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.
- A Message Board for people to meet and discuss DRiP-related topics.
- Getting Started
- A guide to getting you started with dividend investing.
- Info / Tools / Forms
- Information, spreadsheets and databases specifically for the dividend investor.
- Links to the best information available to the dividend investor.
Articles from The Prudent Investor
Safe Stocks for Dividend Investors
by George L Smyth
There are numerous metrics that one can examine when considering a stock purchase. Three numbers are especially helpful to the dividend investor.
Dividend investors, by nature, look for stable companies to add to their portfolios. Wild swings and monster gains are fine for the speculation crowd, but for the dividend investor concentrating on retaining one’s wealth is of paramount importance.
There are some things one can look for in a company during the examination stage that can help act as an in/out decision to cull companies that will not work in the portfolio. Companies that do not make this grade might be acceptable for further examination and possible inclusion in an alternative strategy one might be considering.
Four of the companies in my portfolio are Aflac, Aqua America, 3M and Johnson & Johnson, and I made the decision a while back to use them as examples in these articles. They have worked well for me over the past couple of decades, but whether or not one should include these companies in their own portfolios is a completely different issue. I seriously do not want to offer stock picking advice.
As I go through each of the considerations that one should have when seeking companies for inclusion in their dividend investing portfolio, I will use these companies as examples.
Of course, the dividend yield is the first thing on any dividend investor’s list of things to examine. If a company is not offering much of a dividend then as far as dividend investing is concerned, the company may be tossed from consideration. After all, dividend investors do need an attractive dividend.
Very generally speaking, the higher the dividend the better. Whenever I make a statement of this sort I am impelled to immediately follow it with an explanation that high dividends are not necessarily a good thing.
Simply chasing high dividends, while a strategy, introduces a large amount of risk into a portfolio. This is because a high dividend yield can simply be the result of a drop in the price of the stock. A falling price can be a good entry point, it can merely be a correction from unrealistic expectations, or among many other possibilities it can be a sign of a company’s decline.
One needs to have full understanding of the reason for the high dividend yield before continuing with the consideration of the company. Too often an unrealistically high dividend yield is suspended or drastically cut, leaving the investor who purchased the stock just for the dividend hanging (think General Motors, Kodak, Rite Aid, or a myriad of other examples).
Below we look at the current dividend yields of our example companies.
|Johnson & Johnson||2.54%|
At this moment the average dividend yield of every company in the market is 1.68%, so all example companies are above that average.
Oftentimes the company’s sector makes a difference. NYU.edu maintains a very detailed breakdown of all U.S. stocks, placing them into 94 sectors. Looking at their Dividend Fundamentals by Sector we can get the average yield per sector.
|Johnson & Johnson||Drugs (Pharmaceutical)||2.27%|
|Aqua America||Utility (Water)||1.56%|
In our example companies, only Aflac’s dividend yield lags their industry. If one were looking for a dividend yielding company in the Life Insurance sector then this would be something to keep in mind, but certainly should not be a single reason for not considering.
Dividend Payout Ratio
The dividend payout ratio is the annualized dividend rate divided by the annual earnings per share. This ratio is an indication of the amount of earnings that are returned to the investor, with the remaining amount available for reinvestment, paying off debt, and other company necessities.
Used by itself, this number is less meaningful than combining it with other considerations. On the one hand, the lower the payout ratio the more the company can use for growth, on the other hand, the higher the ratio the more dividend investors get in the immediacy. There is a balancing aspect here.
This number can vary widely. New companies and small capitalized companies usually hold onto their cash reserves so that they have resources to grow. Higher payout ratios are generally offered by more stable companies that wish to reward their owners.
As above noted, dividends are sensitive to the sector they are in, so we examine the numbers of our example companies in comparison to their sectors.
|Company||Sector||Payout Ratio||Sector Payout Ratio|
|Johnson & Johnson||Drugs (Pharmaceutical)||43.8%||61.4%|
|Aqua America||Utility (Water)||66.7%||66.6%|
Whereas two of these companies are right on mark with their sector averages, Johnson & Johnson offers a lower ratio than its sector and 3M a considerably higher one. The Johnson & Johnson number is not the concern 3M is, which wildly varies from the average. Numbers that are way out of bounds need to be examined to see if the variance is telling us anything meaningful.
