In low-interest rate environment, investors sometimes look to dividend-paying stocks as a mean of generating income.
Many yield-seeking investors look to stocks that have historically paid high dividends as a potential means of generating more income than can be found in bank savings vehicles. Although consistent dividends are not guaranteed, and even the bluest of blue-chip companies can fall on tough times, when the return on Treasury bonds is barely breaking 2%, dividend stocks tend to gain favor with some investors.
Retail traders “have been very hungry for dividend-paying stocks,” says JJ Kinahan, chief market strategist, TD Ameritrade. He cited evidence of that in August's Investor Movement Index® (IMX), which tracks investor sentiment.
“Dividend-paying stocks have fallen in and out of favor over the last year as the belief that the Federal Reserve was going to raise interest rates has wavered,” Kinahan says.
The Fed has raised rates twice this year, and some investors expect it to do so at least one more time. The Fed’s initial projection was to raise rates four times this year. Last year, the Fed also fell short of its rate-raising forecasts. In other words, although interest rates are rising, the pace has been slow, which means interest rates may continue hovering near historically low rates for quite some time.
Dividends are one piece of your stock investment return; the other is price appreciation. But one common theory of stock valuation, the dividend discount model, says a stock is worth the present value of all future dividend payments. So, from that standpoint, dividends can matter a great deal over the long term, especially if you plan to reinvest dividends into additional shares.
Let’s take a look at what a dividend is and how it plays a role in a portfolio.
It’s a portion of the company’s earnings paid out in cash or shares to stockholders on a per-share basis, sometimes as a lure to get investors to buy the stock. Dividends are generally paid out of earnings as a reflection of the company’s strength, although some companies have been known to borrow funds to cover their dividend payouts. That is sometimes a warning signal that cash flow is trickling.
The calculation calls for the last dividend, multiplied by the number of payments per year, divided by the stock price. If a stock trades at $55 and the dividend payment is $0.39 a quarter, the yield is ($0.39 x 4)/$55 = 0.0284 or 2.84%, in this scenario a bit higher than the yield on the 10-year Treasury, which stood at about 2.2% in late August.
Some blue chip companies might seem like they are—they’re what Wall Street calls the dividend aristocrats. Those are companies among the S&P 500 that have both the ability and the willingness to pay dividends to shareholders—and to do it at higher rates year after year for more than 25 years. Although the dividend aristocrats have historically outperformed the market, even during dips like the last recession, there are no promises when it comes to stock picking—even when the track records are long.
For investors, that’s a double whammy. Not only are the fixed payments lowered, but the share price generally falls, too, which means the value of the investment has headed south. The dividend aristocrats don’t typically cut dividends, but as with anything in investing, past performance is no guarantee of future success.
A change in management can prompt a cut, or economic conditions sometimes force companies to slash the payout. ConocoPhillips (COP), for example, was the only one of the big three oil companies to cut dividends early last year after the plunge in oil prices led to more “prudent” future planning, as Chief Executive Ryan Lance said in a statement at the time. Earlier this year, COP got back to raising dividends.
One way to keep tabs on whether dividends will be slashed is to look at the cash flow statements on the company’s quarterly reports. If it appears more cash is being paid out in dividends than the company is generating, the company may consider cutting or even doing away with the dividend.
That, of course, will depend on your stock strategy, but many financial experts encourage investors to look at their stock holdings quarterly to ensure they’re meeting the goals set out for them. That includes dividend-paying stocks.
“The closer in yield government fixed-income bonds get to the yield that you experience from your stock, you should start asking yourself about what ultimately is the safer investment,” Kinahan says. “At the end of the day, your capital is still your primary concern.”
All investing involves risk including the possible loss of principal.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Inclusion of specific security names in this commentary does not constitute a recommendation from TD Ameritrade to buy, sell, or hold.
Payment of stock dividends is not guaranteed and dividends may be discontinued. The underlying common stock is subject to market and business risks including insolvency.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2019 TD Ameritrade.