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| Dividend Growth Investing FAQ |
Q: What is a dividend?
A: A dividend is a payment by a company to its shareholders. It is usually in cash, although
occasionally the payment is made by handing out more shares. Dividends come from the
company’s profits. Dividends are a way for a company to direct positive returns to shareholders
so that they can share in the success of the company.
Q: Do all companies issue dividends?
A: No, but many do. It is up to each company's management and board of directors whether to
distribute dividends. Those individuals also decide the size, frequency, and increases in
dividend payments. Decisions about dividends are strategic decisions every company makes
regarding the best allocation of its profits.
Q: What kinds of companies issue dividends?
A: Dividend-paying companies can be found in every sector of the market, although some
industries are “famous” for paying dividends (e.g., utilities, energy companies, financials, and
pipeline companies). But at least a few companies in every industry pay dividends. It is easy to
construct a well-diversified portfolio of dividend-paying stocks. The diversification benefits
include globalization, because many foreign companies pay dividends, and most American
dividend-payers have international operations.
Q: Why would I want dividend stocks?
A: Two main reasons. First, studies show that over very long terms, dividend stocks have had
the best total returns of any category of stocks on the market. Second, dividends provide a
reliable, growing stream of income. You can do anything you want with it: re-invest it, keep it, or
spend it. I call dividends "stocks' secret weapon."
Q: Aren’t dividend stocks only for retirees?
A: No. That’s an unfortunate misconception.
As mentioned above, dividend stocks have the best historical long-term returns of any stocks—
better than technology, financial, and consumer stocks, to name a few. This may seem non-
intuitive, since technology stocks, for example, are normally associated with powerful growth.
But it turns out that steady growth, when combined with regular dividend increases and the re-
investment of those dividends, is even more powerful over long terms. The dividend-growth
strategy gives you two layers of compounding: (1) The growing dividends themselves, plus (2)
the reinvested dividends. The latter purchase more shares, which generate more dividends,
which buy more shares, etc. It’s a virtuous circle.
The compounding effect of growing dividends and reinvestment is how dividend stocks
generate their market-beating returns. Of course, the dividends can be kept and spent. That’s
generally what retirees do with them. But younger people—in the “accumulation” phases of
their lives—can benefit greatly from the compounding returns available from re-investing the
dividends from their stocks.
Q: How often are dividends paid?
A: Quarterly payments are most common, but some companies pay monthly, and a few pay
semi-annually or just once per year. Occasionally companies declare “special dividends,” which
are one-time events. Most companies, though, settle on a consistent schedule of quarterly
dividend payouts and stick to it year after year. Companies headquartered overseas often
have semi-annual or annual payout schedules, rather than the quarterly schedules most
common in the USA.
Q: How do I buy dividend stocks?
A: Dividend stocks are bought and sold just like other stocks. The fact that they pay dividends
does not separate them from the regular brokerage system.
Q: Are dividends safe?
A: The quick answer is yes. That said, it must be noted that dividend-paying companies come
in all shapes, sizes, industries, etc. All stocks are subject to market risk. Before buying any
stock, you should do your due diligence. Analysis of the company’s business model, history,
financials, and the like is mandatory before buying any stock. It is not unknown for a company
to freeze or cut its dividend. That said, more than 100 companies have raised their dividends
every year for more than 25 years, and more than 450 companies have done it for more than 5
years. And of course, once a dividend has been sent to you, the company cannot take it back.
Q: What qualities do the best dividend stocks have?
A: The top four qualities are these:
- (1) Consistency and safety of the dividend. You can evaluate this by checking the
company’s history of paying dividends, the regularity of payments, whether the company
is in any difficulty that might imperil the dividend, how much it will be impacted by cycles
in the overall economy, and similar factors.
(2) Consistent dividend increases. Some companies have raised their dividends like
clockwork for many years, even decades. To maximize your returns, you want a company
that will regularly raise its dividend, not freeze it or cut it. The company’s dividend history
is instructive here. There are plenty of reliable dividend-raising companies to choose
from.
(3) Initial yield. The yield of a stock is its dividend expressed as a percentage of the
price you paid: Dividend ÷ Price = Yield. It’s like the APY of a bank account or CD.
Dividend yields can vary from 0% (no dividend) to 20% or more. Many stocks have yields
in the 1% to 5% range. As an investment proposition, a yield as low as 1% is probably
not worthwhile, even if the company is growing it regularly. At the other end of the scale,
a yield as high as 15% or 20% might indicate an unsustainable situation.
(4) The potential for the stock to appreciate in price. Along with the dividend, you
want your stock’s price to go up too. Then your total return each year = price increase +
dividends. So you want to buy high-quality companies at reasonable prices, because
those are the most likely to go up in price over the long haul.
Q: Aren’t the stocks with the highest yields automatically the best dividend stocks?
A: Not necessarily. It’s easy to find lists of the highest-yielding stocks, or to generate such lists
by using simple stock screening tools. Some firms use such lists as “teasers” to entice
unsophisticated investors. They use headlines like “Highest Yielding Stocks Revealed” or “Wall
Street’s Secret Stock That Pays You 18%!” as if there were some magic to it. Such ads are for
suckers. You can find those stocks on your own in two minutes.
