The idea that you don’t need to make any effort and receive money periodically fascinates everyone. Not surprisingly, this is the ad focus of many search companies to attract subscribers.
I recently received this email from one of these. I transcribe part of the email below.
“This is a quick reminder: you only have until market close today to invest in the microcap recommended by our team.
This is the company that will pay a “superdividend” of 57% to shareholders who own the shares until today, 12/17.
Therefore, we recommend to ALL our subscribers to take advantage of this unique opportunity.
It’s a rare chance for you to put $10K of your money and get $5,700.00 in an extraordinary dividend.”
You can see several advertisements on social media suggesting the urgency of not losing the “y” share dividend that will be paid on January 3rd. Naively, many investors rush to buy this same stock to receive the dividend, and only then realize the nonsense.
Perhaps you are asking yourself: “Wouldn’t earning a dividend be positive?”
Undoubtedly, buying shares from a company that has solid cash flow generation prospects, enough to cover its investments and even distribute earnings can be a good long-term strategy.
However, there are two fallacies related to dividend strategy that you need to understand.
Before talking about the fallacies, I explain the three important dates for the dividend. There is the announcement date, the ex date and the payment date.
The announcement date is simply the instant at which the income is declared.
The second moment is the date, after which, whoever buys the share is no longer entitled to the dividend. This is the ex date.
Finally, there is the date on which the dividend is paid. However, only those who had the share before the ex date receive this dividend. The payment date may occur months after the announcement date and is deliberated at the shareholders’ meeting.
With these concepts, I explain the first fallacy below.
Most people mistakenly believe that the mere fact that you receive a dividend payment means that you will keep more money than when you invested.
I explain with an example.
Imagine you buy a stock today for $100. Assume your ex date is tomorrow. Consider that this share is expected to pay a dividend of 57%, that is, R$57, as this was the value disclosed on the announcement date.
The day after the purchase, which is the ex day, you wake up with two elements in your wallet:
– a stock whose price is no longer R$100, but is now only R$43, and
– a provision for dividends receivable (on the payment date) of R$57.
So, you wake up with the same R$100 you invested the day before. There is no such thing as “money creation”.
Rushing to buy a share right before the ex date, in order to receive the dividend is like rushing to buy a car worth BRL 100,000, paying the price of BRL 150,000 for it, as it has a cash bag of R$ 50 thousand in the passenger seat and that was placed there by the current owner of the car. In the end, of the R$150,000 invested in the car, you will end up with the R$50,000 cash bag and the R$100,000 car.
Therefore, it is a fallacy that buying a stock just before the ex date is a good investment.
The second fallacy of the dividend is that the dividend strategy has a better risk-adjusted return because of its lower volatility.
Without a doubt, dividend-paying companies usually have more robust cash flow. However, the dividend strategy is not significantly less volatile than investing in a broad index such as the Ibovespa.
Additionally, the return of the dividend strategy has been lower in the last decade than that of broad indices, such as the Ibovespa.
Thus, the Sharpe ratio, which measures risk-adjusted return, for the dividend strategy is worse than that of a diversified strategy that does not focus on dividends.
The table above shows this comparison of risk and risk-adjusted return in 3, 5 and 10 year windows for indices in Brazil and worldwide.
I’m not saying that buying dividend-paying stocks is a bad strategy, but it can be just as risky and pay worse than other strategies.
Michael Viriato is an investment advisor and founding partner of Investor’s House
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I have over 8 years of experience in the news industry. I have worked for various news websites and have also written for a few news agencies. I mostly cover healthcare news, but I am also interested in other topics such as politics, business, and entertainment. In my free time, I enjoy writing fiction and spending time with my family and friends.
