A friend of mine asked me about dividends the other day. So this week I’m going take a quick dive into dividend investing. For a long time I hadn’t ever given dividend investing much thought. The concept was not much more to me than the Monopoly guy on the Chance card.
“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” — John D. Rockefeller, 1901
What is a dividend anyway? In the context of stock investing, a dividend payout is a regular distribution of a portion of profits to shareholders. They are especially attractive to the likes of retirees and income-focused investors. Dividends are paid for a variety of reasons. The company wants to incentivize shareholders to buy-in on a stock and hold onto it. Or perhaps the company sees little future growth and rather pay dividends in lieu of reinvesting into expansion or R&D.
However, beware of simply picking a stock with a high dividend yield. It could be an attempt to attract investors toward a troubled company. Always check the fundamentals such as PEG, D/E and Intrinsic Value to ensure the company has reasonable growth prospects and that the company isn’t too highly levered by debt, and its stock is ideally intrinsically undervalued.
Over the years, I’ve come to realize how powerful dividend investing can be, especially when combined with the power of S&P 500 investing. In a post from last year, I talked about how an S&P 500 dividend fund I was heavily invested in outperformed during the 2022 bear market. The market was down 19% and the fund I was in was down 9%.
The fund’s strategy was pretty simple—invest equally across all 11 sectors, leaning toward stocks that have a track record for consistently increasing dividend payouts over time, even through recessions. This would indicate that the companies in the portfolio are generally stable and financially healthy, which is likely the primary reason the fund did better than most in 2022.
A diverse subset of S&P 500 value stocks that pay dividends will continue to be a part of my portfolio as I migrate toward 100% equities this year (see Stocks & Bonds post from last month). The dividend payers will be the downside protection measure instead of bonds.
Picture this, an S&P 500 stock selling for $100 with a 7% dividend yield, pays $7 per share. If the stock drops to $50—my doomsday scenario—then that yield jumps to 14%. If the data shows that the company fundamentals and overall value are strong, and I expect the high-yield will be maintained based on the company’s track record of consistent or increasing dividends, then I’ll scoop up more shares for the yield alone, compounding the ROI when the stock does recover.
“When stocks yield as much as bonds, you get the growth free.” — Arnold Van Den Berg
P.S. I'm sharing some investment information, but it's important to remember that what I'm providing is for informational purposes only and should not be construed as financial advice.
Happy Investing,
John
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