Dividend investors should do their homework, or risk getting burned with this income-seeking approach.
Investors are in a jam. Back-to-back market crashes seem to have taught baby boomers that they can’t rely solely on capital gains to fund their retirements anymore, and record-low interest rates have stemmed the once-steady cash flow from bonds.
“If you want the potential inflation hedge, the income, and some chance of capital appreciation over the long run, there is just one door open – high-yield equities,” said Josh Peters, founding editor of Morningstar Inc.’s Dividend Investor Newsletter.
Of course, dividend investing isn’t exactly new. It’s been around as long as, well, dividends, and some Blue Chips have payment histories stretching back more than a century. What is new is that investors of all stripes are looking into dividends, which were once written off as too boring for anyone but well-heeled retirees. Compared to most of the alternatives out there today, though, those yields of 3% or so look downright growth-y, say some proponents.
The potential advantages of buying dividend-paying stocks are obvious, said Sam Stovall, chief equity analyst for S&P Capital IQ. “Since 1926, about 40% of the S&P 500 Index’s total return has come from reinvested dividends. Getting a 40% premium on your money just for letting it ride is hard to beat,” Stovall said. That yield provides a nice payment every quarter, but in the event of a hard market fall, dividend paying stocks will get whacked just like the rest of the market.
Another plus, particularly during shaky equity markets, is that dividend-paying companies tend to have large market capitalizations and may have more stable business operations, which means that their profits might not be as vulnerable to economic downturns. As a result, their stocks may be less volatile than the market in general, Stovall said.
Use the TD Ameritrade Screeners tool to determine a potential stock’s divided yield, dividend frequency, and more. When creating a customized stock Screener, select Dividends as one of your criteria. You can set alerts on ex-dividend and payable dates.
Many popular dividend strategies, such as The Dogs of the Dow, focus on finding the highest yielding stocks within a certain group or sector. But not all yields are created equal, Peters warned. Investors need to look behind that number to decide its true value. First, of course, there is the standard due diligence. Dividends are paid out of net income, so does the company have a long history of growing its earnings? What about its balance sheet? It is carrying a lot of debt?
“If earnings drop all those creditors need to be paid before a dividend can be paid,” Peters says. “That’s what happened to the banks in 2008 and 2009.” Many top financial services companies had to cut dividends during the global financial crisis.
Then investors need to gauge management’s commitment to maintaining and growing that dividend. Does the company have a long track record of paying dividends, and how often has it raised its dividend over the years? This analysis is critical because the real strength in dividends is their ability to grow, Peters said.
Say a stock is yielding 4% today. If the company has consistently raised its dividend 10% a year, in seven years the income from that investment could double – on top of any potential capital appreciation. “That dividend becomes more valuable than one that doesn’t grow,” Peters said. Of course, dividends are declared by the company’s board of directors, and even a very long dividend history can change at any quarter.
Finally, “look for companies, with economic moats – a competitive advantage that will last over time,” Peters said.
For example, say you are comparing two companies: One owns natural gas pipelines and the other is an apparel retailer. The retailer can post huge profits when it hits the fashion trend just right, but fashions move quickly. If the company is depending on those profits to sustain a dividend, investors could be in trouble when skirt lengths change. Pipeline companies, on the other hand, enjoy high barriers to entry, such as extensive up-front costs and regulatory oversight. “They generate lots of cash and enjoy a competitive advantage that can last for decades,” Peters said.
Investors can also tell a lot about a company by its yield alone, S&P’s Stovall said. That’s because like bonds, a stock’s yield moves in the opposite direction of its price. Too high – anything over, say, 6% – and there is probably a good reason why the stock has dropped and the yield has risen, said Stovall.
Too low and investors have probably piled on the stock already, driving its price up beyond its current market value. It would take a drop in the stock price or a big jump in the dividend to get back into what Stovall considers a reasonable range – between 3% and 6%.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.
The information contained in this article is not intended to be investment advice and is for educational purposes only. Clients must consider all relevant risk factors, including their own personal financial situation before trading.
Morningstar Inc., Compustat and S&P Capital IQ are separate from and not affiliated with TD Ameritrade, which is not responsible for their services, policies, or content.
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. © 2018 TD Ameritrade.