Someone in another thread posed the question of whether companies that pay stable dividends can help to mitigate SORR (sequence of returns risk).
Someone posted an example showing that taking a dividend is no different from selling shares to raise the same cash:
Where it says "End of year both stocks double", both companies have recovered equally in terms of Market Cap (i.e., doubled). However, in terms of Enterprise Value, Company B has recovered more than Company A, making the outcome in the Company B case appear to be better than it would be in an apples-to-apples recovery scenario.
For simplicity, let's assume neither company carries debt, so:
Market Cap = Enterprise Value + Cash (in the corporate treasury)
In the example, there was one dividend payment by Company A. Let's assume that, prior to that payment, both companies had exactly $1/share cash in the corporate treasury, so after the payment, A's treasury is zero and B's still has the $1/share (and let's assume that the cash stays there from then on). And let's assume the market recovery happens prior to any additional cash being accumulated.
So, according to the "Market Cap = Enterprise Value + Cash" equation, prior to dividend payment, we have:
Company A (per share): $5 = $4 + $1
Company B (per share): $5 = $4 + $1
After the dividend payment and subsequent market recovery, we have:
Company A (per share): $8 = $8 + $0
Company B (per share): $10 = $9 + $1
These are the numbers implied by the example given. What I'm suggesting is that an apples-to-apples comparison would show both companies recovering equally in terms of Enterprise Value. In that case, if Company A, like Company B, recovered to an Enterprise Value of $9/share, it's market price would also be $9/share, resulting in the following outcomes for the two investors:
Company A investor: 10 shares * 9 dollars + 10 dollar dividend = 100 dollars
Company B investor: 8 shares * 10 dollars + 10 dollars (sold stock) = 90 dollars
Thus, in the apples-to-apples recovery scenario (equal recoveries in terms of Enterprise Value), the Company B investor came out behind due to SORR.
Now, before anyone interjects some nonsensical "haha, there is no magic money", I'll just declare once and for all: I do not believe in "magic money". It does not exist.
What I'm saying is that, contrary to the "dividend irrelevance" theory, there's a fundamental difference between what happened at the point where the dividend got paid (in the case of Company A) and the shares were sold (in the case of Company B). Here's what it is.
For simplicity, let's assume that both companies have 1,000 shares of common stock outstanding. At the beginning, Investor A owns 1% of Company A, and Investor B owns 1% of Company B. After the dividend payment (A) and the share sale (B), Investor A still owns 1% of Company A (although the value of that company is reduced due to the corporate treasury being emptied), while Investor B owns only 0.8% of Company B (including 0.8% of its Enterprise Value and 0.8% of its cash on hand). Although their account values are the same at that moment, Investor A will have greater participation in the subsequent market recovery than Investor B, due to owning a greater amount of Enterprise Value (which represents a company's money-making ability, i.e., the value of the actual business operation, not counting cash on hand). And that's a meaningful difference (contrary to the "irrelevance" arguments) because there can be different outcomes, as I've shown above.
So we see an example of a situation where dividends are not irrelevant. Of course, there must be other examples where Investor B does better than Investor A. This example was constrained (in the earlier thread) to a situation of a company that has a history of reliable dividend payments over market cycles (some refer to this kind of company as a "dividend aristocrat"), and the company pays out all its earnings in dividends (as it doesn't have other uses for the cash).
What I'm saying is, in situations that look anything like that, then yes, there may be some SORR risk in taking cash by way of share sales rather than by way of dividends, particularly if one is faced with selling shares in a down market.
Of course, someone may say "equal recovery in terms of Market Cap is apples-to-apples, and equal recovery in terms of Enterprise Value is not". In that case, it would be interesting to know why you think that (other than just "it is"). My suggestion is that if the two companies are equal overall (other than whether they pay dividends or not), then an equal recovery should be equal in terms of Enterprise Value (and if not, then one has to explain why one company should diverge to a lower Enterprise Value than the other).
That thread was locked due to a lot of insults flying around. Please don't do that in this thread, thanks.... some people equate dividend payouts with a "forced sale" of stock.
This argument seems incorrect to me, since it ignores SORR when we are in retirement.
Someone posted an example showing that taking a dividend is no different from selling shares to raise the same cash:
At first glance, the above is pretty straightforward. However, I'm not sure that this example is making an apples-to-apples comparison between Companies A and B.The math would be this.
You own 10 shares at 10 bucks for total of 100 dollars of Stock A
I own 10 shares at 10 bucks for total of 100 dollars of Stock B
Both stocks drop 50% and we need money to pay rent.
