– John D. Rockefeller
Hi, it’s Kent again – filling in for Justice for another day. Let’s slightly shift gears today. Yesterday I gave examples of how to take a “sector-based” approach to finding stocks.
Today I want to talk about dividends.
The Safe Haven Investor Focus
When you think about protecting and growing your wealth over the long term, one of the first things that comes to mind, or should come to mind, is dividends.
I believe dividends and dividend-paying stocks should be a core foundation of any diversified long-term investment portfolio... especially one focusing on safely building wealth and retirement assets.
My goal for Safe Haven Investor readers (and with Taipan Daily too) is to provide ideas and insights for long-term wealth creation (i.e. for your retirement), with a conservative or safer approach – that is, a priority of minimizing downside risk.
A Dividend Refresher Course
First, as a refresher, you probably know that dividends are a means of paying shareholders excess cash. Dividends are not a requirement and can be cut at any time (as we witnessed in record amounts this past year). For this reason, a company’s dividend policy sends important messages (i.e. signals) to the investment community. Starting, raising or cutting dividends are a very important part of corporate finance strategy.
For companies that are growing rapidly (like technology companies, for example), excess cash is used to fund projects, acquisitions, or research & development that will grow earnings. So, they don’t really have dividends.
In companies that have slower growth prospects, like utilities and tobacco companies, the company distributes a large portion of its excess cash to shareholders by way of the dividend.
And then there is everyone else in between – companies that pay a modest dividend amount, but still have opportunities to deploy cash to grow earnings. (There is a much deeper qualitative, quantitative and analytical foundation for dividend policy and theory that is quite fascinating, to me at least, but that discussion is for another day.)
It’s also good to think about the “payout ratio.” The payout ratio is an important metric to look at when analyzing dividend-paying stocks. It is a key measure of dividend sustainability.
The payout ratio is simply the dividend amount paid in dollars divided by the total earnings. If it gets too high, then watch out! Typical dividend-paying companies keep the payout ratio between 25% and 45%. Again, it can be lower if the company is using earnings and cash flow for other projects (e.g. 0% for technology companies) or higher if growth opportunities are more limited (e.g. utilities).
When it comes to protecting and growing your wealth, dividend-paying stocks are invaluable for so many reasons – especially in today’s environment. Let’s discuss a few.
Important Component to Total Return: Clearly, receiving a paycheck in the mail on a regular basis (typically quarterly) is a nice feeling! You can’t lose it in the market any more. In other words, “A bird in the hand is worth two in the bush”… especially when the bush is on shaky ground.
And that’s a return on your investment. When you talk about how much money you made in a stock, it’s the sum of the stock price appreciation plus any dividends you received over that time period. That’s called the total return. And since 1926, dividends have represented 30% of the total return of the S&P 500 index!
Power of Reinvesting: There’s a whole new world of benefit to dividends if you choose to reinvest your payments into more shares. By doing so, you are adding to your principal base, which then lets you earn BIGGER dividends in future.
It’s the amazing law of compounding. You’re no longer receiving your check in the mail with this strategy, but the good news is, that money is going back to work buying more dividend-earning shares, which provides the foundation for more upside and bigger returns. And that builds on itself, quarter after quarter, as long as you want it to. It’s a very powerful (and somewhat underutilized) strategy that I highly recommend, especially if you are saving for retirement.
Providing Stability and Support in a Flat, Frothy Market: If you believe, as I do, that the market is frothy and going to have a setback or correction sometime soon, then stocks with yields will provide income and help offset negative returns during such a period.
For example: If the market has a 10% correction and you own a stock that pays a 5% yield, then you only lose 5%, not 10% – that’s downside protection. And after the big run-up in the market, I like the odds of a correction... which is why I like even more having a defensive, dividend-paying portfolio.
And, too, what if we are in long, flat market environment, where the stock market basically doesn’t do much? That could happen in an economic environment of stagflation or deflation. Well, it would be good to know you are earning something even if stocks went nowhere, right? With this strategy, you’re getting a dividend cash payment while the market is flat. Being “paid to wait” is always nice.
A Unique Environment Today: Bond yields are very low right now, with no real change expected for the next few quarters (until unemployment and the economy show stronger signs of a turnaround). Right now the yield on the S&P 500 index is greater than bond yields! That’s rare.
So you can earn a dividend, just like a bond interest payment, but also pick up any upside in the stock price. The way the market is moving higher these days (and I’m not one to stand in the way of a high-speed train), you can make more than you do from Treasuries and benefit from Mr. Market’s ascent. This is not a long-term observation, but definitely one unique to these times and worth investigating closely.
Source: Bloomberg, Claymore Securities
In Search of… Dividend Ideas
Now that I’ve (hopefully) gotten you excited about dividends, where should you look? Well, my fellow Taipan editors and I are always presenting solid, well-researched ideas in our writings. And, of course, the Safe Haven Investor portfolio has several excellent, safe, high-yielding companies that are recommended as a “BUY” right now. So you’ve got some good places to start!
As you may soon discover, there are plenty of dividend ideas exciting and compelling enough to talk about over cocktails with friends (or at the water cooler with co-workers). More importantly, dividends are a means of building back your retirement savings, sleeping better at night, and worrying less about short-term swings (unless you are trading them on purpose!).
Thanks again for reading my thoughts over the past two days. And again, please send any questions or comments you might have by way of firstname.lastname@example.org, and he’ll forward them all on to me.
I really enjoyed writing to you about stocks, investing and, most importantly, protecting and growing your wealth!
Great Returns and Great Times,
Editor, Safe Haven Investor