I noticed a few personal finance bloggers are listing the dividends that they earned over the course of 2007. Dividends fit nicely into the idea of “passive income”, where you basically build up enough assets that pay you back at certain periods, and hopefully you can accumulate enough to meet all your expenses, and voila, you are financially free.
People love dividends, and I would assume that a large majority of people think that’s the only legitimate way to make money from a stock on a long term strategy.
But when you think about it, when a company pays its shareholders a dividend, the company is really declaring that they don’t have investment opportunities that will provide an above average return.
Warren Buffet states clearly why his corporation Berkshire Hathaway doesn’t pay a dividend. If they did, he would personally have to invest the money he got from the dividends. And he would invest in the same companies that Berkshire invests in, so it doesn’t make any sense. He doesn’t have better investment opportunities personally than he does managing the same money within the corporation.
Why would you want to park your capital in a company that doesn’t have a good use for it? Why give your money to someone who says they have more than they need, and they just want to give it back to you?
Think about it this way, lets say you own 75% of a corporation through their stock. This corporation has $1,000 sitting in its bank account, and as the majority shareholder, you get to decide whether the company should pay dividends or invest in its own business ventures. You would only vote to pay dividends if you didn’t think the business had a position to make good use of the cash. If your corporation paid you the dividend, and then you reinvested the dividend in the corporation, it wouldn’t be worth the hassle, plus its not tax efficient. You have to pay personal taxes on the dividend income before reinvesting, which is a major waste of money.
So the way I see it, seeking wealth by investing in strong dividend paying companies is a viable path, but it is certainly not the optimal path.
By the way, I have made $73.90 from dividends so far this year. Getting paid a dividend feels pretty nice. But so do a lot of other things that aren’t the smartest things to do with your money.