Homemade Dividends

What Are Homemade Dividends?

Homemade dividends are a form of investment income generated from the sale of a portion of an individual's investment portfolio. These assets differ from the traditional dividends that a company’s board of directors distributes to certain classes of shareholders.

Understanding Homemade Dividends

The ability of investors to create their own homemade dividends has provoked questions about whether traditional dividends offer real value. Some investment experts argue that since a stock price will decrease by exactly the amount of the dividend on its ex-dividend date, it neutralizes any financial gains.

This idea sits at the crux of the dividend irrelevance theory, which claims that investors fundamentally do not need to pay heed to a company's dividend payment policy, since they retain the option of selling off portions of their equity portfolios, should they ever need to generate cash. Naysayers of this theory counter-argue that when an investor sells a portion of their portfolio, they end up with fewer shares, which consequently results in a depleted asset base, despite any short-term monetary gains they may enjoy.

Economists Merton Miller and Franco Modigliani were among the first voices to espouse the irrelevance of corporate dividends when they publicized their theories in the early 1960s.

Traditional Dividends

As noted, a company’s board of directors is charged with the responsibility of declaring dividend payouts to shareholders. Following the declaration date, the company establishes a record date to determine which shareholders are eligible to receive distributions. The ex-dividend date, which occurs precisely two business days before the record date, denotes the final day a seller is still entitled to collect dividends, even if they have already sold their shares to a buyer.

Normal dividends typically occur on a regular monthly or quarterly basis, while extra or special dividends are one-time distributions. Generally speaking, a company's board declares special dividends after witnessing exceptionally strong earnings results or when a company seeks either to materially change its financial structure or to spin off a subsidiary company.

Companies with sector exposure to basic materials, oil and gas, financials, healthcare, pharmaceuticals, and utility concerns historically produce the highest dividend yields. Furthermore, companies structured as master limited partnerships (MLPs) or real estate investment trusts (REITs) are also top dividend payers, because these companies are typically mature and they exhibit stable cash flows.

In contrast, start-ups and other high-growth companies, such as many technology plays, seldom offer high dividends. These companies usually prefer to reinvest any earnings they make into research and development or to the expansion of operations.