# Investing for dividends is like driving half a car …

Like this guy, you could probably drive in half a car (at least, if you were smart enough to first select the best half  i.e. the bit with the engine) …

… but why would you want to?

You could take your supplements purely for the extra vitamins, and you may even gain all extra the nutrition that you need …

… but, why wouldn’t you want to take one that has all the trace minerals that you need, as well?

You could probably invest in real-estate solely for the rental income …

… but, why wouldn’t you want to get some capital appreciation, as well?

If you feel the same way as me, why should investing in stocks be any different?!

That’s what I have to ask James @ Dinks Finance who says:

Dude, dividend stocks are not substandard investments. They may not yield as much as directly investing in your own business, but they can and do produce very respectable returns for many people.

Well, dude, you probably wouldn’t choose to regularly drive half a car; you probably wouldn’t choose to take half a supplement; so, why would you choose half an investment?

And, make no mistake: selecting an investment purely on the basis of its dividends is choosing half an investment.

Why?

Well, Matt Kranz of USA Today says:

The total return [of any stock] is a tally of the net gain, or loss, an investor received by owning a stock and receiving the dividend. When you add the change in value of the stock to the dividend, you calculate the investors’ total return.

To calculate total returns on a stock, Matt says:

Start by adding the value of the dividends to the stock price at the end of the period. Subtract from that sum the price of the stock at the start of the period and divide that difference by the price of the stock at the start of the period. Multiply by 100 to get the percentage.

Here’s an example. Say a stock started the year at \$20 a share, paid \$2 a share in dividends and ended the year at \$25 a share. The total return would be:

(27 – 20) / 20 or 35% total return

Dividend investors usually then counter with an anecdote of great personal returns, like this one from Tim:

I don’t know what sort of return you require but I have invested in a number of dividend producing stocks over more than 20 years and at least for my purposes the returns have hardly been sub-standard. Investments in MO, PM and MCD to mention several have provided very nice returns over the years.

But, Tim, if you follow my advice and look for stocks on the basis of their Total Returns rather than just Dividends, then you still may have invested in MO, PM and MCD, but you would also have invested in both AAPL (Apple) and BRK (Warren Buffett’s Berkshire Hathaway).

Westwood (a registered investment advisor) explains why chasing high dividends is not always the best strategy:

Generally, the highest yielding stocks are there because investors question (by forcing the price lower and, thus, the yield higher) the long term prospects of the business, and/or whether the payout can continue.

Current day examples include Avon Products, with its high 5.0% yield.

While Avon may be a well-known business, the company carries a lot of debt, and many speculate the dividend will need to be cut to manage this large debt load.

Or, consider the 8.5% yield of Pitney Bowes.

While the absolute yield is attractive, the level of EPS (earnings per share) is flat with 1999 and the stock is at a 20-year low. Again, investors question the long term health of the postage meter market, and Pitney Bowes’ ability to fund its dividend going forward.

So, people who look specifically at stocks that produce dividends are looking at only half the story …

… that’s why I say that investing for dividends is, almost by definition, a sub-standard investment selection methodology:

You may happen to come across the best stocks in the country, but – if you invest in the best returning stocks, regardless of what combination of dividends and/or capital appreciation produces those returns – then you are sure to!

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## 6 thoughts on “Investing for dividends is like driving half a car …”

Do you do a lot of investing in stocks in general? If so, do you pick them yourself?

As you know I do a lot of real estate investing and I’m looking to diversify a bit. What are your thoughts?

Regards,
Michael

P.S. Did you get that link I sent you about the “New Elite”?

2. @ Michael – Thanks for the link. I invest mainly in RE but have about \$250k in stocks at any point in time. I always invest in individual (and, usually, ‘value stocks’); my favorite resource is: Rule # 1 Investing by Phil Town.

3. I have a few stocks in my portfolio that pay dividends, but I consider that to be a great added benefit – not a major factor in why I purchased them!

4. @ Elizabeth – I’m not even sure that I could name which of the stocks that I own even have dividend! And, for those that offer the service, I always opt in to their dividend reinvestment plan

5. While total return is what matters, it’s worth bearing in mind that historically there are plenty of studies which show that dividends provide more of the total return than capital gains. As far as I am aware, this has never been definitively explained but the best of the explanations which has been offered is that investors simply pay too much for potential growth.

One plus about dividends – you get some cash without having to time the market.

Cheers
traineeinvestor

6. @ TraineeInvestor – “Dividend payments have contributed about 40% of the market’s annualized return since
1936.” [Source: ISI via Westwood] … not quite half a car 😉