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Now that we’ve launched the MB Dividends Index, I’m feeling internally pressured to give some additional context about what dividends are, how they work, and the pros and cons of investing using a strategy that incorporates receiving dividends. There’s a lot of interest from readers, so I want to talk about some basics, talk about some of my own thoughts on dividends, and hopefully add some depth and color to the concept for you in case you plan to look in this direction.
> What are they? Dividends are profits that are distributed directly to shareholders. Yes, there are property dividends and stock dividends, but when those are declared, it’s a special circumstance. No proper dividend investment anticipates property/stock dividends.
> How are they declared? Dividends are declared by the board of directors, out of unrestricted retained earnings. They're not automatic. They need to be declared by a vote each time.
> What are unrestricted retained earnings? That’s just the profit that is left over for a given period, after all of the other stuff has been “taken” out of it, like carve-outs for capex spending or set-asides for regulatory compliance. Net income for a given period isn’t the whole story. What if the company needs to build a new factory, buy some planes, or try to build its resort casino? That company might need to “restrict” some of that period’s net income for one of those projects. So once all of those needs are decided by the board, the board is then able to determine if a dividend will be declared out of the unrestricted retained earnings, and if so, how big that dividend will be.
> Dividend obligation? You’d think so, but a company isn’t obligated to declare or pay dividends. The closest we get to an obligation is the REIT sector, which requires a REIT do distribute at least 90% of its distributable income in a year by way of dividend, but if a REIT simply decided not to pay dividends, it’s unclear if the individual investor would have any recourse. The REIT company would lose its preferred tax status, and it would have dire consequences for the REIT itself, leading to (likely) a huge drop in the value of the REIT’s shares, but an undeclared dividend might as well not exist at all for retail investors.
> Ok, but what about OGP? Even for a company like OGP, its dividend policy (90% free cash flow) is one that is self-created by the board. It’s not a legal imposition. And even then, OGP’s board and management team can strategically decide not to sell gold, which would prevent it from generating free cash flow, which could suppress the dividend. Dividends are not interest payments, like bondholders might receive. They don’t come with the same legal rights.
> What are the important dates? For holders, the most important date will be the payment date. This is when the cash shows up in your brokerage account. For those using strategies that harvest dividends through short- or medium-term holdings, then the most important date would be the ex-date, which is the day the stock begins trading WITHOUT (ex) the right to receive the dividend. In the Philippines, when a dividend says that it is “payable on July 16 to shareholders of record on July 4”, the ex-date is the business day before the record day (July 4). That means, if you want to get that dividend, you need to own the stock by the end of the trading day on the day BEFORE the ex-date. If you buy on the ex-date, you’re buying dividend-less stock. If you buy before the ex-date, you’re buying the right to receive the dividend, provided you still own that stock at the end of the trading day on the record date.
> Do I still need to own the stock to get paid? Weirdly, no, you don’t. Let’s say you own ABCDE stock, and ABCDE declared a ?5.00/share dividend payable on July 16 to shareholders of record as of July 4, like our example above. You already own ABCDE, but you don’t want to hold it any longer than you have to, because you have something else you want to buy, but you still want that div. You don’t super care about the ex-date (July 3) because you bought ABCDE like two years ago, so you’ll automatically be recorded to receive the dividend at the end of the day on the record date, July 4. But you don’t need to hold the stock until the 16th to get paid. Anyone holding the stock at the end of the record date is going to get the dividend, so if you want, you can sell ABCDE the day after the record date (July 5) and still receive the dividend for your shares on July 16. It feels weird, but just think about it like this: the checks are written on the evening of the record date, and they arrive by mail on the payment day. Of course, that’s not how it works, but I find this analogy helps reduce the confusion.
> Danger! Be mindful of how weekends and holidays interact with ex-dates if you’re planning to try any of these dividend-sniping strategies. Remember that the ex-date is the business day before the record date. Not the calendar day. If the record date is June 9 (Monday), the ex-date is not June 8 (Sunday), it’s June 6 (Friday), which is the previous business day. Except that in this example, June 6 has just been declared a holiday, so the previous business day is actually June 5 (Thursday). If you want to get that dividend, you have to own the stock by the end of trading on June 4, and hold it until the end of trading on June 9.
> Special vs regular: I’ve written about this before, but there’s not really a difference between a special and a regular cash dividend on the surface. They’re both coming from the same place (the pool of unrestricted retained earnings), and they’re both going to the same destination (shareholders). The biggest difference is intent. By categorizing something as a special dividend, the board is basically saying: “Here, take this, but don’t get used to it, it’s not going to be like this all the time.” The board is managing shareholder expectations to consider the special dividend more of a one-off, one-time thing, not as something that should be explicitly integrated into share price projections.
> High yields are good, right? Yes, but also no. Think of “yield” as the premium that investors demand for holding the stock. For a super-steady stock that holds its value well and distributes consistent and growing dividends, this might be a relatively low yield. A good example here is AREIT. There isn’t a lot that can throw this cash machine off course. Rains don’t shut down the mines. The price of the commodity (commercial office space) doesn’t fluctuate too wildly. The product isn’t directly exposed to political shenanigans like the non-renewal of a franchise. But then we have a stock like OGP, which carries all three of these risks. The dividend yield will be higher than that of AREIT because investors demand a higher return to accept the risk. If AREIT and OGP both delivered 15% dividends, and those were the only two dividend stocks available on the market, you’d expect a good number of investors to sell OGP to buy AREIT to lessen their risk exposure. As buyers push into AREIT, it drives up the price, and that naturally drives down the yield. As sellers leave OGP, the price of OGP falls and the yield climbs. At some point, the stocks reach a balance where investors feel like the risks are appropriately priced. Long story short: high-yield stocks are great, right up until they aren’t. SCC is a good example. That high yield came crashing down when the price of coal plummeted.
> Will I get rich from dividends? Probably not, but you won’t get poor either (probably). Dividends get hyped as this effort-free way of making buttloads of passive income, and I’ve seen a lot of posters imply that dividends are the path to Porsche riches. The reality is that while some yields are chunkier than others, it takes P25 million worth of AREIT stock to get P1.5 million in AREIT dividends per year. Again, I think dividends are a good component of any portfolio, especially for those over 30 with stable professional careers, but we all know if you already have P25M that waiting for four quarterly payments of P375K is probably not going to register as “getting rich”, and if a quarterly payment of P375K would make you feel rich, you probably don’t have P25M to drop on a single REIT stock.
MB bottom-line: Dividends are fascinating because they’re one of the only ways that a company can actually give back directly to its shareholders. For the vast majority of your investing life, your profit and loss will be dominated by the price action of the stuff you bought, but that’s not something that management can control directly (well, buybacks), and it’s not something that shareholders tangibly “get” unless they sell. With dividends, the cash is just airdropped into your brokerage account. That might sound like something fun to talk about, but let me tell you, people have very serious opinions about how you’re supposed to handle dividend income. The most vocal group is the “reinvest immediately” people who insist that the only way to handle a dividend is to F5 until it’s in the account, and then immediately plow the whole amount directly back into the stock that generated it. I can see the long game of this approach. It’s basically like compound interest. But I like to use the proceeds to grab more of the growth stocks that I like at good prices. I don’t spend it on Peninsula halo-halo. I use it to tinker and renovate my other holdings. But that’s just me, though. If you’re a Reinvest Immediately type, don’t hit reply all and tell me about why I’m a clown (I already know anyway). Let’s just be happy we both get some nice divs!
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