Dividend investing: pros and cons

[Kohanz]

I've gotten more involved in my own investments lately and, like many people doing their own research, saw that many people advise to invest in dividend-paying companies for income from the dividend as well as long-term growth. However, a friend (who works in the financial markets) shared some interesting thoughts on this strategy, which don't make it appear to be such a great idea as some would suggest.

As I understand it (correct me if I'm wrong), the motivation for investing in companies with a long track-record of paying dividends is for the dividend yield to provide a semi-guaranteed return. Therefore, one only has to research the company to ensure that it is a good long-term investment and you'll hopefully reap the benefits of both the dividend and growth in the stock in the long-term.

However, my counter-argument is that so much depends on that "research" step and how good you are at picking companies whose share price will grow, that whether they pay a dividend or not becomes almost meaningless. In an efficient market, isn't the value of the dividend accounted for in the share price anyway? It is presented to the amateur investor as some sort of bonus (I initially viewed it this way), but this is not the case. Also, as my friend pointed out, it creates a taxable event. It won't matter for investors like me who are just starting out, but surely when the account size is larger, you'd rather have more control over your taxable income, no?

I'm not an expert on investing, but I just want to start a rational discussion on the pros and cons of dividend investing and if it's really all that it's cracked up to be?

I would suggest that you might be as good or better off expending all your energy on researching which stocks, ETFs, will provide you with the best growth opportunities, rather than how much of a dividend they pay out. A good dividend paying company will give you 5% more than a non-dividend paying company, but again, this is reflected in the share price and, the variance of your return on the actual stock itself I'm guessing is much, much higher than 5% - so the pick itself is much more important than whether the company pays a dividend.

I'm more than open to hearing why I might be wrong.

[ccyk]

I've gotten more involved in my own investments lately and, like many people doing their own research, saw that many people advise to invest in dividend-paying companies for income from the dividend as well as long-term growth. However, a friend (who works in the financial markets) shared some interesting thoughts on this strategy, which don't make it appear to be such a great idea as some would suggest.

As I understand it (correct me if I'm wrong), the motivation for investing in companies with a long track-record of paying dividends is for the dividend yield to provide a semi-guaranteed return. Therefore, one only has to research the company to ensure that it is a good long-term investment and you'll hopefully reap the benefits of both the dividend and growth in the stock in the long-term.

However, my counter-argument is that so much depends on that "research" step and how good you are at picking companies whose share price will grow, that whether they pay a dividend or not becomes almost meaningless. In an efficient market, isn't the value of the dividend accounted for in the share price anyway? It is presented to the amateur investor as some sort of bonus (I initially viewed it this way), but this is not the case. Also, as my friend pointed out, it creates a taxable event. It won't matter for investors like me who are just starting out, but surely when the account size is larger, you'd rather have more control over your taxable income, no?

I'm not an expert on investing, but I just want to start a rational discussion on the pros and cons of dividend investing and if it's really all that it's cracked up to be?

I would suggest that you might be as good or better off expending all your energy on researching which stocks, ETFs, will provide you with the best growth opportunities, rather than how much of a dividend they pay out. A good dividend paying company will give you 5% more than a non-dividend paying company, but again, this is reflected in the share price and, the variance of your return on the actual stock itself I'm guessing is much, much higher than 5% - so the pick itself is much more important than whether the company pays a dividend.

I'm more than open to hearing why I might be wrong.

thats back to basis. do you trust the management?
there are some company with operations that is sustainable without involvement of top level management( eg, pipeline companies, producer of mine and oil field in full production stage). the operation is just a cash generation machine. do you as a shareholder want the money back or want to leave money to management seek out new project(what they say) and pay them fat bonus(what I say)? if i want growth why dont I just buy mid/jr companies? I want to allocate investment in stable income stream and growth by myself, not by management of company. too many management are just leeching fat bonus.

tax issue wont be a problem, if it is in rrsp/tfsa. but then dividend paying companies will draw investor that want dividend to support its stock price.
dividend is the only way to get back money without selling shares, which is important to maintain voting right for the big guys.

[brunes]

However, my counter-argument is that so much depends on that "research" step and how good you are at picking companies whose share price will grow, that whether they pay a dividend or not becomes almost meaningless. In an efficient market, isn't the value of the dividend accounted for in the share price anyway? It is presented to the amateur investor as some sort of bonus (I initially viewed it this way), but this is not the case. Also, as my friend pointed out, it creates a taxable event. It won't matter for investors like me who are just starting out, but surely when the account size is larger, you'd rather have more control over your taxable income, no?


