Academic finance isn't wrong, but it's probably not right for you.

The Ownership Dividend has been met with some acclaim by conservative, dividend-focused investors. That has been gratifying. But the book’s main arguments have been rejected with equal verve by those who think the current nature of the stock market is just fine. While I appreciate the support of the former, the criticisms of the latter are more thought-provoking.

And when I review the main points of contention—buybacks vs. dividends, capital gains vs. dividend payments, investment policy vs. tax minimization, speculation vs. business ownership, and the growth canard—it turns out the divergences are generally not pedestrian variances of data, claims of superior total return, or calculation errors. Instead, they are differences of philosophy. And by philosophy, I mean stated strong preferences that may not meet an academic’s definition of a maxim—an assertion that cannot be broken down further—but come awfully close. In my case, those preferences are at odds with the academic answer to the challenge of decision making under conditions of uncertainty—the academy’s fancy name for the human condition. Modern academic finance as worked out in the 1950s and 1960s was supposed to figure that challenge, quantify it, and solve for it. More data and better algorithms were going to and in many regards led to more informed and consistent investment decision making. But to judge by the continued high level of folly or, at best, guessing, in the stock market, the promise of academic finance has not yet been realized. Perhaps it will be in another 50 years.

To be clear, the blackboard math of the post-war academy still works most of the time. The two exceptions are important ones: the less capital-intensive nature of our economy now makes the M&M dividend irrelevancy argument from 1961 so irrelevant as to be wrong for most intents and purposes. Second, much of the academic antipathy to dividends was generated when dividends were taxed at a higher rate than capital gains, (from the 1950s through the 1990s). That has not been the case since 2003. It’s time to stop casually repeating Fischer Black statements from those times that dividends ought to go to zero because of their higher taxation.

But the issue is not the academy’s formulas, but the assumption that those post-war formulas are the best possible guide to understanding human behavior. Many have written about the physics envy of modern finance. It’s covered at some length in my account from 2018, Getting Back to Business, and there are many dedicated accounts, such as the James Weatherall’s The Physics of Finance, from 2014. These treatments explain why modern finance came to be structured around the same mechanics as a physics lab. The Journal of Finance reads as much as a science experiment as it does a guide to the workings of the public square. Even the more recent literature on behavioral finance makes a rule of our irrationality and shoe-horns it into the rules-based system of equilibrium finance. That we are all irrational and not very good at decision-making is pretty much the same as saying we are all rational and good at decision making. Both are wrong. Non-finance people will recognize the concurrent evolution of the humanities into social science, with the emphasis on the science. Those post-war decades were the high-water mark of confidence in treating society as a mechanical system and using quantitative solutions to manage and improve the human condition. No doubt many material advances have come from that period of confidence, especially in medicine, and obviously in technology.

But in human affairs generally, and in the realm of investing specifically, I’m not so certain the advancements have been as great. That is at the heart of what I consider the conceptual differences encountered being a dividend investor in a stock market. Let’s review them from that perspective.

The dividend vs. buyback narrative is so well-known, I encourage readers to look up any of the vast literature on it. Suffice it here to make just a few big-picture observations. First, words matter. The semantics of grouping dividend payments and buybacks together as cash returned to shareholders stands out, and not in a good way. Dividends go to shareholders; buybacks to go to sharesellers. They are not the same. Only if a lot of math works, and there are many reasons why it usually doesn’t, are buybacks even indirectly helpful to the dividend investor.

But the main conceptual contrast is that a company profit distribution is a business outcome. It is dependent on the condition of the enterprise and the policy of the board. In contrast, a share buyback is a stock market outcome, involving numerous parties and factors unrelated to the company itself. In a classroom setting, they might be lumped together as a use of company profits. But life is not a classroom.

The distinction is nicely captured by Eugene Fama’s purported statement that “Buybacks are divisive. They dividend people who understand from finance from those who don’t.” (It’s also been attributed to Fama’s frequent collaborator, Kenneth French.) My retort is not a correction, but a step back: Buybacks are divisive; they divide people who understand academic finance in the classroom from those to own and operate businesses or bring that sensibility to the stock market. It’s not a direct disagreement, but a point to emphasize the difference between the two worlds. The continued popularity of buybacks—to the tune of $800 billion or so per year for the S&P 500 Index companies—suggests that most investors may not care about the difference (or even prefer companies using excess cash to play the market.) But the dividend investor in a stock market does care. He or she owns the stock for the income stream and its trajectory, not for management’s possible secondary competency in stock market operations.

The second main point of contention concerns capital gains and dividend payments. The calculation of total return requires that they be treated equally. That’s as it should be. But from my perspective, there needs to be an enormous Roger Maris-asterick in this exercise. While a paid dividend can be consumed or reinvested, a capital gain cannot. It is inert, stuck on your screen or on your brokerage statement, as a green number. That’s delightful and may be very satisfying, but it can’t be consumed or reinvested elsewhere until it becomes “harvested.” And as was the case with buybacks, the harvesting of a capital loss or gain is a market outcome, not a business one.

