5 misconceptions about dividend investing

Today I’ve got a short thread to clear up some misconceptions I’ve seen about dividends on social media.

Are dividends deducted from the share price? What does Warren Buffett think about dividends?

Let’s take a look! 🧵

1. Are dividends deducted from the share price? 📉

> “Dividends don’t affect the share price.”

I’ve heard this a thousand times and IT’S FALSE.

Dividends DO affect the price.

If they didn’t, all you’d have to do is buy before the ex-dividend date, collect the dividend, and sell right after for a guaranteed profit.

This strategy is known as “dividend capture,” and we know that in markets, any strategy for making “free” money stops working as soon as it becomes well known (because markets are anti-inductive).

Put another way, when a company pays a dividend, it’s “taking money out” of the business; so it makes sense for the share price to reflect that outflow. In more technical terms, if an asset’s value is based on future cash flows, and we realize part of that cash flow in the present, it makes sense for that value to fall proportionally.

So what happens?

On the ex-dividend date, the price adjusts by roughly the amount of the dividend (with some friction from taxes and market microstructure).

2) “Dividend-paying stocks do better in the market” 📈

People often confuse causation here. They assume:

“Paying dividends causes good stock market performance.”

This is NOT true (at least not entirely).

The reality is that growing dividends and good stock market performance are usually consequences of the same thing: profitable, stable businesses.

Profits explain both (i) the ability to pay dividends and (ii) why the market assigns higher multiples and the company performs well in the market.

It’s true that there’s a reflexive relationship between paying dividends and the “stability” shareholders perceive; but the root cause is a solid business.

In other words, it would be more accurate to say:

“Businesses that are doing well and are stable lead to good stock market performance”

That shouldn’t surprise anyone.

The important thing here is that the dividend is NOT responsible for the good performance, and this confusion could lead you to focus on companies with good dividends but bad businesses. In other words, a terrible investment.

3) “Most of the S&P 500’s returns come from reinvested dividends”

This may be true for certain periods, but it is NOT an argument for dividend investing.

The key nuance here is to consider the counterfactual.

If the company retained that capital to reinvest it (or buy back shares at a good price) instead of paying dividends, that return could show up as price appreciation rather than as a dividend.

That “return from reinvesting dividends” doesn’t disappear if the company doesn’t pay them out; it disappears when they’re paid out and the shareholder doesn’t reinvest them.

In any case, this claim means: “If you reinvest dividends, your returns are better than if you don’t”

That shouldn’t surprise anyone either.

4) “A high yield (>7%) is easy and desirable”

This claim is incredibly dangerous if you don’t talk about the risks.

It’s worth highlighting the risk of yield traps. Companies with high dividends, but at the expense of a deteriorating business or future dividends.

That’s a feast today and a famine tomorrow. A terrible long-term investment.

A high yield doesn’t automatically make it desirable. It’s important to analyze the sustainability of the payout (and the company while we’re at it).

A few things to consider:

• FCF coverage and a realistic payout (not just on paper).
• Business visibility and the sector cycle.
• Leverage (debt/EBITDA, debt maturity schedule, cost of debt).
• Maintenance vs. growth CapEx; sensitivity to commodities or regulation.

Usually, the higher the yield, the less sustainable it is. If there were no risk, people wouldn’t bother buying bonds or renting out apartments.

5) “Buffett is pro-dividends”

Buffett isn’t “pro” or “anti” dividends per se; it depends on the reinvestment opportunity.

If the company can reinvest at high returns, it’s better to retain capital or buy back shares (if the price is right). If not, pay dividends.

Even though I’ve seen it in this particular case, I often see Buffett quotes taken out of context to support anything, just to give a belief an aura of authority.

That’s it for today’s short thread.

Hope you liked it and that it helps clarify a few things.

For some reason, dividends are a very controversial topic in the investing world and are presented as a magic cure-all.

Be careful with the magic 🪄