The Perfect Company Does Not Pay Dividends — The Mathematics of Reinvestment
February 27, 2024
12 min read
The Perfect Company Does Not Pay Dividends
Dividends are important — but it is necessary to understand the concept. Maximising your profits does not depend on investing in companies that pay high dividends. The perfect company does not even pay dividends. Why? Because of simple mathematics. Our original analysis for The Market by NZZ plus the extended investor's view on the reinvestment asymmetry and the dividend income growth strategy.
In 30 seconds — the core thesis
- Dividends give a false sense of security — «It's no problem if the stock falls by 30%, I still get my 3% dividend». This emotional reassurance blocks mathematical thinking. High-dividend strategies are mostly marketing stories, not efficient investments.
- The 60/240 mathematics — at a 40% payout ratio and 4× price-to-book, $40 of dividends after 30% tax become $28, while $60 of retained earnings become $240 of shareholder value. At 100% reinvestment it would even be $400. That's simple mathematics.
- The only sensible dividend strategy is the dividend income growth strategy (aristocrats 25 years, kings 50 years). Focus on growth rate, not yield. Visa — an arvy portfolio position — has increased its dividend 15 years in a row by 26% annually since its 2008 IPO, delivering around 14% return on the original investment today.
The original analysis — the opening
Compound interest is the eighth wonder of the world.
— Albert Einstein, theoretical physicist (1879-1955)
Dividend season begins. Dividends have never been a characteristic of a company that has piqued my interest. Yet, after more than a decade in the financial industry, I am still amazed at how much dividends fascinate the investment community. There seems to be something so alluring about dividend income that it often tempts investors to disregard common sense — or be encouraged to do so by the investment industry.
Dividends or income strategies are not important to me as a stock investor. Why? For simple mathematical reasons.
→ Read the full analysis with all charts on The Market by NZZ
Chart 1: The compounding effect of reinvested dividends
Source: FactSet, J.P. Morgan Asset Management, Data as of 31/12/2023
01The false sense of security of dividends
How many times have you heard that most returns from equity investments are achieved by reinvesting dividends? This thesis is usually illustrated with charts showing the difference between indices with dividends paid out (distributing) and indices with dividends reinvested (accumulating). The latter delivers significantly higher returns over a long period of time. Dividends are important — but the concept behind them is decisive.
One statement Thierry hears very often is emotional and problematic: «It's no problem if the stock falls by 30%, I still get my 3% dividend.» The dividend gives a sense of security — no matter what happens, the 3% will come. That's psychological reassurance, not mathematical analysis.
But why do investors want regular dividend income at all? In retirement you need money to spend — that's clear. But why does it have to come from dividends? Isn't the right approach to invest in a way that maximises total return? After all, you can also sell the stocks you need for your expenses. The dividend preference seems to be a psychological hurdle: the investor wants a bird (dividends) in the hand as it is worth two in the bush (an unknown total return).
High-dividend ETFs — why they are dangerous
Thierry's clear position in the original: the exclusive focus on stocks with high dividend yields (e.g. >3%) gives a false sense of security. Three structural problems: (1) Many holdings are from low-growth sectors with structural challenges — banks, utilities, telecom, energy, automotive — that distribute most or all of their cashflows as dividends because they have almost no long-term growth sources. (2) Earnings power often isn't sufficient to keep the payout level high long-term, leading to exposure to highly indebted companies and often dividend cuts down the road. (3) Strong focus on individual sectors and countries creates cluster risks that also mean increased risks in turbulent times.
Two conclusions from this:
First: dividend or income strategies are primarily marketing stories rather than efficient and ultimately good investment opportunities. The investment industry markets them heavily — they sound safe, they feel concrete. But mathematically they are mostly suboptimal.
Second — and this is important: the only way to focus sensibly on dividend strategies is the so-called dividend income growth strategy. It focuses on companies with high quality and solid balance sheets that can increase their dividends annually — becoming dividend aristocrats after 25 years or even dividend kings after 50 years. The focus is not on dividend yield, but on the growth rate.