You have 10 * 5 = 50 dollars of A
I have 10 * 5 = 50 dollars of B
A pays a dividend of 1 dollar so you have
10 shares * 4 dollars + 1 dividend * 10 shares = 50 dollars
I need to raise 10 dollars so I sell 2 shares (2 shares * 5 dollars), so I have
8 shares * 5 + 10 dollars.= 50 dollars
End of year both stocks double
You have
10 shares * 8 dollars + 10 dollar dividend = 90 dollars
I have
8 shares * 10 dollars + 10 dollars (sold stock) = 90 dollars.
Where it says "End of year both stocks double", both companies have recovered equally in terms of Market Cap (i.e., doubled). However, in terms of Enterprise Value, Company B has recovered more than Company A, making the outcome in the Company B case appear to be better than it would be in an apples-to-apples recovery scenario.
For simplicity, let's assume neither company carries debt, so:
Market Cap = Enterprise Value + Cash (in the corporate treasury)
In the example, there was one dividend payment by Company A. Let's assume that, prior to that payment, both companies had exactly $1/share cash in the corporate treasury, so after the payment, A's treasury is zero and B's still has the $1/share (and let's assume that the cash stays there from then on). And let's assume the market recovery happens prior to any additional cash being accumulated.
So, according to the "Market Cap = Enterprise Value + Cash" equation, prior to dividend payment, we have:
Company A (per share): $5 = $4 + $1
Company B (per share): $5 = $4 + $1
After the dividend payment and subsequent market recovery, we have:
Company A (per share): $8 = $8 + $0
Company B (per share): $10 = $9 + $1
These are the numbers implied by the example given. What I'm suggesting is that an apples-to-apples comparison would show both companies recovering equally in terms of Enterprise Value. In that case, if Company A, like Company B, recovered to an Enterprise Value of $9/share, it's market price would also be $9/share, resulting in the following outcomes for the two investors:
Company A investor: 10 shares * 9 dollars + 10 dollar dividend = 100 dollars
Company B investor: 8 shares * 10 dollars + 10 dollars (sold stock) = 90 dollars
Thus, in the apples-to-apples recovery scenario (equal recoveries in terms of Enterprise Value), the Company B investor came out behind due to SORR.
Now, before anyone interjects some nonsensical "haha, there is no magic money", I'll just declare once and for all: I do not believe in "magic money". It does not exist.
What I'm saying is that, contrary to the "dividend irrelevance" theory, there's a fundamental difference between what happened at the point where the dividend got paid (in the case of Company A) and the shares were sold (in the case of Company B). Here's what it is.
For simplicity, let's assume that both companies have 1,000 shares of common stock outstanding. At the beginning, Investor A owns 1% of Company A, and Investor B owns 1% of Company B. After the dividend payment (A) and the share sale (B), Investor A still owns 1% of Company A (although the value of that company is reduced due to the corporate treasury being emptied), while Investor B owns only 0.8% of Company B (including 0.8% of its Enterprise Value and 0.8% of its cash on hand). Although their account values are the same at that moment, Investor A will have greater participation in the subsequent market recovery than Investor B, due to owning a greater amount of Enterprise Value (which represents a company's money-making ability, i.e., the value of the actual business operation, not counting cash on hand). And that's a meaningful difference (contrary to the "irrelevance" arguments) because there can be different outcomes, as I've shown above.
So we see an example of a situation where dividends are not irrelevant. Of course, there must be other examples where Investor B does better than Investor A. This example was constrained (in the earlier thread) to a situation of a company that has a history of reliable dividend payments over market cycles (some refer to this kind of company as a "dividend aristocrat"), and the company pays out all its earnings in dividends (as it doesn't have other uses for the cash).
What I'm saying is, in situations that look anything like that, then yes, there may be some SORR risk in taking cash by way of share sales rather than by way of dividends, particularly if one is faced with selling shares in a down market.
Of course, someone may say "equal recovery in terms of Market Cap is apples-to-apples, and equal recovery in terms of Enterprise Value is not". In that case, it would be interesting to know why you think that (other than just "it is"). My suggestion is that if the two companies are equal overall (other than whether they pay dividends or not), then an equal recovery should be equal in terms of Enterprise Value (and if not, then one has to explain why one company should diverge to a lower Enterprise Value than the other).
Statistics: Posted by HanSolo — Sun Jul 14, 2024 5:22 am — Replies 0 — Views 41