The problem with really high yields is that they often are not safe. There are just two ways a
yield can get really high: (1) If the price of the stock plummets, so the divisor in the equation
Dividend ÷ Price = Yield gets really low, that will result in a high yield. (2) If the company pays
out practically all (or even more than all) of its profits in dividends, that can produce a high yield.
In the first instance, the price of the stock plummeting may be a good thing (the market is
temporarily undervaluing a really good, solid company), or it can be a very bad thing (the
company is in trouble and investors are fleeing its stock). You cannot know which it is without
doing your own research and due diligence.
In the second instance, clearly a company cannot, for any length of time, pay out all of its
profits as dividends. Companies need to retain some profits to grow. That’s what will make the
price of the stock go up over the long term. So super-high yields are often dividends in peril,
meaning that they are unsustainable over the long term.
Q: What about REITs?
A: REITs (Real Estate Investment Trusts) are a special situation. They are one of a few special
corporate forms which, if chosen by the company, must by law pay out a high percentage of
their profits as dividends. The downside is that their dividends do not qualify for the 15%
Federal income tax rate that applies to most dividends. (That is because they are not taxed at
the corporate level.) For an easy rule of thumb, figure that the yield on a REIT must be about
20% more than a “regular” yield to put the same dollars in your pocket. Example: If a non-REIT
stock yields 4%, a REIT would need to yield almost 5% to net out the same to you. Of course, if
you hold it in a tax-deferred account, you do not pay taxes on the dividends as they are
received.
Q: What is the risk in dividend stocks?
A: Being stocks traded on an open market, dividend stocks are as subject to market risk as any
stock. They can and do lose value in bear markets and downturns. We saw that vividly in the
bear market of 2007-08-09. Any single company, of course, is also subject to risks associated
with its particular business.
That said, an interesting psychological effect takes place in the minds of many dividend
investors. They don’t care as much about the price of their dividend stocks. They focus on the
value of the dividend stream. A typical way this is expressed is, “The markets are doing poorly
right now, but my pain has been tempered by the fact that I continue to receive regular dividend
payments. They have continued uninterrupted, and in fact they are growing.” So dividend
investors have reasons to be happy even when the markets are doing poorly. Some dividend
growth investors see this as being "paid to wait" for stock prices to return to normal.
The "Sensible Dividend Investor" makes a priority of the safety of both the dividend stream and
the stock prices. As to the former, look for stocks that consistently raise their dividends. As to
the latter, purchase strong companies at advantageous prices, but also recognize that prices
will fluctuate over time. Over the long term, if you have chosen your stocks well, you should not
suffer long-term or permanent loss of capital.
Q: How often do you trade dividend stocks?
A: That is up to you. However, it’s fair to say that most dividend growth investors trade their
stocks less frequently than average. They have fewer reasons to sell. They recognize that the
compounding effect of reinvested dividends takes time to build up momentum. They are less
sensitive to temporary price declines than holders of “growth” or other non-dividend-paying
stocks. They appreciate the continual flow of dividends coming to them. And they really like the
annual increases in dividends that the best dividend-paying companies generate each year.
In fact, many dividend investors view price declines favorably, because lower prices provide
better entry points and higher yields for those investors who are accumulating stocks.
Q: I don’t want to re-invest my dividends. I want to use them for current income. Are
dividend stocks still a good idea?
A: Yes. While you will not benefit from the "second layer" of compounding that comes from re-
investing dividends, you will still benefit from the first layer, which is the increasing dividends
themselves. That is because the best dividend-paying companies regularly increase their
payouts each year. About 100 companies have increased their payouts for over 25 years
straight, which is remarkable when you think about it. The longest record of uninterrupted
increases I have found is 59 years. Average annual increases range anywhere from 1% or 2%
all the way up to the 10% to 15% range. Those increases alone, even without reinvesting, keep
you well ahead of inflation.
Also, note that as companies increase their payouts in dollars, the percentage yield to you,
based on your original investment, goes up each year. This is called "yield on cost." The math
is simple. Say you buy a stock yielding 4% that increases its payout 10% per year. Then your
personal yield will become 4.4% in the second year, 4.8% in the third year, 5.3% in the fourth
year, and so on. Each year's proceeds are 10% higher than the year before. (The “current
yield” printed in the newspaper no longer applies to you—that is the yield to new buyers.) Your
personal yield will double in about seven years, and the yield on your original investment will be
9.4% in the tenth year.
No bond or savings account or CD can do that. The rising-income factor is one of the
phenomena that make dividend stocks so attractive in comparison to “fixed income”
investments like bonds and savings accounts.
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| 2012 EDITION NOW AVAILABLE |
| Click on the cover image below to learn more about the publication |
|
| 2012 EDITION NOW AVAILABLE |
| Click on the cover image below to learn more about the publication |
|
| 2012 EDITION NOW AVAILABLE |