The Visa example — arvy portfolio position
A solid but not obvious example of the dividend income growth strategy is Visa, an arvy portfolio position (at the time of the original article). The company started paying a modest dividend immediately after its 2008 IPO. Over the years, the annual growth rate of this dividend was 26% — and the dividend was increased 15 years in a row. Investors who bought shares when Visa paid its first dividend would today realise a return of around 14% on their original investment. 15 years may seem long — but arvy invests long-term. If this time horizon seems too long, equities may not be the right choice for you anyway.
02The most efficient way to grow your capital
The core question: what should management do with the free cash flow generated? It has five options:
To grow shareholder capital, the most efficient path is when management chooses options 1 and 2 — invest in the own business or make (preferably smaller) acquisitions. What matters is that the return on invested capital (ROIC) is higher than the weighted average cost of capital (WACC). Only then does shareholder value emerge.
If the company pays out a dividend, it no longer has this capital for options 1 or 2. That's a less efficient way to grow shareholder capital. Why? Let's do the math.
The mathematics: $40 dividend vs. $60 retained earnings
Today, the average company in the S&P 500 has a payout ratio of 40%. A typical company generates a profit of $100 and pays $40 as a dividend. The $60 stays in the company. The current price-to-book ratio of the S&P 500 is at 4. For private investors: dividends are subject to income tax — let's assume 30% for the calculation.
The reinvestment asymmetry
$40 dividend vs. $60 retained earnings — the comparison
Path A — Distributed
Dividend → reinvestment
$40
Income tax (30%)→−$12
Available after tax=$28
Reinvested at 4× book value→purchasing-power loss
+ Transaction & opportunity costs−further costs
Effective shareholder value
~$28
Path B — Retained
Internally reinvested
$60
No double taxation→$60
Reinvested at book value→100% capital
Shares trade at 4× book value×4market-value lever
Shareholder value from reinvestment=60 × 4
Effective shareholder value
$240
The extreme variant
At 100% reinvestment: $100 → $400 shareholder value. That's the arithmetic of compound interest.
Eye-opening, isn't it? The mathematics is not subjective — it's universal. $60 retained and internally reinvested produces $240 of shareholder value. $40 paid as dividend yields $28 after tax, which you must reinvest at a much higher price (4× book value), with transaction costs and opportunity costs. The asymmetry is structural, not coincidental.
The Swiss tax disadvantage — even stronger than in other countries
In Switzerland, dividends are subject to income tax (capital gains for private investors are typically tax-free). This tax asymmetry further reinforces the mathematical superiority of retained earnings for Swiss investors. Those who primarily rely on dividend strategies here work against two levers simultaneously: the reinvestment asymmetry and the Swiss tax regime. Most financial advisors don't mention this point — it contradicts dividend-product sales.
03The magic of compounding — three companies compared
This effect can be greatly enhanced by focusing on the most important task of a CEO, as Warren Buffett made clear in his 1979 annual letter: capital allocation.
Have you ever wondered why the most successful companies such as Alphabet, ASML, Berkshire Hathaway, Hermès, Microsoft and Visa do not pay dividends, or only a small amount? Because they can reinvest their cash flow into their own business at high returns. They leverage structural growth markets and market leadership to deploy their retained capital efficiently and profitably. If we as investors manage to find such companies, they must not pay a dividend. Paying a dividend would only impair the magic of compound interest.
For illustration, Thierry's three-company simulation over 20 years, starting value $100:
A
The perfect company
ROIC18%
Dividend0%
Reinvestment100%
B
The average company
ROIC18%
Dividend40%
Reinvestment60%
C
The weak company
ROIC6%
Dividend0%
Reinvestment100%
The simulation dramatically shows the difference. Company A — high ROIC, 100% reinvestment — maximises the compound-interest effect. Company B — same ROIC but 40% dividend distribution (not reinvested) — delivers significantly less end value, although operational quality is identical. Company C shows the flip side: even 100% reinvestment doesn't help if ROIC is too low (below WACC). The capital-allocation logic is only valuable when ROIC stays above cost of capital.
If a business earns 18% on capital over 20 or 30 years, even if you pay an expensive-looking price, you'll end up with one hell of a result.