It might be instructive to look at other companies in the Diversified sector and examine their payout ratios. The NYU.edu page offers a listing of the companies in each sector, and after removing the OTC companies as well as those that do not offer a dividend, we have the following.
|Company Name||Payout Ratio|
|3M Company (NYSE:MMM)||63.30%|
|Carlisle Companies Incorporated (NYSE:CSL)||32.15%|
|Compass Diversified Holdings LLC (NYSE:CODI)||100%|
|General Electric Company (NYSE:GE)||6.15%|
|Honeywell International Inc. (NYSE:HON)||44.90%|
|Jefferies Financial Group Inc. (NYSE:JEF)||37.90%|
|Roper Technologies, Inc. (NYSE:ROP)||17.40%|
By their very nature, companies in the Diversified sector may be all over the map as far as payout ratio is concerned. As for 3M, it has five segments - Industrial, Safety & Graphics, Health Care, Electronics & Energy, and Consumer. Each of these segments could be in its own sector, so if one wanted to get nitpicky about these numbers then they could figure the payout ratio for each of these segments, but that would certainly be overkill.
A nice dividend is fine, but what about the future? Will the dividend be stuck where it currently lies or will it be increased over time? Nobody can absolutely predict the future, but looking at past history can offer an indication as to how important the company sees their dividend.
Best is to look not only for a history of dividends, but dividend growth. Companies that only increase their dividends occasionally are unlikely to offer the stability of an increased dividend every year. Our example companies all have histories of increasing their dividends over the long haul. Nadsdaq.com offers the information for our table.
|Johnson & Johnson||$3.73||$3.54||$3.32||$3.15||$2.90||57|
|Aqua America||$0.91 **||$0.85||$0.79||$0.73||$0.69||27|
Perhaps I could have skipped making the calculations in the above table and simply said that these companies are Dividend Champions. Dividend Champions are companies that have increased (not just maintained) their dividend every year over the past 25 years, meaning that they continued to do so through numerous recessions. The column on the right shows the number of consecutive years each company has increased its dividend. That is real dedication to the dividend.
Dividend Growth Rate
Associated with dividend growth is the dividend growth rate. This is the annualized percentage growth of the dividend over a specified period of time. It is an important number because it tells us the degree to which the dividend is being raised.
Companies that show strong dividend growth tend to have characteristics that are positive from a fundamental perspective. They generally have good cash flow, can handle the debt on their books, and continue to be increasingly profitable. A strong rate forces financial discipline on the company to ensure that the expected quarterly paybacks to investors are maintained.
Below is a dividend growth table of our example companies for the three time periods most commonly used. The information was taken from the latest Dividend Champions spreadsheet.
|Company||3 Year||5 Year||10 Year|
|Johnson & Johnson||6.0%||6.3%||6.9%|
All companies listed are showing strong dividend growth over the years, so it is likely that this trend will continue. A stable and increasing dividend growth is essential to the dividend investor.
Summing It Up
It is important to consider many things when selecting a company to purchase and hold over a long period of time. While there is no single number that should be used to make the decision, three aspects of dividend investing – dividend yield, dividend payout ratio, and dividend growth – are the keystones of company evaluation. Taken together, they can start to build a case for or against a purchase, and should be followed with a close examination of the other aspects of the company.
Stock Tips Are Bunk
by George L Smyth
There is a continuous array of articles that promote particular stocks to buy. While they may be useful as a starting point for consideration, purchasing a stock simply on the basis of such a recommendation is a waste of time and money. Please indulge me the rare rant.
Each day I receive an email from Google, which has used the key phrase “dividend investing” to select a series of articles for me. It points me to some the articles that are interesting and informative. The majority, however, are articles either examining a specific stock or offering to have already found a group for me to purchase.
- 3 Top Dividend Stocks to Buy in February
- 10 Mid-Cap Dividend Stocks to Buy Now
- Best Dividend Stocks
- 64 Best Dividend Stocks You Can Count on in 2020
The above are from the last couple of days, and there are many more just like these. I do not necessarily question whether or not the selected stocks are appropriate for the reader, but I am concerned that some who rely on listening to authority figures simply purchase companies from such lists.
