You encounter a stock trading with a high dividend yield, is it a good buy?
Many redditors have been saying that dividends are “meaningless” because they are taken directly out of the stock price. While it is true that a $5 stock which pays a $1 stock will be worth $4 after the ex-div date, this does not necessarily mean that the dividend is worthless.
In the case where a stock is paying an unsustainable dividend, the above concerns absolutely make sense. A $5 stock paying a $1 dividend is not such a great thing if after that dividend payment it goes bankrupt. Very likely is that after the ex-div date, the stock is much lower than $4.
Assuming we are focusing on sustainable dividends, we should instead focus on the following pros of dividends:
Growing dividends may be a sign of good business (growing earnings). This is not always the case (I will write a part 2 on this) but remembering that as a shareholder you are a part owner in the business, it is very reasonable to want a share of the profits in the business. If I owned a restaurant wouldn’t I want some cash flow from it? If I owned rental properties wouldn’t I want the rental income stream? Owning the stock is like being a part owner in the above restaurant or rental properties.
High quality income is always in high demand. Stocks that pay high and increasing dividends theoretically should not stay low forever because they will encounter great demand by a great multitude of investors seeking high and increasing income streams. Think retirees. Think about how the U.S. Treasury yields got to be so low...
Dividends are a more “sure” return than withholding the cash. I need to be very careful on this point - I am only saying that in comparison with the company retaining cash, the dividend assures that you are getting $1 for every $1 in earnings that are being paid in dividends. Potential issues with retained cash is that the company may use it for value-destroying things, such as overpaying for acquisitions, ill-timed stock buybacks, etc. Furthermore, if you were to project your investment performance not by increase in nominal value but instead by the increase in income stream, dividends provide a nice baseline. A stock that I believe will pay 8% every year forever may prove attractive as I would know that I would be increasing my income stream by 8% every year (assuming the stock itself does not go up in value)
Please note that I am not saying that one should buy a stock solely because of the dividend, as there are many reasons why a dividend is not necessarily a good thing. For example, if a company is trading at a p/e of 3 (versus S&P500 at a multiple of 20) and yielding 14%, I might wish that instead of paying out this dividend they might buyback their stock (implying a 33% return on capital).
If one were to buy a stock “because of the dividend,” they must make sure that the dividend is really secure by a steady (and preferably growing) earnings stream, but in which case I should note that the real reason they would be buying the stock would be because it is cheap. The dividend is not the reason the stock is good, it is merely a sign that it may be cheap.
Submitted August 22, 2017 at 09:19PM by linlaoda http://ift.tt/2vcAfRp
