The Dividend Investing Resource Center

Letting Dividends Do Their Work

Dividend investing is a means of building wealth over a long period of time with reduced risk. Many brokers offer fee-free purchases and reinvestments and the ability to reinvest fractional shares. Dividend investing is for the long term buy-and-hold type investor who wants to sleep at night while their investments steadily build.

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Articles from The Prudent Investor

Future Dividend Champions - Cardinal Health

by George L Smyth

Cardinal Health is about to announce its dividend offering, which should make for 25 years of consecutive dividend growth. This soon-to-be Dividend Champion has many pluses and minuses as far as adding it to your portfolio is concerned.

     

Cardinal Health, Inc. is an integrated healthcare service and products company based in Dublin, Ohio. They specialize in the distribution of pharmaceuticals and medical products and manufacture surgical products and fluid management products.  Being around for over 100 years and with 50,000 employees in 46 countries, they are currently #16 in the Fortune 500.

The company is split into two components – Medical and Pharmaceutical.  The Medical segment includes medical gloves, feeding tubes, skin and wound management, surgical products, and numerous other categories.  The Pharmaceutical segment provides one out of every six pharmaceutical products in the United States. 

Performance

10 year chart
Chart via Stock Rover

Over the past 10 years, the company's performance was impressive in the initial five years and disappointing the most recent five years.  This decline is the result of the market moving toward low-margin generics.  One may decide that the company is unworthy of consideration, or, its P/E being about half that of the S&P 500, makes for an interesting opportunity.  A glance at the company's quantitative scores in Stock Rover’s Research Report indicates that the balance might be tipped toward the latter.

quantitative scores
Stock Rover Research Report

An examination of numerous analyst's reports indicates that they appear to be fairly evenly divided between Hold and Strong Buy.  While I do not base my decisions on such reports, it is interesting to see that there are two distinct camps of thought on this company.

Dividend

 

The current dividend yield is an appealing 3.4%, which compares favorably against their peers.  Critically, their Free Cash Flow Dividend Coverage Ratio is, and consistently has been, well below 50%, so there is the confidence that the dividend will remain intact for years to come.

payout ratio
Chart via FinanceCharts.com

An Aside

In researching Cardinal Health I noticed that there were varying opinions on their actual dividend growth streak.  These were not just random people in comments sections of articles offering their school of thought - these were knowledgeable authors.

For instance, Cory Cook, a SeekingAlpha author, wrote “The real number is 15 years of raises due to the dividend payouts between 2001 and 2005. June 2001 through March 2003 (8 quarters) dividend stayed at $0.018 per quarter. Again, in June 2003 through March 2005 (8 quarters), the dividend stayed at $0.022 per quarter.”

Perhaps this will be the subject of a future article, but the bottom line is that there are numerous definitions of what "X years of dividend increases" actually means.  It is reasonable for an individual to look through a company's past dividends and question if it supports that individual's definition.

I will not get into the discussion at this point, but as an example of the interpretation, the Notes section of the spreadsheet states, "The initial goal was to identify companies that had increased their dividend in at least 25 consecutive years. But that definition was broadened to include additional companies that had paid higher dividends (without necessarily having increased the quarterly rate in every calendar year."

A question I posed to Justin Law, maintainer of the CCC spreadsheet, concerned what "without necessarily having increased the quarterly rate in every calendar year" meant.  Wouldn't each company have increased the quarterly rate in every calendar year?

His response was, "This just means the list has some leniency for companies that might not increase their dividend every year. For example, if company XYZ increased its dividend in July 2019, but didn't announce any increases in 2020, it would still pay out greater dividends in 2020 than 2019 due to the first two quarters being higher than the previous year. So the company would stay on the list through 2021, but if it kept the same dividend rate, it would then be removed for freezing its dividend."

I acknowledge that different people can have different mindsets on this issue, have decided to save time and effort by simply following Justin’s research.  For me, the crux of the matter is to find great companies with a long history of dividend increases, and almost any definition of that will point me in the right direction.

The Future

One item of concern consists of the company's exposure to opioid litigation.  While they have already agreed to a settlement to the tune of $5.6 billion, additional litigation could come their way.

debt

Stock Rover Research Report

Another point of concern is the company’s debt situation.  A Debt/Equity Ratio of 3.4 is something that can hold a company back.  They paid down $1.4 billion of long-term debt in 2020, so the direction is positive, but it is something to monitor.

In March, Cardinal Health signed an agreement to sell its Cordis business in the first half of next year.  While it is said to be doing this “to focus on its medical distribution and global medical products businesses,” it must be understood that they acquired Cordis in 2015 and are selling for a little more than half of the purchase price.  Overpaying and failing to integrate are not signs of success.

Finishing Up

There appear to be many reasons for not adding Cardinal Health to one’s portfolio.  That does not mean that there is not a case to be made in its favor.  Each year, since 2014, the company has been able to increase its revenue.  This is projected to continue for the next few years, and continued payback of their debt would be a big step in the right direction.

As the company is not currently valued as highly as its peers, and its P/E is nearly at a five-year low, this could be an opportunity to select an unloved company.  At least, in the short term, the increased need for gloves, gowns, and masks should result in a reliable cash stream.

Finally, with an attractive dividend yield that appears to be safe, this could be a company that properly fits into one’s portfolio.  It is a matter of balancing the pluses and negatives that leads to a proper decision.

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How to Minimize Taxes With Qualified Dividend Stocks

by George L Smyth

It would be understandable to question why an article about minimizing taxes on dividend stocks would appear following the submission of one's tax forms.  The answer is that one needs to plan what they are doing during the tax year before the next form comes due.  Hopefully, this article will help with that planning process.

