Why Stock Dividends Matter, and How They Build Your Wealth
Trivial to the share-price obsessed, dividends hold a key to investor riches
Take a look at the investment headlines, and it’s unavoidable: Stock exchanges and share prices dominate the day, with sectors such as energy and high-tech coming in a close second.
“It’s hard to escape the daily stock market prices,” says Grant Moore, a CFP with Savant Capital Management. “Whether it’s on the news, on an app on your phone or in the paper, the S&P and Dow are seemingly everywhere.”
Ah, but what about the tally of the dividend — or for some, the ho-hum dividend? The frumpy dividend? The dividend that lacks that headline-grabbing bite?
Too often these payments — extended to shareholders as a result of quarterly excess earnings — are held in low esteem by some investors, or else overlooked. In part, it’s a question of jargon: What the hell is a dividend, anyway? Share prices anyone can understand. Stock splits seem logical. But what’s a dividend if not Wall Street chump change?
First, a quick primer: A company is divided into shares of stock and sometimes, the Board of Directors decides to divide part of the profit earned by the business among the different stockholders and mail them a check for their cut of those earnings. For example, if a business earned $100 million in after-tax profit, the board may decide to pay out $50 million in dividends and reinvest the other half into expansion, reducing debt, or launching a new product. Simple enough, right?
The Value of Dividends
And as for their value, think long term. A reinvested dividend means more stock, which means more wealth as stocks climb the ladder. “Dividends can provide consistent cash flow over time so that investors may not even need to sell the stock if they’re able to just live on the dividend,” Moore says. “As a result, too much emphasis is placed on just the stock price alone.”
“Over a long period, reinvested dividends can accumulate a large number of shares, which can be worth substantially more, especially if the shares appreciate,” says Yale Bock, president, Y H & C Investments and a portfolio manager on Covestor. In the long run, “return analysis has shown approximately 40 percent of the total return — capital appreciation plus income — is attributed to dividends.”
“Investors generally do not recognize the importance of dividends,” adds Douglas H. DeLong, senior vice president and portfolio manager at Pennsylvania Trust, a wealth management and investment firm in the Philadelphia region. “But according to a study by Strategas Research Partners, dividends have contributed over half of the market’s total return over the past 85 years.”
Turns out dividends are sexy, after all.
Picking Dividend Stocks
Here are some key things to look for when picking stocks for their dividend value:
Some dividend kingpins fly below the radar.
While some flashy tech companies have flirted with trouble — for example, LinkedIn rescued by Microsoft Corp. (MSFT), Twitter in a #superslump — compare that to Apple (AAPL), a company on everyone’s investment radar. It didn’t start doling out dividends until 2012 — five months after the passing of Steve Jobs. The last time the tech giant gave them out? 1995: nine years before the first MacBook Pro laptop.
Other dividend winners are almost a sure thing in terms of returns.
Johnson & Johnson (JNJ) is known in financial parlance as a “dividend aristocrat.” For 54 years now — ever since John F. Kennedy was in the White House — the New Jersey-based health care and pharmaceutical giant has increased dividends every single year. Even the mighty Apple hasn’t managed an unbroken string over just four short years.
In May 2016, J&J’s dividend jumped a stunning 6.7 percent, upping the payout from 75 cents per share to 80 cents quarterly. Sure, a Band-Aid variety pack costs about 12 bucks. But over 54 years and automatic reinvestment of dividends into shares, you could probably buy enough bandages to fill a semi.
Dividends can mean a retirement boon.
This boils down to a number of key factors, says Sean O’Hara, president of Pacer ETFs, an exchange-traded fund issuer based in Paoli, Pennsylvania. “We would argue that stocks with high free cash flow yield and high dividends are good holdings for investors, especially retirees. They generate higher income, have better growth potential and more downside risk management than broad-based indexes or other equities with less solid fundamentals.”
Look for "ruler stocks."
When you’re searching out reliable dividend returns, try this simple graphical exercise. Place a ruler on a graph from the start of dividend payments to the end. Now, look for the champions where most points line up very close to the ruler. “Colgate Palmolive (CL), Procter & Gamble (PG), and Coca Cola (KO) are all examples of ruler stocks,” says Bob Johnson, president and CEO of the American College of Financial Services in Bryn Mawr, Pennsylvania. “Ruler stocks are ideal for dividend investors because of the consistency in the dividend growth.”
Or, if you prefer: They’re a great measure of wealth creation.