What good are dividend strategies?

No question: Dividend strategies have a lot of fans at GetQuin.

You are happy about the regular "cash flow" of your dividend portfolio.

For you, "good stocks" are those with the highest dividend yield or annual increases or high payout intervals or high dividend increases or a combination of all.

How useful is it to construct a securities portfolio in terms of a dividend strategy, anyway?

• What is a dividend?
• What role does the dividend yield play?
• Criteria for dividend strategies
• Why are many retail investors so incredibly fixated on dividend stocks?
• The disadvantages of dividend strategies
• Can dividend strategies still work?
• Implementation with dividend ETFs
• Dividend ETF - The conclusion

1.What is a dividend?

Dividends represent a form of profit distribution by public companies.

Companies can pay a dividend to us shareholders, but do not have to.

Listed companies decide at their AGM whether to pay a dividend and, if so, how much.

Whoever owns the respective share on this date receives the dividend.

When do you receive the dividend?

The dividend is paid out on the ex-dividend day.

On this day, there is a price correction of the share price. Responsible for this is ...

a) The dividend discount

At the start of trading, the stock exchange adjusts the price of the company concerned downward by the amount of the dividend distributed.

Example:

Company XY resolves at its Annual General Meeting to distribute a dividend of 2€ per share.

The share price on the record date is 100€.

On the ex-dividend date, the distribution is made and the share starts at the adjusted price of 98€ 98 in trading.

In the case of dividend distributions of a small amount, this price discount may be masked by normal trading activity.

Z. For example, companies that pay their dividends monthly or quarterly.

The dividend discount is then hardly noticed.

However, a dividend distribution also takes place in other ways ...

b) Influence on the share price

The announcement of a dividend payout can lead to a price increase.

If enough investors buy the share by the record date to secure the payout.

However, if the announced dividend payout is lower than expected, disappointed investors may sell their shares.

In this case, the share price falls even before the distribution date.

2 What role does the dividend yield play?

However, the fascination with dividend payouts should not obscure an important fact:

The stock yield, i.e. the total return of a stock investment, is made up of the price yield and the dividend yield.

If one excludes taxes and transaction costs, it does not matter whether a stock pays a dividend in ...

• increases in price by 6 percent and pays no dividend or
• rises by 4 percent in price and a dividend yield of 2 percent is added.

A high dividend yield is not in itself an indicator of a good investment. On the contrary ...

a) Good dividend yields = profitable companies?

A high payout ratio can result simply from the fact that the price of a share has previously fallen sharply.

Example:

In three consecutive years, Company X distributes a dividend of €3 per share.

The share price, however, falls continuously over this period. This results in an annually increasing dividend yield for new investors, but for buy-and-hold investors the yield remains the same because the dividend is kept constant:

Year 1:

Dividend: 3€Price: 100€

Dividend yield: 3% (3€/100€)

Year 2:

Dividend: 3€Price: 75€

Dividend yield: 4% (3€/75€)

Share price yield: -25% (-25€/100€)

Stock return: -22% (-25% + 3%)

Year 3:

Dividend: 3€

Share price: 50€

Dividend yield: 6% (3€/50€)

Share price yield: -33% (-25€/75€)

Share yield: -27% (-33% + 6%)

Is the example company now a good investment?

Or should the steadily increasing distribution yield rather be seen as a warning signal?

Perhaps the company only pays a lavish dividend in order to find buyers for its shares?

Remember:

The isolated consideration of the dividend yield is not suitable as a selection criterion for shares.

It makes sense to look at other...

3.criteria for dividend strategies

An important aspect for dividend collectors is whether dividends have been reliably paid out in the past and, ideally, whether they have been steadily increased.

Companies that meet both criteria over a period of at least 25 years are known in the USA as dividend aristocrats.

a)Which selection criteria can be used?

The operators of the Dividendenadel platform, for example, define a "magic square of sustainable distribution quality":

• Continuity: Constant or increasing dividend over the last 10 years.
• Payout ratio: Between 25 and 75 percent of profits distributed to shareholders in the last three years
• Dividend yield: at least 1 percent per year over the last five years
• Dividend growth: companies meeting the first three criteria are ranked according to dividend growth over the past five years

But as I said before: in the end, it's the total return of a stock investment that matters. And not just the dividend yield.

Why are many private investors so incredibly fixated on dividend stocks?

In their 1983 study "Explaining investor preference for cash dividends," authors Hersh Shefrin and Meir Statman cite three reasons:

• Reason #1 - Loss aversion

Investors do not judge profits and losses equally:

While the dividend payout looks like an (additional) profit, the sale of shares feels like a loss.

Even if the bottom line is that the account or portfolio balance is the same.

• Reason #2 - Post-decision-regret

Selling shares requires an active decision. And with every decision, the fear of later regret resonates:

Did I make the right decision by selling?

Dividend distributions make it easy for investors in this respect: You don't have to do anything, the money just flows into your account.

• Reason #3 - Impulse control

Dividend distributions provide investors in the deconsolidation phase with a means of impulse control.

They can easily limit their spending to the level of dividend payouts.

Those who can live on dividends thus need to worry less about their monthly budget.

