Thursday, July 23, 2020

Dividends are a fact, share prices are an opinion

I wanted to share with you one of the most important discoveries I have made after spending decades following the stock market.

Dividends are a fact. 

Share prices represent the opinion of a group of strangers.

Share prices represent the result of the collective opinions of all market participants. Investors usually look at things like earnings, estimates, the state of the economy, read balance sheets and the news, in order to determine whether they want to buy or sell or hold at a given price.

No individual investor knows everything, but their collective wisdom is combined into a marketplace for company stocks. This collective opinion on these securities prices, driven by short-term sentiment and fear and greed, forms share prices. Since emotions change on a day to day basis, prices change.

This is why you may get companies that report great results but shares tank, and vice versa. This is why Ben Graham and Warren Buffett have described the collective wisdom of the crowd as Mr Market. This Mr Market is a manic-depressive individual, who shouts random prices at you. You do not have to act on them however. Successful investors wait patiently, and only strike when they are offered a good deal for their money. Otherwise, they ignore Mr Market. Unsuccessful investors on the other hand, get swept up in the feelings of euphoria or despair. Rinse and repeat, and this has been going on for centuries – while we are more sophisticated than the Dutch Merchants who founded the first publicly traded company in Amsterdam in 1602, we are still only human.

Share prices represents the best guesstimates about the worth of the company, based on the future prospects of this company, as judged by the collective wisdom of the crowds. The crowds include bulls, bears, pigs and commentators. The quoted price that you see on your brokerage account is just an opinion. Until you press the buy or sell button, that opinion would have changed 100 times.
So your individual net results will change based on these opinions. If you see your stock up 100%, that is great, but until you sell to lock that gain, this is all an illusion. The same is true if you are down by 50% in a stock – it is an illusion, and unless you try to sell, it is not reality. Your actions of buying or selling the stock in either case will influence the market of course. While my 100 shares in Blackrock may not matter as much, if you are Warren Buffett you do know that if you had to sell all 400 million shares of Coke tomorrow, you would likely be in a pickle. You may see a price of $50/share, but if you sold right away, you may drive the price to $35 - $40/share. Also, if you try to buy 400 million more shares of Coke, you may drive the price up to $60/share easily.

Dividends on the other hand are a fact.

Dividends are cold hard cash, that is deposited to your brokerage account. Companies declare dividends after analyzing their business needs and share the excess cash flows with shareholders. Any successful business, organization and person knows how much they can save successfully. Dividends come from profits, and are relatively stable. This is quite evident when you compare the historical record of US corporations against share prices. Dividends are derived directly from company fundamentals. Dividends are a direct link between a company’s fortunes and investors returns. Share prices on the other hand are derived by the opinions of others on the prospects of future fundamentals on companies. Hence, dividends are more stable than share prices in the short and long runs.
Every shareholders is treated the same with dividends. They receive a proportionate share of the excess profits to be distributed by the corporation. A dividend is known in advance, and communicated to shareholders. Profitable companies in the US tend to follow a dividend policy that favors a stable dividend payment over time. Profitable and growing companies in the US tend to grow these dividends over time. If you contrast with share prices, each individual will receive a different prices if they were to sell their shares. They would also receive differed prices if they want to buy shares.

As a shareholder, I never know what the opinion on the worth of my shares will be over any given period of time.

I do know what the dividend payment that I can expect will be however.

For example, let’s look at PepsiCo (PEP). In the past 52 weeks, the stock went as low as $101/share in March 2020 and as high as $148/share in February 2020. Based on this information, I cannot tell you if the stock price will be above $101/share or below $148/share over the next year. So if you had to sell your stock, I have no idea at what price you will be able to accomplish that.

However, I do know that over the next 12 months PepsiCo will likely distribute at least $4.09/share in dividends to each share that a shareholder holds. This would be distributed in 4 equal installments of $1.0225/share. If history is any guide, PepsiCo would likely propose a dividend increase in February or March 2021, and finalize it by May 2021.

Dividends are yours to keep when you receive them. Share prices are opinions. You may be excited to see your shares go up in price, but you should know that the others opinion of the business may change by the time you decide to sell. That gain may turn into a loss, but unless you sell, it is merely an illusion.

Today we discussed the irrefutable truth, that Wall Street doesn’t want you to know.

Dividends are a fact. Share prices are an opinion.

Relevant Articles:

Does Paying a Dividend Reduce a Company’s Value?
Dividends versus Homemade Dividends
How to avoid being a dividend loser
How to be a Dividend Winner

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