The cover story of BetterInvesting’s October issue discusses the popularity of equities with high yields and the risks of placing too much emphasis on dividends. With interest rates so low in recent times, many investors are looking at dividend stocks to make up for what bonds and other instruments aren’t offering.
As a result, a number of large, low- or no-growth companies whose stocks offer decent yields have seen their stocks’ prices increase dramatically over the past year.
Dividends can certainly be a fine use of earnings. They usually provide a steady, relatively safe return, and over the long term they’ve accounted for a significant portion of the total return of stocks. For example, look at the difference between the five-year growth of the BetterInvesting Top 100 Index in terms of only capital appreciation (BIXX) versus total return (BIXR), which includes dividend reinvestment.
Dividends can also be a measure of safety in terms of financial statements. After all, you can’t pay out dividends using phony earnings. And dividend increases can be a sign of the company’s confidence in future earnings.
But remember that the dividends paid out can’t be used to fuel corporate growth, and it’s growth that fuels a stock’s price in the long term. So investors who want dividends in their portfolio need to strike the proper balance. Metrics to study include the company’s history of dividends — with preference paid to those with a history of steadily raising dividends — and the payout ratio of dividends to earnings. If the company’s payout ratio is increasing, it could mean management is expecting slower growth in the future.
BetterInvesting is a national nonprofit organization that has been empowering individual investors since 1951. Founded in Detroit, the association (formerly known as National Association of Investors Corporation) was born out of the conviction that anyone can become a successful long-term investor by following commonsense investing practices. BetterInvesting has helped more than 5 million people become better, more informed investors by providing webinars, in-person events, easy-to-use online tools for analyzing stocks and mutual funds, a monthly magazine and a community of volunteers and like-minded investors. For more information about BetterInvesting, visit its website at http://www.betterinvesting.org/investing/landing/openhouse/blog/index.html or call toll free (877) 275-6242.