaks down what dividends truly represent - a choice for investors to allocate profits. Unlike companies that reinvest all profits, dividend-paying firms allow investors a slice of the pie, ensuring greater control over income. This flexibility comes with tax considerations, but it also builds a proactive investment mindset.

The video delves into the comparison between growth and dividend stocks, showing that growth investments can outperform dividends but come with more significant price volatility. Meanwhile, dividend stocks provide a continuous income stream that aids in financial planning and reduces emotional investing decisions. This stability is particularly reassuring during market fluctuations, especially for conservative investors or those nearing retirement.

Ultimately, Matt Derron champions a mixed investment approach — balancing growth and dividend investments. This strategy not only caters to diverse financial goals but also tempers emotional reactions to stock market swings. Whether seeking rapid growth or steady income through dividends, understanding personal risk tolerance and objectives is key. Derron suggests combining these strategies to build a reliable, long-term income stream, supporting financial independence.

Chapters

• 00:00 - 00:30: Introduction to Dividend Investing Controversy This chapter introduces the controversy surrounding dividend investing. It begins by acknowledging that dividend investors often encounter criticism online, with detractors arguing that dividends are not 'free money,' but rather, they are deducted from the stock price. Critics claim that paying dividends suggests a company lacks growth opportunities and that growth stocks will outperform value stocks in the long run. The chapter promises to explore the validity of these critiques, while also highlighting what critics might overlook.
• 00:30 - 01:00: Understanding Dividend Basics and Stock Prices The chapter discusses the foundational concepts surrounding dividends and how they relate to stock prices. It begins by clarifying a common misconception, stating that dividends are not just free money; they actually are deducted from the company's stock price. Through an example, it explains the process where a company announces earnings and decides to retain a portion for future business use and distribute the remainder as dividends to shareholders. In the example, a company trading at $100 per share decides to distribute $4 per share as a dividend after keeping $1 in retained earnings, illustrating the impact on stock prices and financial decisions.
• 01:00 - 01:30: Ex-Dividend Date and Stock Price Impact The chapter covers the concept of the ex-dividend date and its impact on stock prices. It explains that stock transactions usually take 2-3 days to clear. For example, if the ex-dividend date is October 9th, an investor must purchase the stock by the end of October 8th to be eligible for the dividend. The stock price behavior is described as follows: on October 8th, the stock trades at $105, with future earnings accounting for $100, an additional $1 in new retained earnings, and a $4 dividend. On October 9th, the stock goes ex-dividend.
• 01:30 - 02:00: Dividend's Impact on Stock Price and Shareholder Decisions This chapter discusses the impact of dividend announcements on stock prices and how they influence shareholder decisions. The key point is that new shareholders will not benefit from dividends announced prior to their investment, and hence they are not willing to pay extra for such dividends. It is explained that typically, on the ex-dividend date, the stock price adjusts by the amount of the dividend declared. While this is a general observation, various other factors including company news can cause fluctuations in stock prices.
• 02:00 - 03:00: Share Buybacks vs Dividends This chapter discusses the differences between share buybacks and dividends. It explains how dividends are related to stock price, emphasizing that dividends are not 'free money' but rather a return of earnings to shareholders. The chapter also highlights the main distinction between companies that pay dividends and those that don't: dividend-paying companies give shareholders the choice in how to allocate their share of profits. An example is given where a company earns extra per share, deciding to keep a portion for reinvestment while returning the rest as dividends to shareholders.
• 03:00 - 04:00: Dividends Indicate Lack of Growth Opportunities? The chapter discusses the implications of dividends on a company's growth opportunities. It explains how shareholders can choose to use dividends as income, reinvest them into different opportunities, or reinvest back into the same company. The chapter highlights that although there is a tax to be paid on dividends, it provides flexibility for shareholders. In contrast, the chapter also discusses companies that do not pay dividends, retaining their profits for future growth prospects. This suggests that paying dividends might indicate a lack of growth opportunities within the company.