— Charlie Munger (paraphrased), long-time business partner of Warren Buffett
Charlie Munger — whose 6%-vs-18%-ROIC numbers Thierry directly used in the simulation — formulated the core thesis: over the long term, a stock can hardly earn a much better return than the underlying business itself. 6% ROIC over 40 years → about 6% annual stock return. 18% ROIC over 20-30 years → excellent result even at expensive-looking entry prices. That's the arithmetic of compound interest — and a characteristic of equities that no other asset class offers. Bonds and real estate deliver interest or rent — but not automatic reinvestment at high returns.
The decisive caveat
This mathematics only works with two conditions: (1) Management must have a good track record reinvesting profits. Not every CEO masters capital allocation — some destroy value through poor M&A, excessive expansion, or prestige projects. (2) The return on capital must remain consistently above the cost of capital (ROIC > WACC). When both conditions are met, compound-interest mathematics works relentlessly in the investor's favour. When not, it becomes a trap — as with Company C. That's why selection is so decisive.
04What this means for your portfolio
The operational translation of the mathematics into portfolio practice. Four concrete steps:
| Implication | What to do |
|---|---|
| 1. Shift focus — from dividend yield to reinvestment quality | The relevant question is not «how high is the dividend?», but «how well can management reinvest the retained capital?». That means: ROIC analysis before dividend-yield analysis. ROIC above 15% with consistent history is a strong signal — dividend yield above 5% is often a warning signal for lacking reinvestment opportunities. |
| 2. Critically examine high-dividend ETFs | Check the sector distribution in every high-dividend ETF. If banks, utilities, telecom, energy, and automotive dominate, it's structurally a low-growth portfolio. Check cluster risks in individual sectors and countries. Often a broadly diversified total-return approach is better than a dividend strategy. |
| 3. If dividends, then growth-focused | Not dividend level, but dividend growth. Dividend aristocrats (25+ years) and kings (50+ years) are the relevant categories. Visa as arvy's example: small dividend, but 26% annual growth over 15 years — delivers 14% yield on original investment today. That's the logic that works. |
| 4. Consider the Swiss tax lever | For Swiss private investors: capital gains are typically tax-free, dividends are subject to income tax. This asymmetry makes capital-growth-focused strategies even more tax-attractive than international comparisons suggest. When uncertain: consult a tax advisor. |
Further arvy companions deepen adjacent topics: The Tortoise Problem as pillar on quality investing, Winners Keep Winning on the persistence of first-class business models, and Good Story & Good Chart as flagship on the arvy investment philosophy — including FCF-yield valuation discipline.
05The perfect company doesn't exist — but excellent ones do
The magic of compound interest only works if you invest in companies that can reinvest their cash flows at high returns. So you must find winners that keep winning and hold them long enough — years, if not decades, to fully enjoy the compound-interest effect. Easier said than done. And there is no perfect company.
Although perfection is not attainable, we can chase it and catch excellence.
— Vince Lombardi, NFL coaching legend, Super Bowl winner 1967 with Green Bay Packers
Vince Lombardi — NFL coaching legend who won the first Super Bowl in 1967 with the Green Bay Packers, and whose name the Super Bowl trophy has borne ever since — formulated the principle clearly: perfection isn't attainable, but excellence is. For the investor this means: we will never find a perfect company, but we will be able to find an excellent one. That's enough to capitalise on the eighth wonder of the world.
The operational discipline derived from this: apply quality selection rigorously (five criteria of a Good Story), hold ROIC > WACC as a hard filter, examine management's capital-allocation track record, hold long-term, don't fall for the dividend illusion. This isn't spectacular. It's methodical. But over 20-30 years of compound effect it's structurally decisive — exactly as the Visa case shows.
What disciplined investors do
They prioritise ROIC quality over dividend level. They understand that the 60/240 mathematics is structural, not coincidental. They accept that «bird in the hand» dividends are often an emotional reassurance that's mathematically expensive. They seek companies that can reinvest their capital with ROIC > WACC — Alphabet-, ASML-, Berkshire-, Hermès-, Microsoft-, Visa-type businesses. They hold long-term so the compound-interest effect works. They don't let the investment industry sell them high-dividend marketing stories. When they use dividend strategies, they go growth-focused. This discipline delivers structurally superior results over decades — because compound-interest mathematics works relentlessly for those who understand it. As Einstein put it: the eighth wonder works for some, others pay for it.
