A favorite theory of financial economists is that stock dividends are a mirage, bait conjured by companies to create the illusion of free money. Research from the University of Chicago and Boston College says almost everyone falls for it.
Consider a $100 stock that pays a $10 dividend — it falls to $90, just as if it paid nothing and the owner sold 10% of his shares in the market. Same difference, and yet the study found the allure of the corporate payout incites all kinds of costly behavior among investors.
Mainly, they flock to dividend stocks simultaneously, pushing prices up and expected returns down. During times of low interest rates and poor market performance, when demand for dividends is particularly high, expected returns on dividend stocks are 2% to 4% below levels in other times, according to the paper.
In a yield-strapped environment, investors have a bad habit of viewing dividends as bond coupons that produce stable gains over time, according to Chicago Booth’s Samuel Hartzmark and Boston College Carroll School of Management’s David Solomon. This leads them to focus on stocks’ total return rather than the price performance. As a result, investors hang on to dividend-paying equities for longer than they would have otherwise, the research paper, “The Dividend Disconnect,” finds.