If you are investing for the long term, then yes, dividends are not as important. But as you start to get a more mature portfolio, they can bring a measure of stability to your account, by providing that constant cash-flow.

Furthermore, if your goal is to build your investments to the point at which you can retire (which really is everyone's goal, or should be), then dividends can provide a good means to track that - as soon as your dividend income after tax matches your employment income after tax - you are good to retire any time! Keep in mind that due to the preferential taxing of dividends you need substantially less dividend income needed to replace your employment income.

[Stryker]

It all depends on what type of dividend investing you're talking about. I keep away from high yield dividend investing because my real interest for many years now has been dividend growth investing, long before it became popular. I just stick to Canadian dividend growth stocks and these I hold in a taxable account, all sector diversified. I also hold a couch potato style portfolio in our RRSP's as well, just to get some fixed income and foreign diversification in there.

By the way, studies have shown that over the very long term, the majority of portfolio gains have come from continuing to reinvest your dividends, not from capital gains.

[angelok]

However, a friend (who works in the financial markets) shared some interesting thoughts on this strategy, which don't make it appear to be such a great idea as some would suggest.




From 1926 to 2010, the S&P 500 returned a compound annual return of 9.9% with approximately 42%
of this return coming from dividends.

[Stryker]

Investing in dividend stocks pays off (http://business.financialpost.com/2011/08/17/investing-in-dividend-stocks-pays-off/)

Jonathan Ratner Aug 17, 2011 – 9:50 AM ET

Mr. Zyblock also pointed out that better returns can be found with dividend growers.

“With the help of our quantitative team, we find that being selective in this process pays dividends – pun intended,” the strategist said. “Dividend growers outperform dividend payers, which in turn outperform the benchmark, dividend cutters, and the non-payers.”

[Allen32]

However, a friend (who works in the financial markets) shared some interesting thoughts on this strategy, which don't make it appear to be such a great idea as some would suggest.

Don't trust friends advice. Please do your own research and garner your own conclusions as the merits of investment returns.


It is presented to the amateur investor as some sort of bonus (I initially viewed it this way), but this is not the case.
Think of it as interest payment on a loan you made the company. Eventually you will get much of your initial cash outlay back when compouned and reinvested (+20 years of course). Dividend payments become gravy.


Also, as my friend pointed out, it creates a taxable event.
Did I mention... Don't listen to friends. You pay no tax in a TFSA account. You will defer tax in an RRSP account. You pay less tax on dividends then you would in a savings account or GIC. Read up on dividend tax credits in a taxable account. There is a fairly good article on MoneySense (http://www.moneysense.ca/2012/01/17/delectable-dividends/) which is easy to understand.


From 1926 to 2010, the S&P 500 returned a compound annual return of 9.9% with approximately 42%
of this return coming from dividends.
+1
Compounded dividend returns & DRIP matter a great deal over the long haul. Not only that, your collecting money in a downturn if your initial investments are below the waterline. You get nothing but a sleepless night when a non-divendend investements is seriously down. IMHO dividends & dividend growth are a sign of solid business commitment about the future and show me a responsible management of cash (a generalized statement of course). Again IMHO (;)) non-dividend payers are good for shorter term buying/cash growth and also when you want to make a quick buck. I have a number of non-dividend payers in my portofolio but I have done a lot of research on the companies (on my own and not listening to pundits) which have really payed off. However, I don't fall in love with these stocks and they will be sold when I deem that I sufficiently regained enough of my initial investement.

Why Dividends Matter (http://www.investopedia.com/articles/fundamental/03/102903.asp#axzz1zeK1NreS)

[Sanyo]

I love dividends! Unless your lucky to catch the next Apple or Lululemon, there is no better way then to invest in stable dividend companies.

The only con is when interest rates are being raised very aggressively as that could signal a rotation from dividend stocks to high yield bonds. However, many companies are paying anywhere from 1 to 4-5% more in yield from their dividend, then from interest in a gov't of canada bond (plus the possibly of rising dividends every year). Plus, you get a dividend tax credit which helps to offset taxes over interest income which is taxed at the highest rate.

