Dividend Investing is Dead

Today’s post looks at an article from Todd Wenning, a former dividend investor who appears to have recanted.

Todd Wenning

Todd currently writes the Flyover Stocks newsletter on Substack:

I founded Flyover Stocks in 2023 to help investors identify high-quality businesses with durable competitive advantages (economic moats) and management teams focused on long-term value.

Todd has two decades in the financial industry:

From analyzing stocks for The Motley Fool to covering companies on the sell-side for Morningstar and the buy-side for Johnson Investment Counsel and Ensemble Capital Management.

Most interestingly, around ten years ago he wrote a book on dividend investing- Keeping Your Dividend Edge.

• And before that, he ran a dividend investing newsletter.

So something must have changed.

Dividends don’t matter

I have previous with being less than complimentary about dividends, so let’s recap that old stuff before we get around to Todd.

One issue is that many of their supporters treat them as free money, rather than a distribution of profits that causes the share price to drop.

But in a nutshell, the key/only benefit of dividends is that if you reinvest them, they compound up nicely over several decades.

• Unfortunately, the people who push dividend investing at you are mostly semi-retired guys who are spending the income.

Here are the reasons why people think that they might like dividends:

1. people need them for income
2. there are tax advantages 
   • (this usually comes from US commentators – I can’t think of any in the UK other than the paltry £500 annual allowance)
3. they are the driver of growth in your portfolio
4. they improve the capital structure of the company that issues them
5. they are an indicator of company performance and strength
6. high-dividend payers are less volatile

We’ll take each of these cases in turn, comparing high-dividend stocks and low-dividend stocks.

• Bond income is a third case (not increasing with inflation, more reinvestment risk) that we won’t consider.

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First, income.

• We all hope to reach the age where we need a regular income (retirement/decumulation/distribution).
• A solid approach is to cover your costs with “real” (DB) pensions, but these have disappeared for most people (other than the state pension and within the public sector).

For a long time, low interest rates (on safe bonds and cash) meant that dividends looked attractive.

But you can just as easily sell some shares and withdraw the cash.

• You don’t want to sell stocks in a bear market, so you might consider a cash buffer of some years’ living expenses.

The UK tax treatment is pretty much a wash:.

• Dividends (and capital gains) aren’t taxed within SIPPs and ISAs.
• Withdrawals from pensions are taxed whether they come from dividend income or capital sales.
• And we have an annual £500 allowance to protect dividends (compared to £3K for capital gains).

Selling can also usually be at a time of your choosing (ie. to your advantage), whereas dividends turn up like clockwork.

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In the current environment, UK dividends make up around half of stock returns.

• If you reinvest and compound them, they can make up more than half of your long-term portfolio growth (but the reinvestment is doing the heavy lifting – whether retained in a company or in your brokerage account).

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Companies that issue a lot of dividends have to refinance (shares or debt) or shrink.

• Thus, more dividends means that the share price will rise less (the firm is riskier, or there are more shares) in the future.

Buybacks are better. 

1. they support the share price as there is a willing buyer
2. they increase the earnings per share (EPS)

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A large dividend is not an indicator of company performance and strength.

• The level of the dividend is chosen by the board of directors.
• It’s often set by reference to the level of dividends in previous years, since investors respond badly to dividend cuts.

What really matters is whether the dividend is covered by the current year’s earnings.

• You don’t really want to be invested in a company that is paying out more than 50% of its income. 

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Many dividend stocks are really value stocks, and so you are adding a value tilt to your portfolio. 

• That value factor should generally lead to outperformance over time.

But during the days of low interest rates, dividend stocks tended to become expensive “bond proxies” whose prices were driven up by the hunt for yield, making them of poor value.

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Now that I’ve declared my beliefs, let’s get back to Todd.

Dividend Investing is Dead

Todd starts by outlining his own reasons for liking dividends:

• Companies need cash flows to pay dividends, not GAAP accounting opinions
• To increase the dividend, boards need to be confident in the company’s ability to generate more cash flows.
• Growing dividends are suggestive of a competitive advantage, since the board must be confident in the company’s ability to generate higher future cash flows.
• Growing dividends indicate the board’s interest in sharing the company’s prosperity with shareholders.
• Dividends reduce the size of the management’s sandbox, forcing them to be more focused with capital allocation decisions.

But even in his book, he noted that things were changing:

The days of “buying and forgetting” dividend-paying stocks are over – if they ever really existed. In today’s market, new and existing competitors alike are looking to disrupt high-margin, cash-flow generating businesses that are resting on their laurels.

Todd sees three problems with dividend investing today:

1. Consumer staples have been disrupted by advertising disintermediation and changes in consumer behaviours (eg. GLP–1 drugs)
2. The rise of share buybacks, only legalised in 1982 (and despite a 1% tax since 2022)
3. The rise of young tech firms – which don’t pay dividends, and use buybacks to offset share-based compensation – a trend which AI is likely to accelerate

Consider the declining three-year trailing dividend growth trends for Coca-Cola, Colgate-Palmolive, J.M. Smucker, and Clorox – four “Dividend Aristocrats” that have grown their dividends each year for 25+ years.

Compared with dividends, which in the US come with an implicit commitment to pay at least as much in subsequent years, buybacks offer more flexibility. In tough times, the company can retain cash. 

If the stock is cheap, the company can buy stock and increase the ownership slice of ongoing shareholders. For most of the past decade, the S&P 500’s buyback yield had exceeded that of the dividend yield.

This trend is much less developed here in the UK, and we have a higher market dividend yield, but on the other hand we don’t have much tech, or future-looking firms in general, and at 3% of the global market cap, the UK has become a dangerous backwater to specialise in.

The average age of an S&P 500 constituent has declined from 57 years to 15 years. This trend is due to a number of factors, including disruption, failure, acquisition, and younger, rapidly growing (mainly) technology companies kicking out slower, more mature businesses.

Todd left out another reason for the strategy’s dwindling popularity – as with value in general, dividend investing has massively underperformed the tech-driven boom of the last decade.

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I’ve never been interested in dividends (other than the tax-free ones from VCTs), so I won’t miss them, but I know plenty that will.

That’s it for today.

• Until next time.