Sizing up stocks
The plans of the diligent lead to profit as surely as haste leads to poverty. —Proverbs 21:5 NIV
My youngest son Jack loves to eat, period! Not an hour goes by after a meal before he’s saying, “I’m hungry! Can I have a snack?” He’s got a love for food and he eats lots of it. Good thing he’s quite active and can work off all those calories. My oldest son, Cameron, is quite the opposite.
Cameron carefully stalks the dinner table, sizing up his quarry and looking for the best tastes. It’s not a quantity thing with him; it’s all about the taste. He’s the sneaky one Mom has to watch. Cookies stand no chance. If she’s not looking, those cookies become easy, helpless gooey prey. Cakes mysteriously end up with patches of icing gone, vanished with no explanation or trace of who did it. We all know who did it, though! Like- wise, investors are also always on the prowl for tasty treats.
While stock appreciation is by far the most sought-after treat, a company paying a regular dividend can be icing on the cake. However, just as with any investment, there are many things you should consider.
By definition, a dividend is simply a portion of a company’s profits paid to its shareholders. There are cash dividends, stock dividends, and special one-time dividends. Special one-time dividends are an uncommon occurrence and can be issued in the form of cash, stock, or property dividends, usually as a special benefit to shareholders for something such as the sale of a portion of the company’s business, liquidation of an investment, or maybe a major litigation victory. Stock dividends are basically “stock splits,” whereby shareholders receive extra shares of the company’s stock, instead of cash, as a means to reward shareholders, lower the stock price, or increase liquidity.
For a moment, let’s focus on cash dividends, which are regularly scheduled payments made by a corporation to its shareholders. The majority of companies pay dividends quarterly, four times a year. However some pay annual, biannual, or even monthly dividends. Just as my son watches for certain opportune times to grab tasty food, there are key points in time to be aware of when investing in dividend-paying companies:
✟ The declaration date is basically when the board of directors declares or approves that the company will pay a dividend and announces the date of record and payment date.
✟ The date of record is the date on which the company reviews its records and determines exactly who are the shareholders of the company’s stock.
✟ The date at which the dividend will actually be given to the shareholders of the company is termed the payment date.
✟ By far the most important date for dividend investors is the ex-dividend date. Quite simply, if you want the dividend, you have to purchase the stock before the ex-dividend date.
How Do Dividends Work?
Let’s say you own 100 shares of Kimberly Clark (NYSE:KMB) and they pay an annual dividend of $2.96. If they paid a quarterly dividend, you would receive $74 ($0.74 per share) every quarter for a total of $296 ($2.96 per share) per year, regardless of the stock price. And this is where the term “dividend yield” becomes important.
In this example, if Kimberly Clark traded at $83 per share, the dividend yield would equal 3.56 percent. This equation is simply written as: annual dividend ÷ current stock price = dividend yield.
The Divine Dividend
Now that we have the basics out of the way, let’s get to the icing. The easiest way to explain the long-term benefit of dividend investing is to utilize a couple of examples:
Example 1: Let’s say you bought 100 shares of a utility company at a price of $10 per share and held these shares for ten years. Let’s assume the company had an annual growth rate of 7 percent, a dividend yield of 3 percent, and the annual dividend growth rate was 1 percent. If you reinvested all of the dividends, after ten years the initial $1,000 investment would be equal to $2,441.98.
Example 2: Now let’s say you bought a similar utility company that does not pay a dividend. Using the same scenario above, 100 shares of stock at $10 per share for ten years and an annual growth rate of 7 percent, your initial $1,000 investment after ten years would be equal to $1,967.14.
The stock that paid a dividend produced an extra $474.84. That’s the icing on the cake – a higher rate of return!
Cakes and Caveats
Just because a company is paying a dividend doesn’t mean it is a good investment. Sure, sometimes you can have your cake and eat it too, but be warned, sometimes your cake can eat you. Here are’ some things to consider: A high dividend yield doesn’t always equal a high-quality company. Take a stroll through the financial sector and you’ll quickly see what I mean. Once prominent high-dividend- yielding companies, like Citigroup (NYSE: C), Bank of America (NYSE: BAC), and many others have slashed or even stopped paying dividends; not to mention the horrendous depreciation in their stock prices over the past several years.
Stagnant growth can also be associated with many dividend-paying companies. While this is not always the case, many companies experiencing growth problems, commonly due to the “how big can you get” factor or lack of newer products, will sometimes try to retain shareholders by declaring a dividend. And while this isn’t always a bad thing, it is something to be aware of.
In addition, some companies may better serve its shareholders by not paying a dividend and using the capital to grow business. Nonetheless, investing in high-quality, dividend- paying stocks is a great way to build long-term wealth. Dividend-paying companies can also be an added bonus, providing consistent positive returns even during hard times, such as the tough economy we are currently in.
Right now for dividend investors we love consumer staples companies like Kimberly Clark (NYSE: KMB) and Colgate-Palmolive (NYSE:CL) as well as utility companies like Duke Energy (NYSE: DUK) and Dominion Resources (NYSE: D) and high quality dividend paying health care companies like Abbott Labs. (NYSE: ABT). One other sector we like are niched Real Estate Investment Trusts (REITS) like Digital Realty (NYSE: DLR) providing real estate services in the technology sector and Omega Health Investors (NYSE: OHI) providing real estate to the health care industries. All of these companies have some solid capital gain potential and pay at least a 2% annual dividend. Good dividend-paying companies really can be the icing on the cake!
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