An investor needs to understand their own specific mindset as to how comfortable they are with their purchases, as well as understanding why each purchase was made. Without both of these firmly in place using a dart board might be an equally acceptable solution.
Allow me to use a couple of stories to illustrate my point, as the dividend investor is not necessarily in the much larger buy and sell target audience for these articles.
I love music – it was my first (non-human) love and will be my last. Ravel appears to have written specifically for me, Shostakovich has always left me in a state of awe, new composers like Nico Muhly and Anna Thorvaldsdottir keep me learning, and I also shamelessly promote my own music (shameless self-promotion).
On the other hand, I feel that Vivaldi wrote the same piece a thousand times (literally), and have no clue as to why Telemann’s music has bothered to survive. As strong as my opinions are, I know that others have opposite and equally valid opinions.
We all perceive things differently, process the information individually, and are affected by these things in a dissimilar way. While music may (and should be) simply an opinion, one would think that purchasing stocks should be more concrete. After all, as a friend of mine once said, “stocks either go up or they go down” (to which I replied, “or they stay the same”). So like the weight of a liter of water, isn’t a purchase simply right or wrong?
There is an Ancient Greek aphorism from the Delphic maxims – Σαυτὸν ἴσθι, or “know thyself”. This is one of the keys to my point, and can make a purchase either the right thing or the wrong thing. Outside forces can alter a stock’s price in a positive or negative way, but knowing yourself can help determine whether or not a purchase is proper specifically for you.
A number of years ago I had a very good friend ask me advice on her portfolio. I looked at what she owned and suggested that she might want to add some diversity to her mix in the form of international stocks. My recommendation was that she consider a general international index fund that had a low expense ratio and she made the decision to move a chunk of her portfolio in that direction.
This was in 2011 and almost immediately the fund’s value started to plummet. She began to freak out and despite my urgings to the contrary she sold her position while it happened to be at the very bottom. The main error in this situation was that I did not know the risk potential she was prepared to handle, but to be fair, neither did she when I asked. In the investing life, she did not know herself, as is oftentimes the case with new investors.
The fund I had suggested was one that I would have selected had I felt the need for international exposure. Having invested through a couple of recessions, I know that I have a much higher tolerance for financial pain than others, but it was not the case with her. This is why looking at a top ten selection of dividend stocks and just making a selection from the list is never a good idea.
The companies in any list will vary in their beta. Some may occasion wild swings while others just mosey along. Those who know themselves have a good idea as to how they will react to the movements of a stock as time goes on. For some, seeing a price swing wildly may make them decide to shelve their long term approach and either sell in a panic or attempt to find a top to cash in. For others, seeing a slow and steady movement may not provide enough of a boost to their portfolio, and may lead to them discarding their long term outlook to investing.
Know Why You Buy
“3 Top Dividend Stocks to Buy in February”
The title of the article sounds intriguing, but what are the author’s intentions for the investor following purchase? Will one buy in February and sell in March? Is this the urgency for buying in February? This could be the case with the Dividend Capture strategy, which I will explore at some point in the future.
If this is for a long term hold then why is it so important that the stocks be bought in February? If a company is to be held for years then will waiting a month be significant? Is this even advice for a long term strategy? If one does not have a large amount of money and wishes to make numerous small purchases then would these stocks that are to be bought in February not be buys in March?
The list of questions goes on and on – do the author’s intentions match the investor’s needs? If it comes time to sell the stock will the author be there to tell the investor? I think I will stop with these questions, I hope that you get my point.
These are the questions an investor needs to ask themselves when considering a purchase, and will not be answered in the article. There is no one answer that can possibly cover all investors, so each person needs to provide an answer for their own specific situation.
Also, if you know why to buy, you will know why to sell. Certainly there may be times when one has been investing for a purpose, like their children’s schooling or a new kitchen, and the time comes to make that sale. But if one is buying for the long term then circumstances may arise where one may need to sell.
I was an investor in Enron. Don’t laugh, at one time Enron was the largest natural gas producer in North America and it was on that basis that I decided it would be a good company in which to purchase. I started a DRiP and made monthly contributions.