The distinction becomes even greater once you consider the nature of success in the stock market. Isn’t a capital gain the point of the exercise? But a capital gain is a peculiar form of winning: it requires that you sell the asset in order to benefit from it. To be fair, turning the inert capital gain (or loss) into something that can be consumed or invested elsewhere is generally doable from 9:30am to 4pm during the workweek. Still, it’s a strange way of defining achievement.

Perhaps due to that relative ease of selling assets when needed, and assuming minimal transactions costs, the classroom exercise makes no such distinction between the two forms of return or success. For the academics, a green number is a green number is a green number.

In contrast, for the business investor, a green number on a screen is not the same as a cash payment. While the former is contingent, the latter is not. Indeed, a sustainable and usually rising dividend from an on-going enterprise is an unambiguous sign of success. (Dividend investors do look for and expect capital appreciation resulting from dividend growth over time. And market movements create opportunities for the dividend investor to trim appreciated stocks (lower yields) and reinvest the proceeds in other assets (higher yields) to augment the organic growth of income from a portfolio.)

Taxation is the third challenge to being a dividend investor in a stock market, and the most vexing. It is also the easiest to highlight the conceptual difference. That’s because the only material tax differential is one of timing: Capital losses and gains can be timed by those in the position to plan their consumption or other investments. In contrast, dividend payments are subject to taxation upon payment. In a taxable brokerage account that is lightly traded, the tax liability between a high dividend portfolio and a low yielding one may be material. There is no denying that scenario. But my stance is simple: subordinating investment policy to tax minimization is a choice, not a necessity. In the end, as a business investor, I’d rather stick to a defined investment discipline, appreciating the benefits and possible demerits, including the taxing of returns, of such a strategy.

For many investors, minimizing tax payments is their investment policy. And in these highly politicized times, it can be less an investment policy than just a strongly held view of the role of government. That too is fine. Let’s just not conflate not wanting to send any money to Uncle Sam with investment policy. Blaming companies for having dividends or avoiding those that do when what you really care about is the taxman says more about you than it does about investment.

Finally, there is the obvious matter of business ownership vs. renting stocks. During the internet bubble, individuals were famously challenged to say what their holdings actually did. That extreme case is less frequently encountered now. Most investors holding meme stocks have some notion of what the companies do. Instead, the philosophical distinction is deeper. Does the investor consider themselves an owner of the company or just a renter of stocks looking for relative total return over the next year or two. The former has all sorts of implications—proxy voting, being at peace with the agency costs (as a minority shareholder, you don’t get to call the shots) of modern capitalism, etc. The latter involves no involvement, intellectual or other. You are there for the stock to generate some attractive total return and care little about how it gets there.

I’ve been told to my face by one particularly energetic index investor—a prominent finance professor, not surprisingly—that he had no interest whatsoever in ownership. He just wanted passive exposure to the market and that was it. We agree on one thing: there is a distinction. He’s on one side of the issue; I’m on the other.  They are differences of intent, not finance.

There have been other objections to the assertions made in The Ownership Dividend, but the four above have occupied most of the airtime. The others are less material. One is borderline absurd. The objection that dividend payers are unattractive because they have run out of growth opportunities is just intellectually lazy. The nearly $1 trillion—yes, trillion—dollars of buybacks annually from S&P 500 Index companies make a mockery of companies claiming they can’t pay material dividends because they need to invest in their businesses. We won’t dignify that objection any further.

In essence, for each of these instances, there aren’t really right or wrong answers. Instead, there are strongly held preferences that supersede the directives to achieve relative total return (including non-harvested capital gains) in short periods of time. For that objective for the past four decades, but especially for the past 15 years, there’s been only one way to go: non or de minimis dividend paying “growth” companies. Full stop. The point of The Ownership Dividend has been to point out how unusual that outcome was, and why the environment that produced it has changed.

In ten years, we will know for sure. In the meantime, the segmenting of the market options and market participants allows most everyone to get what they want, more or less. But the pendulum has swung too far in the direction of the market being a nearly cashless investment platform. It will swing back towards the middle for a more balanced offering of (cash-based) risk and (cash-based) return.

In the meantime, do keep in mind the tales that you are told. Modern academic finance is a product of its time—the 1950s and 1960s fundamentally, with further refinements in subsequent decades. It is good solid technology from more than half-century ago designed to explain and counter what happened during the Great Crash and try to avoid it in the future. And to get us to a Jetson’s-like society through better algorithms. That system remains excellent for teaching. It’s very hard to teach or operate in a complex endeavor without some sort of equilibrium belief system. On a much bigger and more important scale, organized religion serves the same need to bring some semblance of order to the otherwise challenging spectacle of human existence. And as in the case of religion, a little humility goes a long way to offset the arrogance of excessively formulaic approaches to human behavior.

Comments & rebuttals welcome.