This site is dedicated to the most amazing perk of investing – getting paid. Certain stocks that you can buy right now payout cash from earnings every single year. This is a direct and tangible reward from the company to the people who own parts of it. For a lot of investors these dividends are crucial. Not only do some people live off of them, but even experts tend to regard the dividends as the basis of the stock’s value.
We’ve already touched on why dividends are so crucial, how you can use them to create a monthly income stream, and how you can check to see if the dividends are sustainable. We’ve covered a lot on this site, but we certainly haven’t covered everything. So, here’s a few of the fundamental aspects of dividends we may have missed out:
You Need A Dividend-Focused Philosophy
Not all stocks are meant to be valued the same way. Some companies and industries simply do not pay a dividend or make a even make a profit. Small startups and tech giants prefer to hoard cash and reinvest it as fast as they can.
There’s a lot of investment strategies the look at companies and stocks differently. Some investors tend to focus exclusively on the price movements they can see on the charts, while others are willing to take risky bets on a lot of small companies to see if they can find a winner.
Investing is about your personal philosophy and the way you treat money. To be a dividend investor, you need to be pragmatic, patient, and income-seeking. Dividend investors are focused on stability and tangible rewards. It’s a way of thinking that works with available information and predictable outcomes. The amount of income each investment can generate right away is key for dividend investors. If you’re considering creating a dividend stock portfolio, take the time to pin down your investment philosophy and ask yourself if this is the best strategy for you.
Dividend-Paying Companies Are Rare
A survey of investment professionals found that the most popular stock valuation model was the dividend discount model. The same survey found that the number of companies paying a dividend has shrunk over the past few decades. Dividend-paying companies are getting rarer. Many of the companies that pay dividends pay less than the yield on US treasury bonds. Of the 500 stocks listed on the S&P 500 only 84% of them pay a dividend and only half pay a yield greater than 2.3%.
Sometimes Dividends Are Unconnected To The Business
The reason valuers use dividends to judge a company is because of its connection to profits. A growing and stable dividend usually signifies a company that’s doing well and a management that’s feeling optimistic about future earnings. But a connection between dividends and earnings is not necessary. Some companies hoard a ton of cash and then decide to pay them back in dividends over a period of time.
The best example of this is the Coca Cola Bottling Co. This is a company set up exclusively to manage coke’s bottling plants. It’s paid a regular and consistent dividend of $1 since….1994! Earnings per share, meanwhile, have fluctuated from $1.98 to $4.05. Sometimes earnings even fell below the rate of dividend, meaning the company kept paying $1 in the year where it made less than $1 in earnings per share. This isn’t a red flag by any means. COKE is a subsidiary of a massive and legitimately stable company. The dividend payout policy, however, makes it impossible for an investor to connect the stock price to future earnings and current dividend. Other methods will have to be used here.
Growth Is More Important Than Yield
Another important thing that needs to be mentioned is inflation. The value of money is constantly falling and if you intend to live off of dividends you need to find companies that can manage to grow those dividends in line with (or beyond) the rise in cost of living.
Another reason growth in dividends is important is the way dividend-based valuation models work. DDM, for example, take the present value of all future dividends to arrive at an intrinsic value for stocks. This means the future growth of dividends is an important factor in the overall value of the company. A company that cannot grow dividends beyond the required rate for investment, is not worth buying.
Cuts Are Unavoidable
No matter how hard you try, some things are simply unpredictable. The economy could take a drastic turn and the company you picked could see a sudden shift in the nature of its business. A lot of things can go wrong and if even the most stable and reliable company can be forced to cut its dividends if things get too bad.
Washington Mutual is a good example of this. The bank was started in 1889 and by the mid-2000’s it was well on its way to becoming the ‘Walmart of banking’. The company kept accelerating its dividend payout till 2007, by which time the stock dividend yield was over 5%. Then the financial crisis of 2008 started and it turned out WaMu was holding a lot of subprime mortgages on its books. The company kept cutting dividends every quarter and by the time it declared bankruptcy in 2008, it was paying only 1 cent per share in dividends.
To Sum Up
Dividend investing is a multifaceted strategy. It’s simple creating a dividend stock portfolio, but the dividend investor needs to be careful and patient. She needs to understand the fundamentals of dividend investing, seek out stable companies, and discover problems before anyone else. Also keep an eye out for those rare gems that are dividend paying rock stars.