Dividends may not be as important to investors as they once were

Dividends have historically been a popular way for companies to share profits with their investors and many people think getting dividends is a big reason to invest in a company.

But times have changed. Dividends might not be as important for Canadian investors as they used to be. Let's explore why.

What are dividends?

Dividends are payments a company gives to its shareholders. The company’s board of directors decides how much to pay. For example, if you own shares in a company that pays a $1 dividend per share, and you have 100 shares, you’ll get $100.

This might sound great, but where does this money come from? It comes from the company’s cash or profits. When the company pays a dividend, its value goes down by the same amount. This is important to understand.

How dividends reduce a company's value

When a company issues a dividend, it lowers the company’s total assets. Imagine a company is worth $1 billion and it pays out $100 million in dividends. Now, the company is worth $900 million. So while you get some cash in your pocket, the company’s value has decreased.

Some investors don’t realize this and think dividends are like free money. But they’re not. The company is just giving back some of the money it already has.

Tax benefits are not what they used to be

One reason dividends used to be popular was the tax break. In Canada, there are special rules for dividends, like the Dividend Tax Credit. This made dividends a tax-efficient way to get investment returns.

However, these tax benefits have become less valuable. Over the years, changes to tax laws and rates mean there’s often no big advantage to getting dividends compared to other types of income or investment returns. For many investors, it might be better to focus on overall growth rather than just dividends.

Some investors also don’t want the income and trigger unnecessary taxation when the dividends are issued.

Dividends can be misleading

Some companies try hard to pay steady or rising dividends because they think it makes investors happy. But this can lead to problems. A company might pay more in dividends than it can afford, hurting its ability to grow. Boards of directors also control dividends, so the amount paid can be somewhat arbitrary—it doesn’t always reflect how well the company is really doing but instead is often a tool used to mislead less-savvy investors.

Are dividends still good for anything?

Dividends aren’t all bad. For some investors, they can be a reliable source of income. Retirees, for example, might like getting cash from dividends to help pay for living expenses. Dividends can also show that a company is stable and has strong cash flow. Companies that pay consistent dividends are often well-established businesses.

The other side: Why dividends might not matter as much

Instead of focusing on dividends, many investors now look at total returns. Total return includes both the growth in a stock’s price and any dividends. If a company doesn’t pay dividends, it can reinvest its profits to grow the business. This can lead to a higher stock price over time, which benefits investors.

For example, some of the biggest and most successful companies, like tech giants, don’t pay dividends. Instead, they use their profits to create new products, expand, or buy back shares. Share buybacks can also increase the value of the shares you own without reducing the company’s cash as much as dividends.

What should investors do?

The best approach depends on your goals. If you need regular income, dividends might still work for you. But if you’re looking for long-term growth, focusing on the company’s overall performance and strategy might be better.

Dividends are not free money. They reduce the value of the company when they’re paid. And in today’s world, the tax advantages aren’t as strong as they used to be. It’s worth thinking about whether dividends really fit your investment plan.

By understanding both sides of the argument, you can make smarter choices for your financial future.

This article is written by or on behalf of an outsourced columnist and does not necessarily reflect the views of Castanet.