There are seemingly as many stock investing strategies as there are stocks. According to Jack Plotkin, a former Goldman Sachs banker and expert in financial strategies, most investors are either growth or value investors. Value investing and, in particular, investing in high dividend stocks, is generally considered a more conservative form of investment that is somewhere between equity and fixed income. Value investors look to hold stock for the long term, maximizing dividend-based returns and minimizing capital gains taxes.
What is a dividend?
“A dividend is a cash distribution to shareholders,” explains Plotkin. “Typically, a dividend is paid out of the company’s profits but some companies are so committed to their dividend that they maintain it even when the profits are insufficient to cover it.”
A stock’s return is calculated as the appreciation in its price plus the dividend amount paid out to shareholders over a given time period. In the early days of the stock market, dividend percentage and stability were a critical component of many investors’ decision to buy shares in a company. However, with the rise of high-flying growth companies, such as technology and biotech stocks, investors became willing to buy shares solely for the price appreciation and forego the opportunity to earn dividends.
“When you have the Amazons and Teslas returning a hundred percent in less than a year, it’s hard for the steady dividend payers to compete,” says Jack Plotkin. “Are you really going to buy Johnson & Johnson for its two and a half percent dividend when your neighbor just doubled his money on Apple?”
Are dividends right for you?
Still, Plotkin highlights that for a certain type of investor, high-dividend yield companies can be a good match. Individuals who are looking for a steady, reliable income stream in the face of historically low interest rates may prefer the resilience of value stocks to the volatility of growth stocks.
“All signs point to a bubble brewing,” says Plotkin. “If you look at the NASDAQ right now it looks a whole lot like NASDAQ in late 1999. The tech stocks keep going higher while the economy is contracting, consumer debt is at all-time highs, and unemployment is in double digits. Those steady value stocks are a much safer bet in this environment.”
Jack Plotkin further points out that if one is looking to invest in high-dividend stocks, that could be done by investing in individual stocks or in ETFs (exchange-traded funds) that specifically invest in value stocks. A key investment factor is the size of the dividend yield, but a high yield can also be a sign of looming danger.
“High dividends usually mean that the stock price has plummeted,” explains Plotkin. “If a company is paying out $1 dividend per share and its shares trade at $50, that’s a 2% return. If the stock price drops to $10, that same $1 dividend is now a 10% return. But you have to ask yourself why did the stock price drop from $50 to $10 in the first place? It may signal underlying weakness in the business and if the business is weak, there is a good chance it will cut or even eliminate its dividend. Unlike interest payments, dividend payments are typically voluntary and most companies can suspend dividends at any time.”
Jack Plotkin underscores the importance of looking at not just dividend yield, but also the historical consistency of dividend payments and the continual growth in both earnings and dividend amount over time. Dividend payout ratios represent the percentage of a company’s profits that are paid out to shareholders in the form of dividends. Certain industries are known to have higher payout ratios than others because of the nature of their business.
“Some companies are specifically structured to pay out a majority of their profits as dividends,” explains Plotkin. “REITs are a great example. But, again, you have to consider the REIT’s asset profile and current environment. You may feel differently about a REIT that holds hospitals and medical offices versus a REIT that holds commercial office space in the age of COVID.”
Jack Plotkin on Dividends moving forward
According to Plotkin, large dividends have generally been on the wane in recent years, with the average dividend yield of stocks listed on S&P 500 hovering around 1.7%, compared to 5.68% in 1982 and 9.52% in 1932. A key driver has been the rise of growth companies whose investors prefer that profits be opportunistically reinvested in new technologies and initiatives by the business.
“It’s harder to find exceptional dividend plays,” admits Plotkin. “But there are still many opportunities in the market. The key is to determine your risk appetite and growth target, then tailor your dividend-bearing investments accordingly. Some investors may like the security of the Chevron dividend while others may prefer the upside of an IBM dividend. In making your decision, I suggest starting with the dividend aristocrats – companies that have paid consistent dividends for 20, 30, 40, or even 50 years, and exploring from there.”
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