Robert Arnott, polymath extraordinaire, has done quite a bit of work in this area and may not wholeheartedly agree with the author, links below.
I personally believe that managers contribute alpha via capital gains but as I said in "New York Guano":
A subject near and dear to my heart. I may be the only person I've ever met who read every page of The Cowles Commission's Common Stock Indexes 1871-1937.which showed the value of divi's.
[you must be a blast at parties -ed]
From Legg Mason Capital Management's 'Mauboussin on Strategy':
...These data put the lie to the conventional view that equities derive most of their returns from capital appreciation, that income is far less important, if not irrelevant.
-Robert D. Arnott and Peter L. Bernstein
What Risk Premium Is “Normal”?
Price Appreciation (Not Dividends) Is the Key to Accumulating Capital
Corporate earnings have rebounded smartly, operating profit margins are high, balance sheets are flush, and equity returns over the past decade have been punk. It’s no wonder that investors have zeroed in on dividends as a means to boost shareholder returns. A bird in the hand, the thinking goes, is worth two in the bush.
An investor’s goal is to accumulate capital over time. Investing at its core is the act of forgoing current consumption in order to satisfy future liabilities or to consume more down the road. If capital accumulation is the prime objective, investors must think clearly about what builds capital. Unfortunately, there seems to be a great deal of confusion over the topic, much of it surrounding the role of dividends.
If you listen to the press or read missives from investment firms, you might conclude that dividends play a prime role in capital accumulation. In fact, well-known strategists have pointed out that dividends have accounted for 90 percent of equity returns over the past century. This statistic is potentially very misleading and warrants further examination. Here’s the ending without the plot: price appreciation is the only source of investment returns that increases accumulated capital over time. The cause of the confusion is that analysts do not distinguish between the equity rate of return and the capital accumulation rate. Depending on the choices of the shareholder, the rates can be very different. Understanding the distinction is essential for assessing past results and for thinking about satisfying future financial obligations.
Equity Rate of Return Versus the Capital Accumulation Rate
The equity rate of return is simply price appreciation plus the dividend yield. If you assume capital appreciation of 7 percent and a yield of 3 percent (not too far from the averages for the S&P 500 Index since World War II), the equity rate of return is 10 percent [0.07 + 0.03]. The equity rate of return is an ex-post figure and is conceptually equivalent to the ex-ante cost of equity capital.
However, investors and researchers generally compute equity returns using the concept of total shareholder return (TSR). The simplest calculation of TSR has two components, the annual price appreciation rate (g) and the dividend yield (d). 5 You can express TSR as follows:
TSR = g + (1+ g)*d
For example, if you assume that g is 7 percent and d is 3 percent, then the TSR is 10.21 percentHT: Simoleon Sense, which has a couple solid ref's in its intro.
[0.07 + 1.07*.03]. TSR equals the investor’s capital accumulation rate only when all dividends are reinvested back into additional shares of the company. So the difference between TSR and the equity rate of return is dividend reinvestment. As we will see, this reinvestment makes a meaningful difference in ending capital balances over time. In fact, the capital accumulation rate can be well below the equity rate of return if a shareholder decides to consume rather than reinvest dividends.
The assumption of full dividend reinvestment is rarely valid in practice. Mutual funds collect and reinvest the dividends from the companies that they own, but they have latitude in how they reinvest them. In addition, there is no evidence that dividends from a particular company are reinvested back into that company’s stock dollar for dollar. So within a mutual fund portfolio, returns for an individual stock can deviate from TSR because not all dividends are reinvested on a prorated basis.
While most mutual fund investors elect to reinvest their dividends and capital gains back into the fund, they are notorious for buying after a run up in the market (or in the fund) and for selling after a tumble. As a consequence, individual investors do worse than the funds in which they invest despite the fact that most reinvest while they do own the fund. 6 So a fund’s TSR, as well as the TSR’s of the stocks within the fund, bear little relation to the rate at which investors actually accumulate capital.
The story is even less optimistic for individual investors. Estimates suggest that investors who directly own individual stocks reinvest less than 10 percent of the dividends they receive. This is in spite of the fact that most companies offer a dividend reinvestment program at little or no cost.
As a consequence, individual shareholders rarely earn the TSR for a stock. Even though financial planners widely use past TSR’s as a basis for considering future returns, the fact is that very few institutions or individuals actually earn the TSR.
Let’s take a step back and analyze a shareholder’s choices when a company pays a dividend.
We’ll assume a $100 stock price and a 3 percent dividend yield.
Before dividend payment: $100 stock
After dividend payment: $97 stock + $3 dividend 7
- consume (i.e., spend)
Alternatives for the dividend: - reinvest back into the company’s shares
- reinvest in some other investment
A shareholder can select these alternatives individually or in some combination, and what a shareholder does with her dividends reflects her consumption needs (need for money now versus later). If she consumes, it is clear that the price appreciation of the stock is the only source of returns. If she reinvests her dividend, she is maintaining the amount of her capital committed to the stock and behaves as if the stock remains an optimal investment based on anticipated price appreciation. Superior expected price appreciation would be the basis for investing elsewhere.
Not all investors can reinvest 100 percent of their dividends. We can calculate the capital accumulation rate by reflecting the percentage of dividends that shareholders reinvest through the variable, r....MORE (9 page PDF)
We linked to one of the 90% studies, "BlackRock Says: "Dividends Make Up 90% of Total Return"'.
What Risk Premium Is “Normal”?
Up and Down Wall Street: Rob Arnott "After Lost Decade, It's Still Tough to Find Returns "
Equity Risk Premium: "Why the market’s rate of return—and your nest egg—may never recover"