• 04:00 - 04:30: Example of Growth vs Dividend Stocks The chapter discusses the differences between growth stocks and dividend stocks, emphasizing that both types offer shareholders a claim on profits, albeit through different mechanisms. With dividend stocks, shareholders receive a portion of the profits directly, while with growth stocks, management reinvests the profits to expand the company. The choice between the two depends on whether the shareholder prefers receiving immediate financial returns or potential long-term gains. Additionally, the chapter touches on share buybacks as another way companies can return value to shareholders without immediate tax implications.
• 04:30 - 05:30: Selling Shares vs Receiving Dividends In this chapter titled "Selling Shares vs Receiving Dividends," the discussion focuses on the implications of a company opting to buy back shares versus distributing dividends to shareholders. It highlights that while share buybacks might seem advantageous at first glance, they are not always beneficial, largely depending on the price at which the company is repurchasing its shares. The chapter uses Meta (formerly Facebook) as a case study, illustrating that during 2021, Meta engaged in extensive share buybacks, totaling around $40 billion between April 2021 and January 2022. This move was significant since it was the largest sum spent on buybacks by the company in a three-year period. However, the company repurchased its shares at high prices, between $300 to $335 per share, questioning the financial prudence of such a decision.
• 05:30 - 07:00: Growth Stocks vs Dividend Stocks Performance The chapter discusses the performance of growth stocks versus dividend stocks, emphasizing that investment decisions depend on individual situations. It highlights that stock prices can fluctuate significantly, using Dollar General as an example where shares were bought back at $200 to $250 but later dipped to $109. The narrative challenges the notion that paying dividends indicates a company lacks growth ideas.
• 07:00 - 08:00: Impact of Emotional Decisions on Investment The chapter titled 'Impact of Emotional Decisions on Investment' discusses how a company's ability to consistently pay and grow dividends signals business stability and strong cash flow generation, which investors might see as a sign of reliability. However, growth investors might view the company's focus on returning cash to shareholders as indicative of fewer growth opportunities, predicting slower growth and lower returns. The narrative suggests that if investment decisions were made purely on rational terms without emotional influences, the perspectives might differ.
• 08:00 - 09:00: Emotional Stability with Dividend Stocks The chapter explores the concept of emotional stability in investing, using dividend stocks as a foundation. It highlights the unpredictable nature of the stock market by discussing the example of Peloton. Investors who bought Peloton stock in July 2021 at a high price based on promising growth prospects experienced significant losses as the company's stock plummeted to under $5. The example underlines the risks involved in investing based solely on growth projections, emphasizing the importance of considering the profitability and overall stability of a company.
• 09:00 - 10:00: Mixing Growth and Dividend Strategies The chapter titled 'Mixing Growth and Dividend Strategies' discusses the complexity of investment strategies, particularly the differences between companies that focus on growth versus those that pay dividends. It highlights companies like Google, Amazon, and Berkshire Hathaway, which traditionally have not paid dividends but have seen significant growth by reinvesting profits and buying back shares. The chapter emphasizes that the effective investment strategy depends on the specific timeline and stage of a company's development. It suggests reviewing the total return over recent years to understand investment outcomes, using examples like Google, Amazon, Berkshire Hathaway, McDonald's, and Starbucks, noting that Google has had the best return over the past five years.
• 10:00 - 11:00: Conclusion and Encouragement for Financial Independence This chapter discusses financial independence by analyzing the performance of several well-known companies, particularly dividend payers like McDonald's and Starbucks. It highlights that these companies showed impressive returns, outperforming even giant corporations like Berkshire Hathaway and Amazon over a five-year period. The key takeaway is that retaining earnings or having a growth plan doesn't always result in a significant increase in stock price. The chapter concludes with encouragement for maintaining financial independence through diversified and strategic investments, emphasizing that consistent dividend payers can be very rewarding investments.

