2/3: A dividend has never made a shareholder wealthier
Despite what critics of payout policies may claim, a dividend is by no means a gift to the shareholder and has never enriched its recipient.
The first part of our series showed that a share price reflects what the company owns (including its cash). What happens, then, when a company pays a dividend?
Are you wealthier when you withdraw money from an ATM?
Before discussing dividends, let us take a detour to automated teller machines (ATMs). If you withdraw $50, you immediately have more cash in hand. But have you become any wealthier? Obviously not.
By withdrawing, you have simply transferred money from your account to your pocket. This withdrawn money already belonged to you, and your total net worth has not changed.
The mechanism at work is exactly the same when you receive a dividend.
A share price adjusted downwards
When a company distributes dividends, it consumes cash and mechanically reduces its value by the same amount. In other words, if a dividend is paid, the share price drops in the same proportions.
Take the simple example of a company with an enterprise value of $80,000 and $20,000 in cash. The equity of this company is therefore worth $100,000. If it is divided into 1,000 shares, each share is worth $100. The company decides to pay a dividend of $10 per share, or $10,000 in all. After the operation, the company will only have $10,000 in cash left, and its valuation will drop to $90,000, or $90 per share.
Ultimately, the shareholder who held a share at $100 will have received $10 in cash and will retain a share now worth only $90. Their total assets will still be worth $100.
The payment of a dividend has simply monetized a value that they already owned through their share.
The concept of the coupon
In the past, the term "coupon" was used to refer to the dividend. The reason for this was simple.
When shares were still physical documents printed on paper, the dividend was indeed represented by small detachable coupons (similar to a stamp). At each payment period, the shareholder simply had to hand over a coupon in exchange for the dividend payment. This was referred to as "detaching the coupon".
From a visual perspective, the collection of dividends over time reduced the size of the share certificate (reflecting its value).
While this visual aspect of the share "melting away" as dividends are paid no longer exists today (due to dematerialization), the principle remains perfectly true from an economic standpoint, and we still speak of prices "cum-dividend" or "ex-dividend."
Of course, in the stock market, adjustments are not always perfect. This is because between the dividend payment and the next quote, a multitude of other factors (specific or macroeconomic) can influence the price movement.
So how does a shareholder get wealthier?
The enrichment of a shareholder in terms of net worth does not come from dividends, but from the evolution of the price of the shares they own—for example, when a company increases its earnings or improves its outlook.
It is the increase in the share value over time that enriches the shareholder. It then matters little whether this value is distributed as a dividend or not.
Paradoxically, an excessive dividend can even be a disadvantage for the shareholder. This is what the third part of our series will demonstrate.