Anyways, yes good dividend stocks pay off. But always remember valuation as well and dont buy just for the sake of the dividend, but if a company has had years of paying them, its a good bet it will continue in the future (look at stocks like Philip Morris, McDonalds and Coke in the States and the banks, telecom and pipelines in Canada). Liquor stocks are also a favorite of mine as people drink in good and bad times (if your not a strict ethical investor).

[chevron]

From 1926 to 2010, the S&P 500 returned a compound annual return of 9.9% with approximately 42%
of this return coming from dividends.

Yes, but of course if the companes had kept larger cash holdings or engaged in more share buybacks, the return would have been more towards share price. I'm fairly agnostic about dividends, ultimately it's all about the earnings.

[Kohanz]

From 1926 to 2010, the S&P 500 returned a compound annual return of 9.9% with approximately 42%
of this return coming from dividends.

You're comparing to eternal buy & hold, which is pretty ridiculous. I don't think anyone is employing true buy & hold these days anymore...

[cjottawa]

Some reading for you:

http://www.investopedia.com/terms/b/bird-in-hand.asp#axzz1zfPEp9N1
http://canadiancouchpotato.com/2011/01/18/debunking-dividend-myths-part-1/

I find dividends attractive because of inefficiencies within large organizations. I've worked for Fortune 500 and government and witnessed firsthand all kinds of processes, systems and people who sit idle too much. That's wasted money. Scheduled dividend payouts remove that money from the company's stockpile where it could (potentially) be under performing and puts it in my hands.

IMO, most of your/my/anyone's portfolio should be in index funds. See the Canadian Couch Potato model portfolios for suggested components: http://canadiancouchpotato.com/model-portfolios/
More on asset allocation here: http://www.bogleheads.org/wiki/Lazy_Portfolios

If you're dabbling in the market, reserve 5-10% of your funds for dividend paying stocks.

I'd suggest DRIPs, directly with dividend payers that have them, since fees are zero, versus $29 per trade with a broker. More on that at these links:
http://www.dripprimer.ca/
http://www.finiki.org/wiki/Dividend_Reinvestment_Plan
http://dripinvesting.org/boards/boards.asp

[Kohanz]

Don't trust friends advice. Please do your own research and garner your own conclusions as the merits of investment returns.

Of course I do, but I happen to also trust this friend's insight (and experience) quite a bit. My own experience is also somewhat more than just a beginner, as I have worked with this person in the past on automated equity trading software.


Think of it as interest payment on a loan you made the company. Eventually you will get much of your initial cash outlay back when compouned and reinvested (+20 years of course). Dividend payments become gravy.

This is if all goes well. However, over twenty years, a company is also going to experience wild swings in value. They may go in your favour or they may wipe out your investment. My point is that these swings in value are often more powerful than the dividends and should be your main concern when researching.


Did I mention... Don't listen to friends. You pay no tax in a TFSA account. You will defer tax in an RRSP account. You pay less tax on dividends then you would in a savings account or GIC. Read up on dividend tax credits in a taxable account. There is a fairly good article on MoneySense (http://www.moneysense.ca/2012/01/17/delectable-dividends/) which is easy to understand.

Sure, the TFSA is nice, but the space afforded by it is hardly enough for a serious investor.



+1
Compounded dividend returns & DRIP matter a great deal over the long haul. Not only that, your collecting money in a downturn if your initial investments are below the waterline. You get nothing but a sleepless night when a non-divendend investements is seriously down. IMHO dividends & dividend growth are a sign of solid business commitment about the future and show me a responsible management of cash (a generalized statement of course). Again IMHO (;)) non-dividend payers are good for shorter term buying/cash growth and also when you want to make a quick buck. I have a number of non-dividend payers in my portofolio but I have done a lot of research on the companies (on my own and not listening to pundits) which have really payed off. However, I don't fall in love with these stocks and they will be sold when I deem that I sufficiently regained enough of my initial investement.

Why Dividends Matter (http://www.investopedia.com/articles/fundamental/03/102903.asp#axzz1zeK1NreS)

These are valid points - it sounds like you have a solid approach. Personally, I lean more towards investing in ETFs (especially commodities) rather than individual companies as I feel it offers me more diversification. I have and do invest in companies, but I find their valuations to be a lot more volatile over the short term than some of the indexes I now lean towards.

[Stryker]

You're comparing to eternal buy & hold, which is pretty ridiculous. I don't think anyone is employing true buy & hold these days anymore...