People are Wrong about Dividend Stocks. Here’s why Transcription

• 00:00 - 00:30 if you're a dividend investor you've no doubt come across people on the internet who question your ability to do simple math the comments that you've undoubtedly heard are dividends aren't free money they come out of the stock price dividends mean the company has no more good growth ideas you don't need dividends you can always just sell shares or over the long term grow stocks are always going to outperform dividend paying value stocks now we'll say there is some truth that's baked into each one of those comments and we're going to go over all that but what people with that perspective fail to realize is that
• 00:30 - 01:00 investing is bigger than just simple math but first let's go over the math so that we understand what the argument is and let's start with the classic dividends aren't free money they come out of the stock price now here's how dividends and stock prices work in general let's say a stock is trading for $100 and on October 1st they announce earnings of $5 in excess cash per share they plan to keep $1 in retained earnings to use in the future for the business and they decide that they'll distribute the additional $4 per share as a dividend for shareholders who own
• 01:00 - 01:30 the stock on October 11th now it takes 2 to 3 days for stock transactions to clear so let's say the X dividend date is October 9th that means you have to buy the stock by the end of October 8th in order to receive the dividend and how this generally impacts the stock price is that on October 8th the stock should trade for $105 which is basically broken down with future earnings being worth about $100 then they have $1 in new retained earnings and a $4 dividend that's coming to shareholders and then on October 9 9th the stock goes X
• 01:30 - 02:00 dividend meaning new shareholders won't receive it and they're not going to pay a premium for a dividend that they're not going to receive so the stock should trade for about $101 which breaks down with future earnings being worth $100 and they still have that $1 of new retained earnings so on that X dividend day the stock price should basically drop the amount of the dividend and of course those are just general numbers there's all kind of variables that impact a stock price whether it's news about the company or other things that make it go up and down but in general this is how the market
• 02:00 - 02:30 handles dividends in relation to price so when people say the dividend comes out of the stock price they're right it does it's absolutely not free money it's the earnings that a company generated that they're giving back to its shareholders but that's not the whole story the main difference between a company that pays a dividend and one that doesn't is that the shareholders get to decide how they want to allocate their slice of the profits now here's what I mean so if we have company a which is the one that we just talked about and they made an extra $5 per share they're keeping $1 for the business which we still own shares in
• 02:30 - 03:00 and they're giving us $4 for each share that we own to do with whatever we want so if we need to use it as income we can if we want to reinvest in a different opportunity we can do that as well or if we want we can reinvest back into the same company because we believe in it now obviously you will pay tax on that dividend but tax is the price that you pay to have the option to use the profits however you want that's the price of flexibility and then if we have company B that doesn't actually pay a dividend but keeps the full $5 in the business and for future growth prospects
• 03:00 - 03:30 you still have a claim on those profits because you're a shareholder but you're trusting the management team to make good decisions in terms of how they allocate those profits so one isn't necessarily better than the other they're just different in terms of who makes the decision on what to do with your slice of the company profits either you or the company now obviously both companies could also do share BuyBacks with the excess profits which benefit shareholders as well by increasing their overall stake in the company and they generally don't have to pay taxes on that either but again share BuyBacks a
• 03:30 - 04:00 version of the company making that decision for you and in case you think that share BuyBacks are always better than dividends there are plenty examples where they're not and it really has to do with the price that the company is buying the shares back at and one of the most obvious examples of this was Facebook or meta in 2021 where they did about $40 billion worth of share BuyBacks between April 2021 and January 2022 by far their largest amount of Buybacks in a three-year quarter span ever and it was at prices between $300 to $335 per share and they did that just to
• 04:00 - 04:30 watch the stock dip all the way down to $90 per share within the next year and even more recently we talked about Dollar General where they bought back shares in the $200 to $250 range just to watch the stock dip to $109 less than a year later so just like with everything there's nothing that's always good or always better it really depends on each individual situation and whether you want the company to allocate your profits for you or if you want to do it yourself but how about when people say that paying dividends means the company has no more good ideas for growth a
