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
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.
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.
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.
Are dividends the same as index funds?
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.
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.
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.
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.
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.
Freeloader, if you get more than $1000 in UBTI (which MLPs usually generate) in that Roth, your broker is going to have to file a tax return and bill you $200-$500 to have it professionally prepared.
Just be careful.
@IP - I'm safely under the threshold for the year. Not a tax expert by any means, so glad you brought that up.
Is the $1000 threshold in overall distributions or $1000 per MLP?
$1000 in UBTI overall.
Remember that with an MLP, UBTI is not necessarily the same as distributions. Usually it's lower, but it can be higher.
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).
Good advice. I've got a fairly sizable position in Kinder Morgan, which I believe generated negative UBTI.
On a similar vein, have you looked into the KMR? I'm tempted to swap out some KMP for the KMR, seems to be slightly more tax efficient, especially if you plan to reinvest dividends anyway.
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