Since I just buy dividend growth stocks and sit on them, as long as the companies continue growing that dividend, I can hardly call myself a trader. I wouldn't call Tom Connolly (http://www.dividendgrowth.ca/dividendgrowth/) a trader either, and he's been doing the same for over thirty years.

[Phat_cow]

So, how does one collect their dividends if they have investments in a dividend paying company? Does that company automatically know you that you have investments with them?

[brunes]

So, how does one collect their dividends if they have investments in a dividend paying company? Does that company automatically know you that you have investments with them?

They get deposited into your brokerage account, after which you can do with the money whatever you want - use them to buy more stocks, or transfer them to your bank account to buy hamburgers.

A lot of people use dividend income as their monthly paycheque.

[FiNaL WaR]

Yes they know you hold the stock (or the company like questrade) then it receives money and distributes it to all the clients.

[wm009]

I'm just going to chip in a little bit. First, watch yourself when people talk about dividends especially on the internet. I'm not saying everyone is like that, but the numbers I see thrown out are nothing more than statistical masturbation as it adds no value at all. You'll hear people talk about how their dividend yield went up 20% this year and how they're making a 20% yield on their initial investment, and blah blah blah. This is all masturbation. The only statistic that matters is total return. And when you see it, you'll find that it isn't anything special.

That's my first point to you. It may look like the grass is greener on the other side, but are you really getting a fair view of total return or some statistical masturbation?

Secondly, dividends have their place. If you're looking to earn income (like when you're in retirement) this is something that you'd want. Does it make it superior (for returns)? No.

Dividends have a tax advantage, but it doesn't make them ideal. First, you have to pay tax on dividends when they're paid. You can't defer it. Where as a capital gains you can defer for a long time. It seems to be a consensus that dividends are lower taxed than capital gains. And for most tax brackets this is true. But it's not the be all and end all. In Ontario when you start making more than $80k/year, capital gains is cheaper (and can be yet again deferred). In Quebec, once you make more than $42,700 a year, capital gains become cheaper.

[Jungle]

Pros: mature companies giving cash
Cash can be re-invested.
Easy to find companies that have history dividend increase every year. This usually means profits are increasing and share price will increase also as company makes more money.

Cons: money is not being re-invested in company to grow. Look at apple for example. They did not pay a dividend (up until recently) and used money to grow, make new products, ect. Share price has followed insanely

But I am not good enough to find the next apples nor do I want to gamble with my retirement money, so choosing dividend paying stocks is so much easier.

Not sure about anyone else, but I almost wet my pants when companies increase dividend, especially when it's twice a year (BCE recently) or above 10 % (suncor, CNR)
I get a higher raise from these companies then I do at my own job!!

[rob444]

In an efficient market, isn't the value of the dividend accounted for in the share price anyway?

This has always been the main argument i've heard against dividend investing. As other have mentioned the money that is going to dividends, is not going to grow the company itself so as a result the actual growth potential of the stock price should be lower vs a similar company that pays no dividends and instead re-invests that potential payment.

So the question i would ask to the more experienced dividend investors here... is have there been any studies done on the historical growth rates of stocks in similar market segments, for dividend vs non-dividend paying that shows non-dividend ones have a higher growth potential?

Also would it makes sense to say that if a company performs poorly or is in a segment/industry that happens to be in bad economic times, the company with a strong track record of sustained/increasing dividend payments (i.e. div aristocrat stock) would lose less of their stock price since the dividend aspect will make it more attractive to investors?

I am fairly new with my dividend portfolio, but the main reason I target dividend stocks is to re-invest with each payment. In most cases you can more or less count on a certain dividend income, regardless of if the stock price is up or down over a given time. With a non-dividend stock, if i wanted to re-invest my profits elsewhere I would need to see an increase in the share first, then sell a set number of shares proportional to the increase, pay capital gains, and then re-invest wherever. And of course if the share price has decreased, this would be impossible.

