Dividends: There's No Such Thing as a Free Lunch on Wall Street

I've written in the past that dividend investments can be a solid piece of your portfolio. I prefer growth stocks, and in that realm, dividends are basically meaningless. However, with more and more stocks, trusts, exchange-traded funds and the like, there are definitely intelligent ways to invest for yield.

Today, however, many investors are looking for certainty in an insanely volatile, uncertain world. And because of that, many people are examining certain financial stocks or trusts that have an indicated dividend yield north of 10% ... sometimes 20% or more! Thus, all you have to do is buy and hold, and you'll get paid a bunch of money ... or so it seems.

As always, when you're putting your money to work, you can't leave your brain at the door. Ask yourself: Why would XYZ company be willing to pay me 10% or 20% per year when everything else on the planet is yielding in the low single digits? The answer: They're not. And in most cases, the companies aren't even pretending they're going to pay you that amount. Let me explain.

When a stock's "indicated yield" is cited, it's simply a matter of taking the most recent dividend payment (say, $1 per share), and dividing it by the most recent stock price. Now, three months ago, that stock might have been priced at 100 a share; with a $1 quarterly dividend, that meant a yield of 4%.

But today, after the market's decline, that same stock might only be trading at 40. Thus, since the last dividend was $1, the indicated yield is 10%, assuming the dividend will remain unchanged.

I've heard from a few dozen people who are going nuts over certain securities that are supposedly yielding 15% or more. But the odds are very, very much against you getting any sort of payout like that. If it's a cyclical company, for example, which has been benefiting from rising commodity prices, it's likely to slash its dividend in a big way during the coming months. And, of course, any financial firm with liquidity issues is likely to chop its payout in order to preserve capital.

That's not to say there aren't some great dividend plays out there. I've written about Verizon (VZ) before; I'm not pretending to have done exhaustive research on the company, but earnings are steady (actually rising 5% to 10%), and business isn't going to fall off a cliff because of the economy. Other stalwarts like Johnson & Johnson (JNJ, yield = 3.2%), Coca-Cola (KO, yield = 3.5%) and even Philip Morris International (PM, yield = 5.5%) are likely to keep their payouts roughly the same.

The message here is: Beware of the supposed free lunch on Wall Street, because there is no such thing. Double-check the safety of the dividend before you jump in.

Comments

[birder:]

As valuations have collapsed, dividend yields have dramatically increased--across the board. Granted there is no guarantee that these dividends will not be cut as there is no guarantee that we are indeed not headed into another depression. But lets take for example the pipe line companies. Many if not most are now paying north of 10%. Is natural gass usage going to be dropping dramatically? Actually, there is some reason to believe that natural gas usage is actually going to increase. As for Cintolo's growth stocks, how many has he actually made money on in the past 10 years?

Just for fun let's compare one pipe line to one growth stock over the last 10 years.

CSCO -1.5% return PAA +13.4% return.

2008 Nov 27 08:30 AM

[notsosmart:]

nobody has figured out a way to pave over the ocean.FRO has paid for my entire investment by dividends.the ceo takes no pay. just dividend payout.oil has to move & be stored.the dividend is volatile but its been there. even cut its still great.beware of anal sts.they all have an agenda.

2008 Nov 27 09:38 AM

[Dans Deep C...:]

I touched on this same topic on my blog today in reponse to a realtor's dicussion about cap rates on investment properties. My view is that some of these solid dividend plays offer better value than high-end real estate with low cap rates and prices still near all-time highs.

dansdeepcreekblog.blog...

2008 Nov 27 10:26 AM

[wsd:]

if one takes a close look at "growth stocks" what one sees for most part are companies that have failed to produce a single dollar for shareholders during the height of product cycles. Unless you buy and trade these stocks frequently its doubtful you will make money with most of them. Remember the NASDAQ average at current levels, doesn't even include all the companies that have gone out of business since 2000. The reality of growth stocks is its a way for managment and insiders to have an exit plan. Investors beware. Dividends have been documented to add 40% to the return over time.

2008 Nov 27 11:39 AM

[Anthony Alfidi:]

Growth stocks with good management and market position can turn into value stocks as their industry matures. Microsoft is heading that way, certainly since it started paying a dividend.

2008 Nov 27 07:23 PM

[Toeser:]

Wrongo bear breath. Yes, many high yield payers will cut or eliminate dividends, but that will by no means be universal. Some companies are doing just fine but have had their shares whacked by a fearful market. I bought many high-yield depressed stocks in the 2002 bear market, and most of them never skipped a beat. One I sold in early September, just before the market tanked. It had paid me a very high yield for six years, and the stock appreciated during that time as well. So, know what you are doing, but don't avoid a dividend just because it seems too good to be true.

2008 Nov 27 08:34 PM

[Boubou:]

Here is one of the mantras - " hold a portfolio of growth stocks long enough and you'll enjoy (8,9,11% nominal ) returns with low risk".
So long as your entry point and exit point are OK, they should add. If you are around retirement now , for example you are up the creek. The illusion of future growth is no good to you.
"diversification, diversification, diversification..........
Only this time no asset class is OK, except cash.
But what 'expert' is going to sell you cash?
Look , they just want you IN THE GAME to milk you dry throughout your working life and then until death do us part.
Those of us who earned our money the hard way, one hour at a time should no way be in this game.

2008 Nov 28 09:51 AM

[Boubou:]

Tosser, I'm with you. most of my retirement dividend stocks are still above average and if I'd gone for growth (starting 1999) I'd be up a much deeper creek than I am now.

2008 Nov 28 09:54 AM

[notsosmart:]

yes-all a scam.you have to be lucky & coordinate with the scammers.its really vegas,slower losses & nobody brings you a drink.pay your debts every month. pay off your house as fast as possible(no helocs) & pay cash for the car.dont give them a cent of interest(or as little as possible) or you might end up as so many eating your granite counter.

2008 Nov 28 01:48 PM

[Leser:]

Good article, Michael Cintolo. Thanks.

2008 Nov 28 11:41 PM

[Old Rick:]

I've read this article 2-3 times over 3 days and tried to figure out the point of a "growth stock investor" writing to warn value/dividend investors about the pitfalls of buying high yield stocks as if the value/dividend investor were not already looking at such things. As WSD said above, I wonder who the growth stock investors were listening to when Cisco (mentioned above) hit $77 in early 2000 and they "bought on the dips" all the way to $10.

2008 Nov 29 12:02 PM

[kurt walter:]

Give me those dividends. I don't trust most managements to re-invest in the business. They mess up too much.

2008 Nov 29 07:24 PM