Is investing in dividend-paying stocks a good idea?
The answer is yes. But there are some caveats.
Companies that give back some of their earnings to investors in the form of a quarterly dividend can be great stocks to own for the long haul. Dividends provide some safety — a steady stream of cash that a person can rely on even in tumultuous times.
“If you think the market is fully valued, you want to look for more secure, higher-quality stocks that pay dividends, especially if you are more conservative and concerned about preservation of capital,” said Vincent Catalano, chief investment officer with Redmount Capital Partners.
Many dividend payers also allow investors the option to buy more shares through a dividend reinvestment plan, or DRIP. Investors who sign up for a DRIP automatically have the dividend payments used to purchase more shares.
Don’t just focus on yield
If you are looking to buy stock in a company that pays a dividend, you need to do your homework. Don’t just focus on the yield, which is the annual dividend payment divided by the stock price.
Investors often are attracted to stocks with a dividend yield that’s higher than benchmark bond rates like the 10-Year US Treasury, which now yields 2.5%.
A company can have a high yield because its dividend is growing. That’s a good sign. But it can also have a fat yield because the stock price is shrinking. Those are the companies you want to avoid.
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Along those lines, Catalano said investors should probably avoid dividend payers in highly competitive industries. Those kinds of companies may even need to cut their dividends when times get rough.
Just look at Kraft Heinz (KHC), for example. That company slashed its dividend earlier this year after reporting a massive writedown. The company has struggled to adapt to changing consumer tastes and now needs to invest heavily in developing new products.
Telecom CenturyLink (CTL) cut its dividend this year, too. The company isn’t a big player in wireless and its sales are expected to fall this year and 2020 as it tries to compete with larger rivals.
Struggling Victoria’s Secret owner L Brands (LB) trimmed its dividend in half last year as well.
“Just because the yield is attractive, that is not enough. There are companies on the decline that can’t find growth and pay a higher dividend. Those types of companies may be the dinosaurs of this particular era,” Catalano said. “You want dividend growth plus earnings growth.”
That’s why some giant tech companies are now among the most attractive dividend paying stocks.
Sure, most of the FAANGs don’t pay any dividends. Facebook (FB), Amazon (AMZN), Netflix (NFLX) and Google owner Alphabet (GOOGL) are all still in hypergrowth mode and plow back much of their profits into acquisitions and research and development. For those companies, paying a dividend might actually be considered a bad sign.
Dividends plus earnings growth is a recipe for success
But older, more mature tech companies like Apple (AAPL), Microsoft (MSFT), IBM (IBM), Cisco (CSCO) and Oracle (ORCL) all pay healthy dividends that have steadily increased over the past few years.
Quincy Krosby, chief market strategist with Prudential Financial, said these companies are no longer being penalized for paying dividends. The market recognizes that they have so much cash that they can use some of it for dividends while also having plenty left over for investments and stock buybacks.
“The key is to make sure the company has strong cash flows. We look for companies that are well managed. Focus on quality as opposed to just reaching out for higher yields,” she said.
What’s the best way to invest for the long haul? Are bonds better than stocks? Do you have questions about how to build wealth? Ask us here and you may be included in a future column.