• 04:30 - 05:00 company that consistently pays and grows dividends over time is showing a strength and stability of their business model and the ability to generate cash flow for investors it's another measure we can use to determine how reliable or volatile an investment might be and growth investors are going to say exactly because the company doesn't have any more good ideas for growth they're just giving cash back and that means they're going to grow slower and have a lower return over time and if investing was done in a vacuum and all things remained equal then I would probably
• 05:00 - 05:30 agree with that but the reality is that it's not done in a vacuum and things are never really equal between companies and just as an extreme example pelaton investors who bought in July of 2021 at $125 per share after they just announced amazing growth of over 2x year-over-year probably don't think all those growth prospects were worth it at least now especially for a company that never made a profit and is currently trading at less than $5 a share just brutal and I know that I'm picking a really extreme
• 05:30 - 06:00 example and the reality is a lot more nuanced than that because you can have a company like Google or Amazon or obviously brks your half away and they've never paid a dividend they reinvest profits they buy back shares and they've had amazing growth and success but again it depends on your exact timeline and where each company is at in their story cuz if you take the total return of the past 5 years between the following companies Google Amazon Berkshire haway McDonald's and Starbucks you might be surprised at the results out of the five Google has had the best
• 06:00 - 06:30 return out of all of them at 115% which probably isn't much of a surprise but then the next two best performers are the dividend payers McDonald's and Starbucks at 80.8 6 and Starbucks at 77.0 n respectively and both of them have outpaced the total return of Berkshire Hathaway and Amazon over the past 5 years so again just because the company retains earnings and has a plan for growth doesn't mean that it's going to materialize in terms of a higher stock price sometimes just having a
• 06:30 - 07:00 solid business that generates cash consistently is going to have a better overall return it just depends on each individual business okay but what about the theory that Dividends are unnecessary because investors can just sell shares whenever they need cash and this is one of those things that is technically true like if you have good total returns you have the flexibility to sell shares whenever you want then you can absolutely do that and it works what it means though is that you're more susceptible to Market timing and factors that impact the current stock price which could determine your tax impact
• 07:00 - 07:30 how many shares you have to sell or how much money you'll be able to access at any one time and one of the great things about dividend stocks is you can plan for the future as to what your cash flows are going to be especially if you're investing in stocks that consistently pay and grow their dividends so while stock prices go up and down you know that your cash flow coming in is likely to stay steady or even grow regardless of what the market is doing in any given month or year plus being able to plan your cash flows in advance means you can adjust to complement your income needs without being dependent on a a certain stock
• 07:30 - 08:00 price at the time that you need your money and I view investing in dividend companies like having a true business owner mindset because you've invested in a company and they're paying you part of the profit so owning Starbucks is like being a part owner of a coffee shop or owning Valero is like being a part owner of an energy company but I don't have to sell my shares to realize income from that ownership stake because they're paying me in cash every quarter there's nothing wrong with selling your shares whenever you think is best if you don't like dividends but it does add additional variability into your process that you have to manage an account for
• 08:00 - 08:30 and a slightly different mindset and that just might not be the right thing for everybody okay but what about the claim that over the long term grow stocks are going to always outperform dividend paying value stocks so obviously we've already talked about this on an individual stock basis and it's really going to depend on each individual company that you're looking at so it's impossible to answer from that perspective and even if you're talking about a group of individual stocks it's really going to be highly dependent on how well the companies are that you pick end up doing but I think it's only fair to look at it from a
• 08:30 - 09:00 general growth index versus a dividend index to see how they perform differently over time so I decided to use the following three Vanguard funds or ETFs vix vanguard's growth Index Fund viig vanguard's dividend appreciation index ETF and VM vanguard's high yield dividend ETF and I used ETS for two and a fund for one just so that I can get the most historical data to be able to compare the three and I was able to get up until January 2007 so a little over
