Meta enters the dividend multiverse of madness

Metafinancial engineering. One of the world’s most inventive companies just enlisted a centuries-old financial confidence trick. Just ahead of its 20th anniversary, Meta Platforms said last week that it would start paying a quarterly cash dividend to shareholders. The recipients of the money pushed the market value of Facebook’s owner up by 20% the following day, perhaps considering the decision a symbol of financial discipline. They should, however, see it for what it is: a distraction.

Meta’s dividend places the social media giant led and controlled by Mark Zuckerberg in a storied group. The habit of returning regular cash to investors, initiated by the Dutch East Indies Company more than 400 years ago, is a staple at over 85% of the world’s publicly traded companies worth more than $10 billion, according to LSEG data. It’s easier to single out those that don’t, including big technology outfits Alphabet and Amazon.com, than those that do. Dividends are popular and becoming more so: Morningstar analysts count $1 trillion of funds targeting dividend payers, a number that has increased 10% annually since 2018. Companies that hike their payouts for 25 consecutive years, longer than Meta has existed, are knighted as “aristocrats” by S&P Global and slotted into their own index of nobility. As of January, there were 67 of them.

Dividends have simplicity on their side. They’re clear-cut and equitable, since all holders of regular shares get them in proportion to their economic stake. But just because something is common or coveted doesn’t make it smart. In practice, dividends provide zero value for shareholders. For some, they’re worse than being given no cash at all, and for tax reasons are often less appealing than other ways companies can distribute funds, if they decide they have no better use for the money.

Nothing from something

In a very straightforward sense, dividends don’t give investors anything they don’t already own. If a company pays $1 in cash to its investors, the value of what’s left, which is represented by its share price, should fall by exactly $1. This makes dividend payments a very different proposition from, say, interest paid on a bond. An investor that wants to wring cash from backing Meta could simply sell a fraction of a share every three months. Once, that would have been complicated. Now it’s not: brokerages including Robinhood Financial and Charles Schwab let U.S. customers offload slivers of shares without fees or commissions.

In the real world, receiving dividends can prove worse than no payout at all. The typical U.S. investor gives up to 20% of what they receive to Uncle Sam in taxes if they’ve held the stock for more than a couple of months. If they instead sell shares to generate cash, a similar tax rate is applied, but only to the capital gain achieved since the original purchase. Assuming they eventually sell their entire holding, the tax paid should even out. But investors who manufacture dividends themselves would have chosen exactly when to pay, and deferred some of the cost. For the many foreign investors who pay higher tax rates on income than capital gains, dividends are positively punitive.

The question then is why investors like dividends at all. It’s hard to find a rational answer. Samuel Hartzmark and David Solomon at Boston College Carroll School of Management concluded that one reason is a logical disconnect: investors simply don’t grasp that dividends reduce the value of the companies paying them. Instead, they act as if dividends and share-price performance exist in parallel universes. Indeed, the herd-like quest for dividends, say when interest rates are low, could lead to valuation distortions that shave 4% off investors’ returns over a one-year period, the study estimated.

Even investors who do understand the mechanics may just like the idea of having extra money in their pockets. They are more likely to spend dividends than job income on non-recurring purchases, a study by German and Austrian scholars found, further supporting the idea that dividends are seen as free money.

Not all investors have fallen under the spell, including some famously old-school ones. Warren Buffett has resolutely distanced his Berkshire Hathaway from the cult of the dividend. He prefers stock buybacks, which allow him to exploit perceived low prices in his conglomerate’s shares. Yet Buffett also invests in plenty of companies that pay dividends, and says he likes it when those payouts rise, suggesting that even the Oracle of Omaha is not immune to their logic-defying allure.

Something from nothing

From a company’s perspective, dividends make more sense. For one, they are financially a little more appealing than buybacks. President Joe Biden approved a tax on stock repurchases in 2022, based on the dubious notion that companies would therefore invest more in their operations and employees. He later said he hopes to quadruple the levy’s rate to 4%. Dividends may also be slightly cheaper to administer than buybacks since they eliminate any investment banking fees for scooping up shares in the market.

Furthermore, if investors stick with their dividend fetish, it’s perfectly rational for chief executives like Zuckerberg to take advantage. Paying a dividend could allow Meta shares to be included in mutual and exchange-traded funds that only hold shares in companies making regular payouts. Such funds buy 0.5% of a company’s outstanding shares the year after it initiates a dividend, Goldman Sachs analysts have found. The Wall Street bank, in a report published on Monday, cites data suggesting that debuting a regular payout can push a stock’s price up 2%, while missing a dividend payment can wipe out 9% of a company’s market value.

Ultimately, the main appeal of dividends is that they’re a signal: the company paying them is saying it thinks its earnings will support a regular stream of cash, and that it will have one eye on its shareholders even as it invests in future projects. That might explain Meta’s decision to offer $5.3 billion a year in payouts at the same time it is earmarking up to $9 billion more investment this year than last, mainly on servers and data centers.

There’s a big danger in confusing correlation with causality, however. Stable, responsible and steadily growing companies pay dividends, which means that such stocks in aggregate might indeed outperform other securities. It doesn’t mean that the dividend itself makes a company a better investment. Considering Meta is renowned for shaking up the status quo, its payout is strangely off-brand. And yet to become a social media powerhouse requires a full understanding of how emotion regularly trumps logic, making the tech giant a perfectly sensible entrant to the dividend multiverse of madness.