Income from dividends is a category that needs to be understood.  Planning for next year’s taxes starts at the beginning of the tax year, so placing this article in April offers a chance to plan for the coming year.

We begin with the possible misconception that dividends are necessarily free money.  I use the word “possible” in the context that it is possible, depending upon your circumstances.  One needs to consider their tax liability to place themselves in the best of these circumstances.

Dividends that are converted into additional shares of a company through a Dividend Reinvestment Program or broker are subject to taxes like other sources of income.  When you receive a dividend, you choose whether to take the cash or reinvest it.  The government does not care which path you take, they do, however, want their cut regardless of the choice.

The inception of planning is to consider the issue of qualified dividends.  The key is that qualified dividends are taxed at the same rate as long-term capital gains.  Whereas regular federal income tax rates can go up to 37%, qualified dividends are taxed at 20%, 15%, or even 0%.

I wrote an article, Qualified vs. Unqualified Dividends, which explains the difference between these two types of dividends.  This difference boils down to either being required to pay taxes or potentially not having to pay taxes, so it is significant.

The skinny is that qualified dividends are those that are paid by U.S. corporations, held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date, and are not under the type listed as unqualified dividends.  I will go over these three requirements individually.

Qualified dividends are those that are paid by U.S. corporations

The first requirement that the dividends must be paid by U.S. corporations is self-explanatory but may answer a question by those holding mutual funds.  Some tax forms from these funds may show income in both the qualified and unqualified categories, and that would be because the fund holds some foreign companies that offer dividends.

To be a qualified dividend the stock must be held for more than 60 days during the 121-day period that begins 60 days before the ex-dividend date

The second qualification may sound somewhat circuitous but generally means that the IRS requires a minimum holding time.  If you buy just before the ex-div date and sell right after receiving the dividend, it no longer is considered qualified. 

An example would be where one purchases shares of a company on July 5, the ex-dividend date is July 12 and the shares are sold on August 8.  The dividends the investor received would then not be considered qualified dividends because the stock was only owned for 34 days.  If the investor had held the shares until November 1, they would have been owned for more than 60 days within the May 13 (60 days before the ex-dividend date) – September 10 (60 days after the ex-dividend date) timeframe, thus the dividends would be considered to be qualified.

There is a short-term dividend strategy called the Dividend Capture Strategy in which this situation needs to be taken into account.  In this scheme, the investor purchases a stock just before the ex-div date pockets the dividend, and sells the stock.  As this dividend becomes unqualified, full taxes will be imposed, so this needs to be taken into consideration if employed.

Qualified dividend not under the type listed as unqualified dividends

This sounds like one of those commercials that tell you not to take the drug they are advertising if you are allergic to it.  The deal is that some categories remove the ability to call a dividend qualified, and most of them you probably will not need to worry about, like employee stock options, dividends from money market accounts, and special one-time dividends that place them in the unqualified category.

The most prominent category in this group would be REITs.  This group of investments normally has an enticing dividend yield, but full taxes will be required for them.  This means that a portion of those dividends will disappear to taxes, making them less attractive.

Your Tax Bracket

If you are single and earn $445,850 or more in 2021 then congratulations, financially, you are doing considerably better than I am.  The good news for the rest of us is that there will be a reduction in the taxes paid on qualified dividends.

To see where you stand, take note of the below table.

2021 Qualified Dividends Tax Brackets

For single filers
with taxable income of
For married joint filers
with taxable income of
For heads of households
with taxable income of
Tax rate on
qualified dividends
$0 to $40,400 $0 to $80,800 $0 to $54,100 0%
$40,401 to $445,850 $80,801 to $501,600 $54,101 to $473,750 15%
Over $445,851  Over $501,601 Over $473,751 20%

Information from The Motley Fool

Earning under $40,400 if you are single ($80,800 as a married couple) means that you will not pay taxes on those qualified dividends.  In this particular case, we are finally talking about free money.

Mutual Funds

As noted above, dividends acquired through mutual funds are still subject to taxes.  Funds held in IRAs, 401(k)s, or annuities are not taxed while they are in the account, only when the distribution is taken.  These funds should take care of themselves as far as taxation is concerned, but we do need to understand something about funds outside of this area.

Taxable events that happen due to the activity of the fund manager are passed along to the shareholder of the fund.  You may hold a fund for years, but if the fund manager buys and sells stocks at a higher value, then you are paying taxes on the capital gains, as well as the dividends.

There is something that may not be understood when it comes to the possibility of paying taxes twice on the gains.  For instance (looking at a simplified instance), take the example of purchasing $10,000 of a fund, which receives $400 per year in dividends, which are reinvested. 

In five years, the fund becomes worth $15,000, and then you sell it.  Initially, you may think that you will be paying taxes on the $5,000 gain, but that is not correct.  The $2,000 of reinvested dividends ($400 x 5 years) is part of the cost basis, so the taxable gains are not $5,000, but $3,000.  Keep this in mind when filling out those tax forms.

Finishing Up

There is rarely a free lunch to be found, but if you are in the lower income tax bracket then you may be able to receive dividends without paying taxes on them.  Before making that assumption, however, you need to understand the conditions that could make this possible. 

Holding the right class of United States dividend-paying stocks for an appropriate amount of time can make the difference, so examine your holdings, and keep these conditions in mind when considering new purchases.

 

Other Articles of Interest

Qualified vs. Unqualified Dividends

Understanding the Dividend

Understanding Dividend Yield

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This website is maintained by George L Smyth