A Discussion On Dividends

As our kind Wall Street Mentor discussed earlier this week, one of the possible uses of excess cash is to pay dividends to your shareholders.

Dividend stocks have been getting some ink over the last couple of years, principally because these payments provided the lion’s share of total returns on the S&P500 since 2001. Average total return during that time for dividend stocks was 3%; the nonpayers saw a 5.7% loss. Lately, investors have also been noticing that there are no less than 227 companies in that index with a greater payout percentage than the 10-year Treasury bond. And that outperformance seems likely to continue (if you believe the Fed’s 2014 forecast, that is).

In the 90’s, when the New Economy hype was in full swing, dividend stocks were frowned upon (“widow and orphan stocks” was one derisive label). Even today there is a belief that generous payouts are essentially a waste, that they’d be better used as reinvestments or R&D (paging Warren Buffett). For obvious reasons, these steady eddies ended up having the last laugh.

But really, it all depends on what your investment objectives are at this point. I think most of us would agree that dividends are a nice thing to have especially for the very long-term investor, but probably shouldn’t be the primary reason for investing. Overall upside potential for equity appreciation is number one for most.

But hey, there’s no reason there can’t be both; one wouldn’t have to come at the expense of the other. Dividends encourage buying of the stock as investors believe they’ll be rewarded. Just take a look at McDonald’s (MCD), which only recently cracked the $100 per share ceiling while sporting a 2.8% dividend yield. Or Coca-Cola (KO), which is hovering around the upper 60’s with a 2.7% yield that it just raised.

How would you personally place dividend stocks like these in your portfolio, if at all? Is the recent success just a product of risk aversion, or is the party only getting started? And finally, with payout ratios recently averaging 27% of earnings when the historical average is 53%, is there room for more?

(all numbers/statistics from CNBC)

 

No reason to hate on dividends. They're nice to have in 2011-type years. I've got 10% in JNJ alone

"When I was young I thought that money was the most important thing in life; now that I am old I know that it is." - Oscar Wilde "Seriously, psychology is for those with two x chromosomes." - RagnarDanneskjold
 
IlliniProgrammer:
I am a big fan of dividend stocks. My non-retirement portfolio yields roughly 5%.

That said, the US market is starting to look a little expensive. So if you are going to buy dividend stocks, it might be better to stick to boring regulated utilities and consumer staples.

If you think 4% dividend yields are great, wait until they're back up at 5%.

Personally I like holding my high dividend yield positions in a Roth IRA account, I prefer the tax-free growth on my dividends, compounding over time. Can't go wrong with a little MO.

 
humble_dude:
Isn't it true that dividends don't really create extra wealth for shareholders? If so then paying dividends is a rather unproductive process and value investors don't like things that are unproductive.
Are you referring to Miller Modigliani? In that case you would need an efficient market absent of taxes, with perfect information.
 

Very back of the envelope but if you think about it a stock's return can be broken down into 2 components; yield and dividend growth. If you rearrange the Gordon's Growth Model it is as follows:

r= D/P + g where D/P is yield and g is dividend growth

If the dividend grows at 10% p.a. over the long term, for the yield to stay constant the stock price will also appreciate by 10% p.a. In other words dividends drive capital returns!

One thing you are forgetting is the power of compounding. If you have a DRIP or a reinvestment program dividends can be very powerful. Some companies have been paying dividends through thick and thin and compounded over time this has yielded amazing results.

 

If you don't have a cash brokerage account, I'm not going to argue, but if you do, your IRA account is really a better place for bonds, REITs, royalty trusts, and money-market funds if yields ever become meaningful. In other words, stuff that's taxed at ordinary income tax rates rather than already preferred LTCG rates.

I like filling my cash account with dividend stocks. Yes, it's a little tax inefficient, but I can treat it as a second paycheck.

 

Perhaps I'm the only one who thinks this, but I see dividends as the primary reason for investing.

After all, what's the point of buying something that never gives you anything in return? Now sure, you can sell a non-dividend equity at a higher price and make a profit, but why would anyone buy it? You never get anything from it, bar of course, a higher selling price. But then again, why would anyone buy it this time?

