I am a dividend non-believer

OK, this is probably going to offend a lot of people. Especially those who worship dividend income over anything else.

When I scroll through Twitter, I find that a large proportion of “FinTwit” are part of the dividend income cult. Those Twitter pages that track the amount of dividends they receive each month and are looking to build X amount of “annual dividend income”.

Maybe it is made worse by the fact that I largely focus my investments towards index funds (because the statistics don’t lie) but there is also a fundamental reason why I don’t buy in to the dividend investing cult.

In my opinion, dividend stocks are no different to normal stocks. If you take the equivalent company (same market capitalisation, same revenue, same profit, same outlook), there should be no difference based on whether the company pays a dividend or not. The total return (i.e. stock appreciation + dividend income) would be exactly the same between the dividend paying stock and the stock that does not pay dividends.

For me, a dividend is effectively a forced sale of a small percentage of a given stock. It makes no difference to the total return you receive from a particular investment. If you want to receive an income from your investments, you always have the option to sell the equivalent amount that you otherwise have received from a stock if it paid dividends.

Those within the “dividend income cult” often suggest that dividend paying companies are “safer” than non-dividend paying companies. Particularly those dividend paying companies that are listed as Dividend Aristocrats. I completely disagree with this.

Just because a company is paying a dividend (and continues to) does not make it a safe investment. For example, AT&T is listed as a Dividend Aristocrat but here are the returns if you had invested in AT&T (including dividends):

• 1 year = -7.1%

• 3 years = -14.1%

• 5 years = -12.5%

The company might pay an attractive dividend of around 6% but it has hardly been a stellar performer. The S&P500 index tracker (£VUSA) has returned the following over the same period (without dividends):

• 1 year = -5.1%

• 3 years = +43.5%

• 5 years = =+78.0%

£VUSA also pays a 1.4% dividend on top. So as you can see, by investing in AT&T, you would have lost out significantly.

Overall, dividends are likely to hurt a company’s stock performance since the money paid out in dividends would likely be better invested back into the business to improve future returns for shareholders. Paying a dividend puts a stop to the compounding of that cash (unless re-invested by the shareholder).

Innovation also appears to be getting faster and faster. Therefore, those companies that appear to have a moat are actually being overtaken quicker. A recent study by McKinsey found that the average life-span of companies listed in Standard & Poor’s 500 was 61 years in 1958. Today, it is less than 18 years. McKinsey believes that, in 2027, 75% of the companies currently quoted on the S&P 500 will have disappeared.

So as you can see, companies are not “living” as long as they used to. You also have to consider that nearly 60 per cent of global stocks over the past 28 years did not outperform one-month treasury bills. Dividend paying companies are no exception to this.

If anything, those companies paying dividends are likely mature businesses that are now able to give surplus cash back to their shareholders. But the next phase in the business life cycle would therefore be decline.

Business life cycle

Those businesses that are most likely to provide more extreme returns are probably those within the start-up or growth phases. These companies can be more nimble and develop products or services that can disrupt the incumbent mature businesses of today. However, finding these disruptive businesses is very difficult with only 1% of stocks accounting for all of global stock market wealth creation.

So all of the above is why I am not a devoted dividend income cult supporter. Dividends are just a distraction from focussing on the important figure which is total return on investment.