06Frequently asked questions
Are dividends always bad?
No — Thierry's position is nuanced. Dividends make sense when the company has no reinvestment opportunities with ROIC above WACC. Then a dividend is better than unprofitable reinvestment. The problem arises when dividends are used as the primary investment criterion — then one often selects low-growth sectors. The perfect company is one that can reinvest all profits internally at high ROIC. Few exist — but they do.
What about share buybacks?
Share buybacks are more tax-efficient than dividends (no immediate income tax), but they have similar structural problems — the capital leaves the operational business. They make sense when the stock trades below intrinsic value. They are problematic when management uses them as a substitute for organic growth. Thierry's preference remains clear: internal reinvestment with ROIC > WACC is the first choice. Buybacks are option 4 of 5 — below internal investment and acquisitions.
Does the Visa logic only work for technology businesses?
No. The logic applies to any quality business with structural growth and high ROIC. Hermès for example is not a tech company, pays a small dividend, but reinvests extremely disciplinedly in production capacity and brand capital. Berkshire Hathaway doesn't pay any dividend — Buffett reinvests everything. The pattern is sector-agnostic as long as ROIC > WACC is structurally maintained.
How does arvy apply this philosophy concretely?
arvy follows the quality focus with ROIC->-WACC discipline as central selection criterion. Visa was a portfolio position at the time of the original article (February 2024). The current position distribution, sector allocation, and transparently documented sales you find in the arvy Quarterly Report Q1 2026.
Is this a recommendation against all dividend stocks?
No. The original closes with the acknowledgment: «there is no perfect company». Many excellent businesses pay moderate dividends and reinvest most profits internally. The critique targets the exclusive focus on dividend level as investment criterion — especially in high-dividend ETFs. The dividend income growth strategy remains a sensible niche when growth rate rather than yield level is the focus.
Further reading — the thematic anchors of this analysis
The arithmetic of the eighth wonder
Einstein is said to have called compound interest the eighth wonder of the world — those who understand it earn it, those who don't pay for it. The mathematics is brutally clear: $40 paid as dividend become $28 after Swiss tax, reinvested at a market price that's four times book value. $60 retained earnings, on the other hand, produce $240 of shareholder value. At 100% reinvestment even $400. This asymmetry is structural, not coincidental — it's the arithmetic of the eighth wonder applied to equities.
What separates disciplined investors from average ones is not superior market forecasting or higher IQ. It's the willingness to see through the emotional pull of «3% dividend safety» and accept the mathematical reality. Companies like Alphabet, ASML, Berkshire Hathaway, Hermès, Microsoft, and Visa pay little or no dividends — because they can reinvest their profits at ROIC above WACC. That's no coincidence, that's compound-interest mathematics in action. Investors who understand this and implement it consistently build wealth over decades that's unreachable through any dividend ETF. Investors who lose themselves in high-dividend marketing stories pay for the eighth wonder — rather than earning from it. A perfect company doesn't exist. But excellent ones do. And excellent is enough to capitalise on the eighth wonder. The choice is personal. The mathematics is universal.
Original written by Thierry Borgeat, Co-Founder of arvy, for The Market by NZZ. The extended arvy companion piece reviewed by Patrick Rissi, CFA and Florian Jauch, CFA. All reinvestment calculations follow the original methodology (S&P 500 payout ratio 40%, price-to-book 4×, Swiss income tax 30%). Visa is cited as an arvy portfolio position at the time of the original (February 2024); current positions in the quarterly report. Last updated: April 2026.
Disclaimer: This article is for general educational purposes and does not constitute personal investment advice. The Swiss tax assumptions are illustrative — individual situations vary, consult a tax advisor when uncertain. arvy is a FINMA-supervised asset manager with a CISA licence (Art. 24). Imprint & Legal Notice.
