Facebook recently announced that they're issuing, for the first time, a dividend. I've found dividends to be widely misunderstood and will take a moment to explain why.
Dividends Are Not Like Bonds
Most people incorrectly equate dividends and bond payments.
With bonds, you are paid a set amount every year until the end of the bond period, at which point you receive back what you paid initially for the bond. Dividends are not that way.
With a dividend produced from a publicly traded stock, the value of that dividend decreases the value of the company and, therefore, the stock price. Here's an example I use with my students that assumes you own a stock that's producing a dividend:
Stock Price: $100
Future Dividend Amount: $2
The company issues their dividend
Stock Price: $98
Cash in your account: $2
As you can see, you don't come out ahead because of the dividend. You started with $100 in value and ended with $100 in value. The dividend is effectively transferring value from the stock price to cash.
When exposed to this information for the first time, I've found seasoned investors to become upset. The way I discovered this is because I had a grand idea back in college to make a few bucks: just buy a stock the day before the dividend, reap the dividend, then sell the stock.... I didn't come out ahead, tried to learn why, and discovered this.
Why Do A Dividend?
So why do companies issue dividends? The primary reason, in theory, is that the company has excess profits and, after pursuing all possible new ventures within the business, they want to give some excess cash to their shareholders so they can deploy it however they choose.
Warren Buffet's company, Berkshire Hathaway, does not pay a dividend. The Oracle of Omaha's reasoning is that they want to accumulate the cash and one day deploy it when they find opportunities that may only work if you have a lot of money (they currently hold around $150 billion in cash per a quick Google search).
There are other potential benefits of companies issuing dividends, such as forcing management to be disciplined. A counterargument would be that said companies pursue short-term financial goals rather than long-term shareholder wealth when forced to provide regular dividends.
Conclusion
Whether companies that pay dividends are good investments or not, I won't get into that today. The primary takeaway I want you to know is that dividends are not the same as bond payments, which many people are not aware of.
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