Over the past few weeks, we’ve taken a deep dive into a strangely emotive subject: stock dividends.
In fact, the two articles (the first being a reader poll) that I wrote on a hypothetical real-estate transaction was not really about real-estate at all … it was also about DIVIDENDS.
Did anybody pick up on that?
You see, the problem with the real-estate deal is that if the property isn’t good enough to generate its own profits, the Rental Guarantee forces the developer to dig into project reserves, excess cashflows, or even future profits (by borrowing more money to pay the investors the ‘guaranteed’ amount) … none of these things are good for the project, the developer, or (ultimately) you as an investor!
Lets face it, everybody who invests wants to make a profit … so, do your due diligence before you get in and let the project deliver what it can …
Similarly, a company that focuses on issuing ‘high’ dividends through thick and thin to attract shareholders – with a board of directors that doesn’t adjust their dividend strategy to market realities quickly enough – is facing just the same problems as the developer forced to offer income guarantees to attract investors to a real-estate project … it’s all great when things are going well, but when the economy sours, things change – for the worse – very quickly, under these sorts of deals.
Now, I haven’t said that you shouldn’t invest in dividend-paying stocks … others, are just saying that you should – just because they are dividend payers – which is just plain dumb.
To my mind, the fact that a company offers dividends is just one factor – a relatively small one at that – in my decision to invest in a stock …
… to my way of thinking, it’s like choosing a dentist for your kids on the basis of the volume of candy that he hands out at the end of the visit:
– Shouldn’t we choose the dentist on the overall quality of his work (and, maybe price as well)?
– Doesn’t handing out candy at a dental practice seem somewhat strange to you?
Well, that’s exactly what you are doing if you choose a company because it pays great dividends …
… now, you may use other criteria as well, but if you are EXCLUDING great companies from your list because they DON’T happen to pay a dividend, then this also applies to you!
– Shouldn’t you choose a stock on the basis of its great past/future BUSINESS performance?
– Since CASH is the lifeblood of a business and the driver of future investment and growth (eg for R&D, retooling, opening new stores, etc., etc.) shouldn’t we prefer a business that conserves it, rather than one that doles it out like candy to attract shareholders?
Look, just because a company issues dividends doesn’t mean that it’s making profits … the two SHOULD be directly related, but often they are not:
1. Profits (better yet, free cash flow) are a function of a sound business model,
2. Dividends are at the whim of the board of directors.
So, why not go direct to the source: look for companies with a strong current and (expected) future cashflow, and take your money out when YOU need it, not when the board of directors says you can have it?
So, is there a place for investing in dividends … surprisingly, YES.
But, not when and how you think:
Instead of laying out dividend paying stocks against other Making Money 101 and Making Money 201 activities, hold your thoughts until you reach your Number and are looking at preserving your wealth (i.e. with various Making Money 301 strategies).
You COULD then invest in solid, dividend-paying stocks (although, you may elect to go for a company’s Preferred Stock, rather than their Ordinary Shares) because having a semi-reliable income stream may be more important to you than overall return (i.e. you are trading off convenience for you against leaving your children or church a sizable inheritance) …
… or, you could try one of these MUCH better Making Money 301 strategies:
1. Buy Inflation-Protected TIPS (treasury bonds) or inflation-Protected MUNI’s (municipal bonds) with 95% of your portfolio, and put the remaining 5% in year-long call options over the S&P 500, to give you exposure to the potential upside of the market.
2. Buy (and hold) a rental property or five – live off the income (well, 75% of the income – leaving the rest as contingency against vacancies, repairs & maintenance, etc.) and bequeath the capital appreciation to your children/charity/church.
3. If you MUST look for dividends, buy Preferred Stock instead of ordinary/common stock (just as Warren Buffett has of late); these are a special class of stock that act more like corporate bonds, but: are less volatile than a stock; have more upside/downside than a bond; often produce higher dividend returns than the dividend on an ordinary share in the same company; and, are more likely to be paid … the issuing company usually pulls out all stops to maintain the dividend on these Preferred Shares even while lowering dividends on Ordinary Shares (a.k.a. Common Stock).
There, you are now better equipped to make decisions on dividends – at all stages of your financial life – than 99% of so-called ‘dividend experts’ 🙂