Investing : Dividends - Good or not?

Hello again,

So, if you're investing in a company, are dividends a good thing to search out or not?  Companies giving you money, are you kidding, that's got to be good, hasn't it?

The answer to that question really lies in the answer to another question: How good a return on equity (ROE) is that company producing?

That answer will tell us how much growth you can expect a company to produce for $1 of equity.  So if you multiplied the ROE by the share price that answer would be what you would expect in total returns for your investment.

If the return on equity is good, then dividends are not necessarily the best
thing, because that company might well be capable of giving better returns 
on you investment than you could.  
Unless of course, you're a better investor than they are?

So, how do we know what a good return on investment is?  Well, let's put it a different way, let's look at opportunity cost, the cost of not doing something else.
Let's just imagine (have you got your eyes closed?) that instead of investing in all that stock market stuff, we'll go the safe option and put the money into a saving account, that earns 6% per year.  That's the benchmark.  If our return on equity is less than that safe 6%, then it's clearly not worth bothering with, unless there's something that might indicate that it will grow significantly.

So, in short, dividends are great when a company isn't all that good at growing it's investment, and not so great when the company is good at making money.

That begs the question, why would you ever want to get dividends then?  Well, unfortunately for us poor intelligent few, we have to put up with people looking for income from investments. Management of companies often divide the returns in half, half for dividends, half for re-investment.  

So what's wrong with that?  Well, you get some income, for sure, and put that money in your 6% saving account, or some other shares.  Meantime the other 50% is used by the company to produce a 20% return.  Bugger!

A way of looking at getting income out of an investment that doesn't pay dividends, could be to sell a few shares instead.  If they're appreciating in value, and you really need that money, then that could be a way to go.

There's another downside though, tax.  Bugger - again.  When you take the income, you get taxed, then you re-invest that money.  Now, your money has to make the amount of tax extra on top of the return you wanted before you can get the returns you desire.

So let's say you get a $1 dividend payout per share.  How lucky is that?  Don't get smug just yet!  
Since you're a pretty smart cookie, you also earn a reasonable salary, and 
get taxed at close to 50%.  Now your payout is 50 cents.  Not so smug now, 
are you?  
You now need to make a 100% return on that 50 cents when invested to get 
back to the original $1 dividend payout.  Then, from there, you then need 
to make money on top of that to get a return on that original $1.  That 
return if left to be reinvested would only have to make the good return 
to be successful.

That doesn't make dividends look quite so good now does it?  Well, yes and no.  If you want an income, it's possibly because you've retired, otherwise you'd be looking for growth, would you?  I hope you would anyway!  So if you're after income, you probably also want to reduce your risks too, don't you, so that you can afford to retire, buy a huge yacht, and sail away.  Damned right!  When risks are reduced, so are rewards, so it means by having the income that you're inherently looking for something that will have a lower risk, in which case, as mentioned earlier, you would probably find that you're looking at a company that doesn't have a huge ROE, and in that case, having a dividend payout is good.  Nice!  That worked out well, didn't it!