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Dividend investing: pros and cons

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  • Jul 13th, 2012 10:03 am
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[OP]
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Jun 9, 2003
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Dividend investing: pros and cons

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.
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Nov 26, 2005
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Kohanz wrote:
Jul 3rd, 2012 2:13 am
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.
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Kohanz wrote:
Jul 3rd, 2012 2:13 am
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.
To be nobody but yourself - in a world which is doing its best, night and day, to make you everybody else - means to fight the hardest battle which any human being can fight; and never stop fighting. -- E. E. Cummings
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Jul 23, 2007
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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.
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Mar 19, 2010
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Kohanz wrote:
Jul 3rd, 2012 2:13 am
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.
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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.”
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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 which is easy to understand.
angelok wrote:
Jul 3rd, 2012 8:09 pm
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
If at first you don't succeed, destroy all evidence that you even tried.
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Feb 9, 2009
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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).
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May 2, 2012
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angelok wrote:
Jul 3rd, 2012 8:09 pm
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.
[OP]
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angelok wrote:
Jul 3rd, 2012 8:09 pm
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...
[OP]
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Allen32 wrote:
Jul 4th, 2012 7:21 am
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.
Allen32 wrote:
Jul 4th, 2012 7:21 am
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.
Allen32 wrote:
Jul 4th, 2012 7:21 am
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 which is easy to understand.
Sure, the TFSA is nice, but the space afforded by it is hardly enough for a serious investor.
Allen32 wrote:
Jul 4th, 2012 7:21 am
+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
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.
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Kohanz wrote:
Jul 4th, 2012 12:33 pm
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 a trader either, and he's been doing the same for over thirty years.
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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?
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Phat_cow wrote:
Jul 11th, 2012 7:30 pm
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.
To be nobody but yourself - in a world which is doing its best, night and day, to make you everybody else - means to fight the hardest battle which any human being can fight; and never stop fighting. -- E. E. Cummings

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