• 09:00 - 09:30 25 years of data and if you look at the performance over that time there is no question that the growth fund perform better with an overall average of 11.37% compound annual growth rate compared to 99.07% for the dividend appreciation ETF and 7.77% for the high dividend yield ETF now part of that in theory is that it's kind of designed to do that I mean the growth fund is called growth for a reason plus from a macro perspective we had multiple zero interest rate time
• 09:30 - 10:00 frames in this 25e period to where if you look at the data we only had about four or 5 years in that 26e period where the federal funds rate was higher than 0.5% that's actually pretty crazy when you think about it like there was only four or five years higher than that level and in environments like that growth should definitely outperform but here's the point as crazy as this may sound we don't have to choose one way over another because investing in growth and investing in dividends both have their advantages and disadv advantages
• 10:00 - 10:30 for example growth in general will outperform value over time assuming there's no weird macro environment things going on but it's also going to have wild price wings that impact people emotionally and there's a recent study that said 66% of investors have made an impulsive or emotionally charged investing decision that they later regretted this is more common for Gen zers at 85% than any of the other age groups which Trend down from there and now this was just a study of about 1,00 Investors so small sample size but I think it's important to talk about how
• 10:30 - 11:00 emotions impact our investing let's take the Facebook example again so Facebook or meta has been one of the most popular and profitable companies to ever exist and it has been for a long time so let's say you bought it 5 years ago around $166 a share you look now and you say hey it's at 298 a share and I've made an 80% return it's pretty good but what you don't realize is that during that 5 years your stock would have done this it would have dropped to $53 per share 1
• 11:00 - 11:30 and 1/2 years after you bought it so you would have been negative on your investment 1 and 1/2 years after buying and then it would have risen to $380 per share a year and a half later so you would be 2x your initial investment after 3 years but then it would have Dro back down to $90 per share about one year after that so after 4 years you would have been down 46% on your initial investment and then ultimately it Rose back up to $298 where it's at today so 5 years later you're back to that 80%
• 11:30 - 12:00 total gain so while it's easy to look at that performance chart and say oh yeah I definitely would have held in reality that's a lot harder and this is only a 5-year time Horizon which in investing terms is relatively short so imagine what it's like over 10 years or 20 or even 30 I mean how many people who bought at $166 a share 4 years later were really holding when it was at $90 I just don't know and it's not that dividend stocks don't have price wings too they have absolutely do but one
• 12:00 - 12:30 advantage dividend stocks have is that they're giving you consistent and growing dividend payouts so even when the price is going crazy your dividend payments are steadily growing over time so from a mental standpoint it helps to reduce the anxiety and panic around share prices because if you can still see that your income stream is steadily growing over time you're less likely to overreact just because there's some temporary massive drop in share prices and this is really the main point not only do we all have different investment goals but we all have different personalities and temperament and they play a huge part in our results when it
• 12:30 - 13:00 comes to investing so while it's easy to say oh I'll just invest in growth for the next 30 Years the reality of Market swings in The Daily News cycle make that very difficult so we have to be able to focus on what our long-term goals are and when you're building a dividend income stream that's steadily growing no matter what it really helps with that but as you guys know I'm a fan of mixing these ideas for the best results if you have a 30-year timeline it's probably good to get exposure to growth stocks and investing in your retirement account into a growth index or fund is a great way to do that because you just keep
• 13:00 - 13:30 adding to it and you don't mess with it too much since it's for retirement that way the swings and price won't bother you all that much to where you make any emotional decisions and building a portfolio of dividend payers is a nice complement to that because it focuses your mind on a long-term outcome that incrementally shows your progress as you go it's not meant to give you the absolute highest return that you ever could have gotten it's meant to slowly and reliably build an income stream that helps you meet your goals in life which is ultimately the reason Reon that we're doing any of this in the first place so
• 13:30 - 14:00 what do you guys think am I totally off base with how we should be looking at dividend investing let me know down in the comments below hope you guys have a great day out there Financial Independence is true Freedom so keep building and stacking wins and I'll see you guys in the next one peace [Music]