In One Up On Wall Street (p. 19), Peter Lynch once remarked that “if anybody’s responsible for the disappearing dividend, it’s the U.S. government, which taxes corporate profits, then taxes corporate dividends, for so-called unearned income. To help their shareholders avoid this double taxation, companies have abandoned the dividend in favor of the buyback strategy, which boosts the stock price. . . Reducing the supply of shares increases the earnings per share, which eventually rewards shareholders, although they don’t reap the reward until they sell.”
I received an interesting private question from a reader recently, asking me what I thought was the best argument against blue-chip dividend investing. I loved that question, and with his permission, I included parts of my answer below.
When you think about owning a diversified basket of high-quality assets for a long period of time, one of the virtues of the strategy is that it is almost fail-proof. Part of me wants to reach out and say, “Yeah, well, maybe during a WWII type of event, the dividend payouts might stop.” I have no idea what will happen during the outbreak of the next war, but here is what I do know: When Germany was streaking across Europe and launching air attacks on the British empire, the highest quality companies in the world continued to make their payouts. General Mills, AT&T, General Electric, Hershey, Colgate-Palmolive, IBM, and the offspring of the Standard Oil managed to return cash to shareholders throughout the 1930s and 1940s (that’s the wild fact—the financial crisis of 2008-2009 did to GE shareholders what the Reichstag and its Chancellor couldn’t do).
I want to discuss with you a phenomenon that has applications in the investing world and beyond: anchoring. Simply put, anchoring occurs when someone tells you a fact or opinion, and then you use that information to make a series of decisions thereafter (that are based on that first bit of information).
If someone performs their own analysis and concludes that Berkshire Hathaway is worth $150 per share, the fact that the price is $115 per share at the time they perform their analysis will affect their subsequent decisions. If, say, the stock goes up to $145, they may be reluctant to buy (even though it is still $5 less than their estimate of value) simply because the twenty percent rise in the price of the stock somehow indicated that it is now expensive.
I’m showing you this video not for the editorial content—one of the deep flaws in arguments about wealth is that, when someone is making $1,000,000 compared to someone making $50,000, the rhetorical question “Does that person really work 20x as hard as the other?” usually follows. The problem with that question is that it equates effort with value.
Imagine someone owns 3.65 million shares, or about 1%, of the Kellogg’s corporation. Because of what he owns, he is delivering $18 million in profitable value to people across the world each year because those people are choosing to take their scarce dollars (which they acquired through work, investing, inheritance, etc.) and buy Rice Krisipies, Frosted Flakes, Fruit Loops, Pop-Tarts, Eggo-Waffles, and so on. A little less than half of that $18 million will show up in the form of $8-$9 million worth of dividend checks that are paid out every ninety days in $2.25 million (or thereabouts) installments.
There was a write about a half-century ago named John O’Hara. He was a cranky guy with a wide variety of interests, and although he had a large number of critics, he was good enough to persuade fellow writer Fran Lebowitz to dub him “the real F. Scott Fitzgerald.”
One of his caricatures that he liked to create in his writings were hypothetical dialogues between characters that represent “Old Money” interacting with young men that were on a quest to get rich in a hurry. It would be hard for a writer like O’Hara to become generally mainstream today, because O’Hara relied on a mixture of strong moral condemnation mixed with relentless stereotyping, and that would create a strong mismatch with the rising sensitivities and general tendency to take abstract insults personally that generally typifies the current socio-political climate.