You can see where I'm going with this. It seems that non dividend stocks share many of the same characteristics as ponzi schemes. People buy the company knowing it is unlikely they'll ever see a return, except they hope (well, they need) sometime commits their money at a higher price. They depend on someone else following the trend.

Of course, they're are exceptions - growing/start-up companies - but many companies fall into the above category.

 
Best Response
rpcas:
Perhaps I'm the only one who thinks this, but I see dividends as the primary reason for investing.

After all, what's the point of buying something that never gives you anything in return? Now sure, you can sell a non-dividend equity at a higher price and make a profit, but why would anyone buy it? You never get anything from it, bar of course, a higher selling price. But then again, why would anyone buy it this time?

You can see where I'm going with this. It seems that non dividend stocks share many of the same characteristics as ponzi schemes. People buy the company knowing it is unlikely they'll ever see a return, except they hope (well, they need) sometime commits their money at a higher price. They depend on someone else following the trend.

Of course, they're are exceptions - growing/start-up companies - but many companies fall into the above category.

You fundamentally don't understand finance.

"After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.” - David Tepper
 
Oreos:
rpcas:
Perhaps I'm the only one who thinks this, but I see dividends as the primary reason for investing.

After all, what's the point of buying something that never gives you anything in return? Now sure, you can sell a non-dividend equity at a higher price and make a profit, but why would anyone buy it? You never get anything from it, bar of course, a higher selling price. But then again, why would anyone buy it this time?

You can see where I'm going with this. It seems that non dividend stocks share many of the same characteristics as ponzi schemes. People buy the company knowing it is unlikely they'll ever see a return, except they hope (well, they need) sometime commits their money at a higher price. They depend on someone else following the trend.

Of course, they're are exceptions - growing/start-up companies - but many companies fall into the above category.

You fundamentally don't understand finance.

I'm fucking dying right now.
Under my tutelage, you will grow from boys to men. From men into gladiators. And from gladiators into SWANSONS.
 

Illini, freeloader: have you considered something like MLPs ? While they might pose some issues on retirement and/or special accounts (they are tax free only up to a maximum, therefore they don't do that well within non taxable accounts) it is not always true. IMHO, right now, REITs seem to be the place to be, taxation aside I wouldn't discount mutual funds either.

 
Hegel:
Illini, freeloader: have you considered something like MLPs ? While they might pose some issues on retirement and/or special accounts (they are tax free only up to a maximum, therefore they don't do that well within non taxable accounts) it is not always true. IMHO, right now, REITs seem to be the place to be, taxation aside I wouldn't discount mutual funds either.
You mean MLPs generate UBTI, which means your IRA has to file a tax return if you get more than $1000/year of UBTI and your broker charges you $500/year to prepare it, right?

Yeah, I keep my MLPs in a taxable account. The K1s are a little annoying, but I can deal with them. There are some ETNs that allow you to hold them in a retirement account, but then you are counting on an investment bank not to go bankrupt. Ask Lehman's SPX ETN holders how that worked out.

MLPs make up about 25% of my after-tax portfolio.

 
Hegel:
Illini, freeloader: have you considered something like MLPs ? While they might pose some issues on retirement and/or special accounts (they are tax free only up to a maximum, therefore they don't do that well within non taxable accounts) it is not always true. IMHO, right now, REITs seem to be the place to be, taxation aside I wouldn't discount mutual funds either.

Same here, I've got a fair amount in pipeline MLPs. Always been a strong performer in my portfolio.

 
Ditzy question, but I'm just starting to trade in my personal account and I'm learning... baby steps. How do you tell if the stock has a dividend? Any tips / advice would be appreciated.
Yahoo finance; check the price history. If you have an interruption in the price history for dividend every quarter, it pays a dividend.

The actual dividend amount is much less important than the company's ability to SUSTAIN a dividend. So either stick to ETFs or look at the company's earnings, operating cash flow, and balance sheet before buying.

 

Overall, but the limit is pretty hard to breach, you could even receive negative UBTI and balance them out.
Just like IP pointed out, you could use alternatives like ishares (so to avoid the production of UBTI and get periodic stock splits in stead) or ETNs and in case you fear the implied risks, closed end funds might be worth a look (beware the higher fees).

 

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