Are dividend stocks running out of gas?

Many investors have concluded that stocks with big dividends will go on thrashing the competition. But the recent burst also offers reason to worry about what comes next. Financial theory provides no convincing reason why a stock that pays a big dividend should outperform one that pays a small one, or none at all. Two giants of modern economics, Franco Modigliani and Merton Miller, published a paper in the 1950s that showed that, in an idealized world, a company can’t raise its stock market value by increasing its dividend.

Common sense suggests that the same thing holds true in the real world. If you receive a dividend of $1, the intrinsic value of the underlying shares should also decline by a buck. If it didn’t—if management could conjure up payouts out of thin air without any effect on the value of the business—every company would pay triple-digit dividends. A dividend essentially takes some of the value in your shares and deposits that amount in your bank account instead. This might be a valuable feature if you don’t trust the company’s top executives to deploy your money wisely. But it also raises a deeper question: Why would you hold a stock with such feeble leadership in the first place?

Source: Globe and Mail

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