The following blog post was submitted by Anthony Prams of www.smartfinancemag.com
As clear as it sounds dividend investing consists in buying stocks from companies that pay dividend. This concept can be seen as a conservative strategy due to the thorough stock picking process that needs to be done in order to successfully beat our benchmark. Dividends are part of the profits that are paid out to the shareholders. So in order to keep paying dividends a company needs profits. Some companies use all the profits generated to reinvest them and expand their activities to new markets or improve their position in the current markets, etc…Therefore, some companies don’t pay dividends. When a company reinvests the profits expects to increase their stock price by increasing the real value of the company. That is how investors make money out of these companies, exclusively by price increase of the stocks. This methodology is seen as risky by some investors because nobody knows how the market is going to react to the investments these companies make.
A conservative investor, in the stock exchange market, looks for companies that can offer a solid and stable flow of income to the portfolio during a long period of time. Conservative investors are recommended to use an attitude of “buy & hold” because in order to get the dividend you need to be holding the stocks at least during certain dates. Other strategies with a faster move of positions “buy & sell” wouldn’t allow the investor to plan the collection of the dividends.
Dividends are a privilege, not a right. This is something very important that needs to be understood. No company guarantees its dividends. Dividends are approved by the board of directors of the company annually and may decide at certain times to cancel the dividend to shareholders in behalf of the interests of the company. That is why a deep research of the company has to be made before buying any stock and decide whether or not to enter in that position at that time.
Unfortunately in the last years we have had many examples of partial dividend cuts or dividend cancellations on many companies from the S&P 500 index. Companies often use the dividend as an incentive to attract investors seeking a regular income. The problem arises when economic uncertainty looms, or when the company decides to allocate that cash dividend to acquire other companies, or even worse, when use those resources to finance its debt.
Chesapeake Energy (CHK) and Linn Energy (LINE) were forced to cancel their dividends few years ago. Two solid companies in the energy sector, totally unexpected. On the other hand Chevron (CVX) and ExxonMobil (XOM) have been increasing their payouts gradually because their competitive advantage has been kept above its competitors for a long time. Dover (DOV) and Procter & Gamble (PG) are the examples of two companies that have each updated their quarterly dividends for 60 consecutive years.
The danger for an investor chasing high dividend is the risk that the market is giving to those companies. There is always a reason… maybe the company is dealing with some turbulence and it is unclear if will be able to keep the dividend, either for sectoral reasons or particular reasons. But there is always a reason why a company offers a high dividend. The market never abandons a chance of making a profit.
As a general rule, we have to be skeptical with stocks offering profits twice plus one the average of the index in dividend return. For example, if the average dividend rate of the S&P 500 is 2%, then all companies with dividends above 5% will be considered too risky for a conservative portfolio. If it is higher than 5% probably that stock has been penalized by the market for any reason and there is an intrinsic risk it needs to be considered before buying the stock.
If diversification is important in any type of investment when applying dividend investing it is even more important. The reason is that an investor seeking for dividend usually needs that regular income to maintain his living standards. Or people who are investing their life savings. Or just a saver that wants to build up a savings fund as a private pension. So they cannot afford to lose that money. By diversifying into different stocks in different sectors, the portfolio will be protected against any structural problems that at any given time can be in a specific sector, like the Oil sector nowadays; where cuts or cancellations on that dividend won’t affect the whole performance of the portfolio. Not all sectors suffer in the same way economic turbulences, there are always some less affected than others.
6 thoughts on “Some Tips About Dividend Investing”
Lots of good thoughts and tips in there Anthony, thanks for sharing.
Dividendsdownunder recently posted…Our Shares Investment Criteria & Process
Thanks Tristan, really appreciate your words. I checked out your website too. Really good job, Im happy to see that I am not the only one trying to share for free some good knowledge.
Totally agree on the “Timing and Stock Picking Proces” you mention on your article. Those 2 factors are key to make any good investment.
It’s funny how often people miss the key elements of dividend investing. I’ve had many a talks with friends who are traditional investors. When the market dips, they drop big time. When the market dips for us dividend investors however, we still get paid – as long as the company is still technically profitable and they continue payments. A lot to think about. Thanks for the article. It went well with the morning cup of Joe!
Dividend Reaper recently posted…Recent Buy: American Railcar Inds Inc.
That is right Dividend Reaper! 😉
Conservative investors should not panic when the market drops. If your invest in reliable companies then its very likely that the dividend will be maintained during the turbulences. Then at some point, when economy recovers, the price of the stock will gain back the loses.
Thinking about the stock ARII you mention in your article. I have to say I do not know the specific case of this particular company. So I am not going to say anything about the contracts they could have for the future years, or the cashflow, etc… what i see as an investor about this company is that belongs to a sensitive sector. All transportation of any kind is always very strong correlated to the Oil price. Is it cheaper now to use trucks, ships, etc…? If the country’s GDP is growing and the macroeconomic data points that is going in the right direction… then i do not see any reason why this type of company wouldnt rise in price when the Oil price goes back to “normal”.
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When you count on dividend as cashflow, you won’t worry about the drop, that’s what I like about dividend growth investing – or SWAN. The draw back is it take a significant amount of principle to generate “meaningful” income. For young investor, you see 4% yield of $10K = $400/year or $33/mo, when you see $33/mo, it’s like nothing, they’d rather go for some stock that would give double the price in a short few month, and buy and sell. Not realizing the compounding interest, and get out of the “get rich fast” mentality and start saving and accumulating.
Hello Vivianne, you are totally right on your conclusion. To avoid risk it is always better to invest the way you described it in your comment.
Always remember that dividends are a privilege and not a right. So keep an eye on your positions because when a stock paying dividend falls far too low maybe it is due to the future cancellation of that dividend privilege.
Never forget to check your investments regularly.
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