[Cerenity]

a company A that pays a dividend is saying:
we have taken part of the earnings, and reinvested it as we see fit in areas where we feel there are opportunities to generate value, and adequate return for shareholders
but business is doing so well, and generating more cash than there are available opportunities
we could throw money at riskier opportunities, or ones that generate lower return, but we do not feel like this is good capital allocation
thus, we're returning capital to you, the shareholder, to let you decide where you want to redeploy the capital

a company B that pays no dividend is saying:
we see many opportunities that will generate excellent returns for our reinvested capital, enough to use up all the cash being generated by the existing business
in fact, there are so many opportunities, that every last dollar generated by earnings can be utilized and generate sufficient return

the key difference between the two then becomes,
do you feel company B's management is correct in their assessment
do you feel company B's management is smart in their capital deployment
do you feel you have no better way to use the capital should it be returned to you in the form of a dividend


it really comes down to whether you think management is prudent in their investment selections, or a bit reckless and tends to overpay for acquisitions, or throw money at unrelated / unfit business areas.

given good management, who really only throws money at superior opportunities, i will always take no dividend, full reinvestment
but given that management often makes very bad decisions to either overpay for acquisitions, buy back stock at price peaks, or hoard cash and let it sit there, company A becomes a pretty attractive option in general, because the company has enough money to reinvest and try to keep growing, and returns the rest to me, so i can look for better areas to deploy that capital. if i think the prospects of company A are good, and i'll get sufficient return at current stock prices, i can always choose to use the dividend to buy more stock. if i don't i can go elsewhere

[Allen32]

@Cerenity: Well said. That is exactly what one needs to consider when evaluating a business and to invest in that company.

[wm009]

is have there been any studies done on the historical growth rates of stocks in similar market segments, for dividend vs non-dividend paying that shows non-dividend ones have a higher growth potential?
There are studies, but they're hard to do. Any dividend company that stops paying dividends needs to be removed. Any company that goes bankrupt is obviously wiped from the results, which end up showing a bias.

There are plenty of statistics that show small cap companies grow faster than large cap companies. Large caps are more likely to pay dividends and small caps typically don't (as they're too busy growing).

[Jungle]

I think over the long term, (20-30 years) they say it's almost impossible to beat market returns. There are exceptions. However, I am no Warren Buffet or Peter Lynch. Also I have no clue which company or management will take cash and make it grow beyond dividend paying companies. If I did, I would be rich. This kind of stuff requires a lot of research and there is no guarantees. The easiest way for me to buy stocks is to just buy the ones that have increased dividend beyond inflation every year. That shows me that have a good track record of increasing profits and making more money, without painstaking research to find the next "gem." The growth may be slow and steady, but looking at their return history is still a typical 5-15% return per year in some cases over the last decade or two. The is very acceptable imo.

[Stryker]

Our taxable portfolio is near 100% invested in Canadian dividend growth stocks, and has been for the last decade. I've been studying investing for over thirty years, and I always learn more from bear markets than I ever did from up trending markets. Lesson learned from the 2008-09 financial crisis was to get more diversified sector wise. This I've implemented as best I can. Other than that, I just let the dividend signal whether a stock should be bought, held or sold. I try to make it the least complicated as possible. Much like the passive index portfolios my wife and I hold in the RRSP's.

[Cerenity]

do you feel the ability to diversify across sectors is rather restricted when limited to just canadian DG equities though?

im not a wise old timer like you (and also not as experienced lol) but my feel is when it comes down to top notch DG equities, TSX selections leaves me feeling not very diversified at all.

i understand the FX risks with US equities, but i think in the long run, the FX is relatively neutral, or at most a small impact, since our economies are so intertwined

[Stryker]

do you feel the ability to diversify across sectors is rather restricted when limited to just canadian DG equities though?

im not a wise old timer like you (and also not as experienced lol) but my feel is when it comes down to top notch DG equities, TSX selections leaves me feeling not very diversified at all.

i understand the FX risks with US equities, but i think in the long run, the FX is relatively neutral, or at most a small impact, since our economies are so intertwined

I've had to give up three out of ten sectors. There's nothing in the Canadian healthcare or technology sectors I'd be interested in buying, but will be covered to a small extent by the U.S. and EAFE index funds and ETF's in the RRSP's. The basic materials sector is covered by the Canadian TSX index we also own in the RRSP's. No room for it in the taxable portfolio, and yes there will be some overlap to a certain extent.

The above is not the way Tom Connolly (http://www.dividendgrowth.ca/dividendgrowth/) does it of course. He says himself he doesn't diversify by sector, nor does he buy foreign equities, let alone index funds. Only Canadian dividend growth stocks and nothing else. He's been doing this since the early 80's, and so far it appears to have served him well.