Ok, as I understand it, companies typically offer dividends when they are mature and growth prospects are limited. Indeed, future growth prospects could well be negative (almost all companies die at some point).
The benefit one gets from owning a stock is the sum of the dividend thrown off and expected gain in the value of the stock. Shouldn't the sum of those two benefits (relative to the price paid for the stock) be the same for all stocks?
I guess my main question is: what is it that we know about dividend paying stocks that the rest of the investing world doesn't know that should give us positive alpha by picking dividend stocks?
(or is the focus on dividend producing stocks due to something that is an advantage to us and few others: eg low taxing of dividends for ppl with low incomes etc?)
Understanding the focus on dividend stocks
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Robert Muir
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Growth stocks usually have a high P/E from high expectations of their future income stream. The stock price has a lot of room to fall if the company fails to meet those expectations.
There is less and less expectation that the economy as a whole will increase which may reduce the chance that growth companies will in fact grow.
Companies that produce a decent dividend usually have no illusions of huge growth so their P/E is usually low. If the market takes a tumble, they probably won't drop as much as a high growth company - especially if it looks like their income stream won't be affected much.
Dividends provide an income stream from a stock without having to sell shares which would generate expenses and possible capital gains. Keep in mind, however, that dividends come directly from the stock price. When a dividend is paid, the stock price drops exactly the amount of the dividend.
There is less and less expectation that the economy as a whole will increase which may reduce the chance that growth companies will in fact grow.
Companies that produce a decent dividend usually have no illusions of huge growth so their P/E is usually low. If the market takes a tumble, they probably won't drop as much as a high growth company - especially if it looks like their income stream won't be affected much.
Dividends provide an income stream from a stock without having to sell shares which would generate expenses and possible capital gains. Keep in mind, however, that dividends come directly from the stock price. When a dividend is paid, the stock price drops exactly the amount of the dividend.
Two other things to consider is that
(1) some people don't want dividends. In a non-retirement account you are going to have pay taxes on the dividends every year. This is a huge drag if you are in savings mode.
(2) dividend stocks have some correlation to value stocks. Value stocks are typically those with low P/B or P/E and historically have earned a premium return over other stocks (i.e., the stocks are riskier and hence investors wouldn't buy them unless they thought they could more return). No free lunch here either.
(1) some people don't want dividends. In a non-retirement account you are going to have pay taxes on the dividends every year. This is a huge drag if you are in savings mode.
(2) dividend stocks have some correlation to value stocks. Value stocks are typically those with low P/B or P/E and historically have earned a premium return over other stocks (i.e., the stocks are riskier and hence investors wouldn't buy them unless they thought they could more return). No free lunch here either.
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Robert Muir
- Posts: 280
- Joined: Thu Jul 22, 2010 10:15 pm
Agreed. Unless you pay no taxes on dividends or you want the income from dividends, then preferably, those stocks are best kept in tax deferred or Roth accounts.
If you have stocks in taxable accounts and you choose to automatically reinvest the dividends, make sure you keep track of the cost basis of each transaction. Otherwise, you could end up paying more in capital gains taxes than you should. I think for ERE, the best bet is to not automatically reinvest - have all the dividends sent to your sweep account and use the funds purposefully.
If you have stocks in taxable accounts and you choose to automatically reinvest the dividends, make sure you keep track of the cost basis of each transaction. Otherwise, you could end up paying more in capital gains taxes than you should. I think for ERE, the best bet is to not automatically reinvest - have all the dividends sent to your sweep account and use the funds purposefully.
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George the original one
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I use dividends to maintain a minimum return and reduce portfolio volatility.
There's some truth to "the stock drops by the dividend when it's paid", but the reality is that day-to-day market price movements can easily swamp the effect. You can easily find examples where the stock price appears totally unaffected by the payment of a dividend. The larger the dividend, however, the more likely you'll see the effect (take a look at BDCs and mortgage REITs, where the dividend is 9-20% per year).
Taxable events such as dividends or capital gains are irrelevant to me as long as I'm protecting my profits (or guarding against losses). Portfolio stability & growth are far more important than avoiding taxes. If one really wants to avoid taxes, then buy federal and state and municipal bonds. After all, to use any profit, you'll be paying a tax at some point unless this is all in a Roth (and you're not subject to sales tax).
There's some truth to "the stock drops by the dividend when it's paid", but the reality is that day-to-day market price movements can easily swamp the effect. You can easily find examples where the stock price appears totally unaffected by the payment of a dividend. The larger the dividend, however, the more likely you'll see the effect (take a look at BDCs and mortgage REITs, where the dividend is 9-20% per year).
Taxable events such as dividends or capital gains are irrelevant to me as long as I'm protecting my profits (or guarding against losses). Portfolio stability & growth are far more important than avoiding taxes. If one really wants to avoid taxes, then buy federal and state and municipal bonds. After all, to use any profit, you'll be paying a tax at some point unless this is all in a Roth (and you're not subject to sales tax).
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George the original one
- Posts: 5406
- Joined: Wed Jul 28, 2010 3:28 am
- Location: Wettest corner of Orygun
When it comes to dividend income, the real magic is in dividend growth. Quite a few companies raise their dividend faster than inflation rises and the dividend is far more stable than the stock market price of the underlying security.
For example, consider ARLP. Over the past five years, while CPI inflation has risen about 20%, their dividend increased by about 96%. Thus the income from this one stock is more like getting annual raises rather than getting a COLA. [note ARLP is an MLP, so the payment is called a distribution instead of a dividend and gets a different and more complicated tax treatment]
Now ARLP is fairly exceptional, but not atypical of dividend growth stocks. PEP has grown its dividend about 84% in the past 5 years. JNJ has grown its dividend 63%. It is this ability to consistently grow the dividend faster than inflation which makes the dividend growth stock an excellent medium for any retirement strategy.
When I'm picking stocks, I'm looking for that dividend growth. If it's not present, then I want a premium yield (6.5% or more) and stability that compensates for the lack of dividend growth. With the MLPs, I've been getting both a premium yield and dividend growth.
For example, consider ARLP. Over the past five years, while CPI inflation has risen about 20%, their dividend increased by about 96%. Thus the income from this one stock is more like getting annual raises rather than getting a COLA. [note ARLP is an MLP, so the payment is called a distribution instead of a dividend and gets a different and more complicated tax treatment]
Now ARLP is fairly exceptional, but not atypical of dividend growth stocks. PEP has grown its dividend about 84% in the past 5 years. JNJ has grown its dividend 63%. It is this ability to consistently grow the dividend faster than inflation which makes the dividend growth stock an excellent medium for any retirement strategy.
When I'm picking stocks, I'm looking for that dividend growth. If it's not present, then I want a premium yield (6.5% or more) and stability that compensates for the lack of dividend growth. With the MLPs, I've been getting both a premium yield and dividend growth.
I like dividend stocks mostly for their lower volatility, as compared to other non-dividend stocks, and inflation protection from dividend growth, as George stated.
Also, I've seen first hand (by doing tax returns) many cases of people living off dividends with low turnover in their portfolio, as opposed to clients with brokers that churn accounts and show no benefit vs just holding a bunch of ETFs or index funds.
Also, I've seen first hand (by doing tax returns) many cases of people living off dividends with low turnover in their portfolio, as opposed to clients with brokers that churn accounts and show no benefit vs just holding a bunch of ETFs or index funds.