Why dividends matter to investors
Joel Dresang: Adam, stock prices have been trading pretty much sideways for most of 2015, but dividends, they’re on a record pace. Let’s talk a little bit more about dividends and how they figure into a balanced portfolio. Start by defining what a dividend is.
Adam Baley: Certainly. A dividend is an elective distribution of a company’s earnings out to its shareholders. Typically, dividends are issued in the form of cash but also can be issued in terms of shares or even other property.
Joel: You wrote an article for our website on why dividends matter, what difference do those cash payouts make to investors?
Adam: They’re a major contributor to total returns and also help to smooth out the ride for investors. When you look historically, dividend-paying stocks have offered most of the gains of an up market but limited your losses just a little bit in the down market. And obviously, you’ve got the value of the dividend all along.
Total Return, by Paige Radke
It can really make sense no matter where you are in your investment life. If you’re young and you’re just starting out and trying to grow your savings, using those dividends to reinvest and buy more shares, it can really help to build wealth and compound your return.
On the other hand, if you’re in your retirement years, you can elect to receive those dividends as cash and help supplement your retirement income.
Joel: Not every company pays a dividend. Are there certain characteristics that dividend payers tend to have in common?
Adam: They’re typically the larger, more well-established businesses, the more mature companies that have been around awhile. They’re also the companies that have had a lot of growth in their past, and they have more consistent earnings now, and they’re able to distribute those earnings and those cash flows, back to share owners. Those are the types of businesses you want to be allocating a fair amount of your resources to.
Joel: Does paying a dividend make those companies any more accountable to shareholders?
Adam: It does. It really helps to hold management feet to the fire and help foster some more consistent business decisions because companies know that they have to pay out that dividend. They really need to focus on the most profitable projects out there. It leads to good business decisions. It also leads to pretty good performance of those companies long-term.
Joel: We’re always talking about risks, what sorts of risks can be associated with dividend-paying stocks?
Adam: Well, at this point in the interest rate cycle, a lot of the really high dividend-paying businesses – you know, energy companies and utilities – they have become a surrogate for bond money as interest rates have come down.
But as interest rates are expected to rise, they can quickly lose their value as a bond surrogate only because bonds are going to offer more competition. So really, pay attention to the types of dividend stocks that you own and making sure that you’re not too vulnerable to rising rates.
Joel: So dividend payers allow me the possibility of capital appreciation but they’ve also got those cash payouts. Do I need other things in my portfolio for stocks?
Adam: You need some growth as well. The natural companion to dividend-paying stocks are growth stocks, the companies that are trying to reinvest their earnings back into the company to grow their revenues.
Dividend-paying stocks are great to generate some income, but there’s more than just income, there’s also some capital appreciation. So, it’s just a matter of a balance. Every investor ought to have a healthy amount of the dividend payers for their consistency as well as the growth type of businesses for capital appreciation. When you blend the two together, they can really lend themselves well to a balanced portfolio.
Adam Baley is a registered representative and investment advisor at Landaas & Company.
Joel Dresang is vice president- communications at Landaas & Company.
5 Reasons Why Dividends Matter, by Adam Baley
Stock Basics, by the Financial Industry Regulatory Authority
Corporate cash to investors, a Money Talk Video by Isabelle Wiemero
Investing for retirement income, a Money Talk Video by Dave Sandstrom
(initially posted Dec. 11, 2015)