Every sale of shares, on the other hand, is a temptation to spend more than might be appropriate.

5.The disadvantages of dividend strategies

A whole series of arguments questions the dividend as a primary selection criterion for equity investments:

• #1 Insufficient diversification

Investors pursuing a dividend strategy engage in stock picking, as only stocks with dividend payments are considered.

The consequence:

If you pick individual stocks from the overall market based on certain criteria, you have to accept a significant reduction in risk diversification.

This is inevitably accompanied by a higher risk of fluctuations in value.

And this is without this additional risk being compensated by a corresponding risk premium!

The minimum number of individual stocks required to have a sufficiently diversified portfolio is disputed.

5-10 stocks are probably far too few, it should be at least 25. However, an ideal value is difficult to determine.

• #2 The market is smarter

As plausible as the concept may sound:

Simply buy high-dividend companies and then generate passive income through regular distributions ...

...a lot of people actually come up with this idea.

Hoping to outperform the average market return over the long term with dividend stocks is not very promising for this reason.

Of course, this can be successful in individual cases.

• #3 Waiver of yield

Dividend-oriented investors are neglecting a part of the stock market that has historically outperformed the overall market by an average of 3.3 percent per year:

Small caps.

This refers to small companies with a market capitalization of less than two billion U.S. dollars.

However, these rarely pay a dividend.

Bypassing small caps as an asset class therefore inevitably means foregoing yield optimization of the overall portfolio.

• #4 Tax disadvantage

Dividends are subject to the final withholding tax at the moment they are distributed to the investor.

This amounts to 25 percent plus a 5.5 percent solidarity surcharge (plus church tax, if applicable).

Price gains, on the other hand, are not taxed until the shares are sold.

This results in a tax deferral effect, which dividend collectors thus give up.

6 Can dividend strategies still work?

Yes, but for different reasons than the supporters of dividend strategies probably assume.

Many dividend collectors simply bring characteristics that favor long-term success in investing:

Typically, they are ...

• Disciplined savers,
• who buy stocks to hold them for a long time ("buy-and-hold")
• whose portfolios have a high equity allocation.

All these characteristics increase the chance of a handsome fortune. However, this is not so much due to dividend payments.

Those who do not feel like implementing a dividend strategy on their own with individual stocks can fall back on dividend funds:

7.Implementation with dividend ETFs

Actively managed products are not recommended for various reasons.

It has been proven that active funds lag behind ETFs in terms of performance, especially due to their high expense ratio.

However, one should also take a close look at dividend ETFs and dividend indices.

An ETF on the DivDAX thus contains just 15 individual stocks from Germany.

Risk diversification: non-existent.

In order to avoid the so-called "home bias" - the preference for companies from one's home country - one should invest in all economically significant regions of the world, i.e.: USA, Europe, Asia and EM.

a) Little choice in dividend ETFs

The highest degree of risk diversification can be expected from an investment in dividend stocks around the world.

The ETF Finder of justetf.com spits out a total of 16 dividend index ETFs for the corresponding search profile (as of August 2022).

If we focus on those ETFs that have a minimum fund volume of more than 500 million euros, a full 5 ETFs remain (all quarterly distributing):

• Vanguard FTSE All-World High Dividend Yield UCITS ETF Distributing.
• SPDR S&P Global Dividend Aristocrats UCITS ETF
• iShares STOXX Global Select Dividend 100 UCITS ETF
• iShares MSCI World Quality Dividend ESG UCITS ETF USD (Dist)
• Xtrackers STOXX Global Select Dividend 100 Swap UCITS ETF 1D

It is notable that the total expense ratio (TER) of these ETFs, at 0.29 to 0.50 percent, is somewhat higher than comparable products that are simply weighted by market capitalization (such as the MSCI World Index).

b) Sometimes better, sometimes worse

A 2018 study by Quirin Bank came to the same conclusions (the observation period here was 10 years):

Investors who rely on dividend ETFs must be content in most cases with a performance that is lower than the returns of the corresponding benchmark indices.

These results not surprising.

However, it does not prove that dividend ETFs fundamentally underperform comparable indices weighted by market capitalization.

After all, there are certainly periods of a few years when dividend portfolios come out on top.

The result shows otherwise:

Ultimately, every selection of shares under certain aspects leads to a portfolio that performs better in some years and worse in others than the appropriate benchmark index.

8.Dividend ETF - The Conclusion

The probability of beating the market with a dividend strategy is extremely low and can only be bought with the willingness to take a higher investment risk.

The best way to achieve an attractive total return at the lowest possible risk is and remains a globally diversified, passively managed ETF portfolio.

It may be that this strategy involves less fun, games and excitement than chasing promising dividend stocks.

Also, looking at the regular cash flow on the account statements certainly provides a kind of satisfaction that an unadorned ETF portfolio cannot.

But this cash flow signals a perceived superiority that doesn't actually exist for dividend strategies.

Dividend fans may act irrationally as investors (which is more or less what we all do in the end), but it is also clear:

In any case, a disciplined dividend strategy is better than investing without a strategy or even completely foregoing equity investments.

In this sense

Enjoy the sunny weather

Your Mickey Mouse