The idea was to have a utility in my portfolio, and since Enron had been Fortune’s "America's Most Innovative Company" for many years this was an easy decision. However, it began to concern me when they started to stray from their core competence. As time went on the reason for which I had bought the company was eroding, which meant that the reason for me to hold the company was also eroding. When the stock started to really fall apart I called Enron’s transfer agent and sold all of my shares.
As we all know now, accounting fraud brought the company down and now its name means something completely divorced from the origins of when I bought it. I walked away without getting my legs cut out from under me, but those who purchased the company with no reason other than the fact that the stock was rising in price had no idea when to leave. These are the people who lost big when Enron completely collapsed.
Where to Go For Help
I am not completely discounting the value of articles about companies that may be right for purchase. I am stressing that the advice given may not be universal – a great stock for one person is not necessarily great for another. Time horizons differ, stress levels differ, portfolio allocations differ – these factors make one’s personal situation unique.
The idea for this article came from a question in the Beginners Corner of the Dividend Investing Resource Center, the mothership of this blog. The question at the time centered on selling stocks. Dividend investors know the power of making numerous small purchases over a long period of time, but what about selling?
The questioner had remembered a financial advisor say that selling was like buying, it was best to follow the cost averaging idea of selling a bit at a time. For me personally this makes sense, as I am retired and am drawing down on one of my index funds while waiting until 70 to start taking Social Security.
However, the questioner noted that he had a $15 fee per transaction when selling. The fees would severely cut into what he would receive so he was considering selling all at once. This is the case of a financial advisor offering good information, but that information may not fit every investor, and I did not fully understand this particular investor’s situation.
My suggestion was to think of the case where one has $50,000 invested in MMM and is retired (no, I do not have that much in MMM). Do they sell their entire stake at once? Probably not. Despite the fee, it will perhaps be more prudent to sell that $50,000 stake in stages.
Turn things around and consider one who has a $3,000 position in MMM and is going to sell. Because of the fees it would certainly make sense to just go ahead and sell the whole thing at once. Selling it in (for instance) five stages would really hurt the investor as far as fees are concerned.
I have always followed what I call the 1% Rule, which is that no more than 1% of the total should be lost to fees. If one has made purchases without cost and is looking at a $15 selling fee, the sale should be at least $1,500. Obviously, if one needs the money or has realized that the company is a loser then that is a different situation, but I think that the 1% Rule is a fairly good general guideline.
This is also why I railed against the introduction of fees to many dividend reinvestment programs. For the small investor these fees usually exceed 1% of the purchase and just kill the idea of plan participation. Fortunately, at least in the U.S., there are numerous brokers who purchase without fee and automatically reinvest dividends.
The bottom line is that the perspective of the author of the article one is reading may not match that of the investor. Looking at the titles offered at the top of this article, if one has a spare $10,000 lying around then perhaps some of the recommended companies would be a good match to purchase immediately. Not many of us do, which is a reason I am writing this blog, which comes from the perspective of the small investor without monster resources.
Wrapping It Up (more shameless self-promotion)
When seeking advice on stock purchases, instead of blindly following the advice of a magazine or website article, it might be a reasonable idea to seek information from knowledgeable people who share your financial characteristics. This is not to disparage the aforementioned articles, but to keep in mind that the audience they are writing for may be a group to which you are not a member.
The Dividend Investing Resource Center has message boards that are freely available to all and encompass U.S. and Canadian DRiPs and tax matters, share exchange, and a beginners section amongst other topics. You will find other small investors who relate to your situation, as well as your long term investing outlook, and can bounce ideas off them.
Know yourself – understand your risk tolerance and purchase companies that match that level of risk. Regardless of money, quality of life is diminished with worry and lack of sleep.
Know why you buy – if you understand why you are making a purchase then you will also understand when it is time to sell. Without this knowledge you are prone to the winds of advice that may not match your intentions.
Understand where you can go to get proper advice. If you are able to sit down with a knowledgeable person who understands your situation then that can be very helpful. Otherwise, seek out like-minded people and move forward only after being assured that the decision makes sense for you and your specific situation.
If these are done then you may be able to fulfill the last of the Delphic maxims – Τελευτῶν ἄλυπος - On reaching the end be without sorrow.