“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” John D. Rockefeller, 1901

“OHHH! SHOW! ME! THE! MONEY!” Cuba Gooding Jr. playing Rod Tidwell in the movie Jerry Maguire, 1996

Welcome to my presentation on Dividend Paying Stocks. At the end of the week, I will send a complete PDF file of this presentation to the Sysops for posting to the archives.

If you have read my biography , you will know that my first investing lessons were taught by Peter Lynch in his books One Up on Wall Street (1989) and Beating the Street  (1993). It was in the latter book where I read:

“The dividend is such an important factor in the success of many stocks that you could hardly go wrong by making an entire portfolio of companies that have raised their dividends for 10 or 20 years in a row. “

He proceeded to mention Moody’s Handbook of Dividend Achievers (now known as Mergent’s Dividend Achievers) as a good source of stock ideas. This book quickly became my directory of Stocks to Study.

It was also through Peter Lynch that I learned of NAIC—The National Association of Investment Clubs since renamed the National Association of Investors Corporation and now using the brand name Better Investing (BI) for its products.

BI’s Stock Selection Guide was designed primarily to help investors evaluate GROWTH stocks. The premise is to find stocks that can grow sales and earnings. Stock prices will follow earnings growth over time. Buying growth companies at good prices will generate investment return.

Dividend paying stocks are generally owned for their INCOME producing qualities and old rules of thumb considered them best suited as investments for Widows and Orphans. (Read the history at: http://www.investopedia.com/articles/analyst/121802.asp )

For most NAIC-type stocks, dividends are either inconsequential or non-existent. In theory, any growing company needs to retain their earnings to grow the business. And most growing companies can achieve better returns on these reinvested earnings than investors could achieve elsewhere, thus compounding the eventual benefit stock investors will receive through price appreciation.

Throughout my reading, I was finding NAIC’s view of owning growth companies being supported by other authors. In 1994, Jeremy Siegel wrote Stocks for the Long Run in which he made the strong case for owning growth companies. In 1996, the Gardner brothers in The Motley Fool Investment Guide convinced me I needed growth stocks too and that I should buy Iomega. So I took the plunge and bought my first “GROWTH” stock. WHAT GROWTH!! But I got very nervous at the explosive rise. “A bird in the hand is worth two in the bush.” So I sold and pocketed nice profits from this rather silly experiment.

For a nervous investor learning about stocks, the idea of periodically getting a dividend check was very comforting. It made stocks seem a bit closer to the very safe CDs and savings accounts where I had been accumulating my money. But there was STRONG evidence that growth stocks were the path to building wealth. And so I had to reconcile how the SSG could work with my favorite kinds of stocks.

I found my answers and wrote an article for BITS magazine explaining my understanding of the Sources of Return.  In the article I explored how the SSG reflects the three sources of return: Earnings Growth, PE Expansion and Dividends. I have attached a copy of that article to this session.

In his 2005 book  The Future for Investors, Jeremy Siegel overturned some of his old advice and said, “reinvesting dividends is the critical factor giving the edge to most winning stoc

Attachments
	Name:   bitsanalyzingreturn.pdf	Size:   118 K

Hi Diane,

Thanks for presenting this discussion of dividends. I too experience a conflict between buying dividend vs growth stocks.I can recall a BI Repair Shop in May 2004 where Maury Elvekrog suggests that" the investor with the long-term perspective is better served by investing in companies paying little or no dividend."Yet, after Enron, I like to see a rising dividend as a sign that the company is TRULY making a profit.

My question is, if one invests in dividend paying stocks, what should the payout ratio be? In his book "The Dividend Rich Investor," Joseph Tigue suggests "leaning toward lower yielding stocks with a history of boosting dividends each year." To me this implies looking for a low payout ratio,e.g., less than 50%.

In contrast, an article in the October 2005 SmartMoney:" Paying Big and Growing Fast" by Jack Hough suggests that higher payout ratios predict faster earnings growth. Hough's article suggests that payout ratios of 60-80 per cent are optimal.(BTW, Hough's article is actually a discussion of a research paper titled "Surprise! Higher Dividends=Higher Earnings Growth" by Robert Arnott and Clifford Asness published in the Financial Analysts Journal in 2003. I read  Hough's article but not the one by Arnott & Asness.)

My second question, as an NAIC-type investor, do you recommend investing only in stocks that pay dividends?

Thanks again for your presentation and also for your plan to post a complete PDF file at the conclusion. I can see from your first installment that I will be printing out and saving your entire presentation!!!

Stan Slater

Hi Bakul,

I list my top ten dividend payers on Thursday but I'll give you a preview of the top three which I will be discussing in more detail:

By Yield:
Allied Capital 7.6%
Duke Energy 3.9%
Citigroup 3.7%

Interestingly, in my 2002 Mergent's Dividend Achievers, Paychex is ranked number ONE in terms of ten-year average annual compound growth rate of dividends. 13 years of consecutive dividend growth and a ten year rate of 46.77%

Regards,
Diane

Hi Stan,

  <<Maury Elvekrog suggests that" the investor with the long-term perspective is better served by investing in companies paying little or no dividend>>

Well Jeremy Siegel disagrees :)

I'm sure we will end up having a book discussion here at the Forum on The Future for Investors. Now that I have my copy back, that may be the next seminar I do unless someone else volunteers.

<<as an NAIC-type investor, do you recommend investing only in stocks that pay dividends?>>

 I am sharing what works for me. I own both dividend payers and non-dividend payers. In the article I attached, I conclude that having diversification in your portfolio based on the sources of return is worth considering.

I do think you need to evaluate dividend payers on different criteria and that's part of what I will be discussing this week.

<<My question is, if one invests in dividend paying stocks, what should the payout ratio be?>>

 I'll be discussing this tomorrow so stay tuned.

Thanks for your interest and questions.
Diane

Here are my top ten dividend payers in terms of curent dividend yield. 

Stock Yield

PGN   5.8

MRK  4.5

NOK   3.9

FITB    3.9

PFE    3.9

LLY   3.0

SNV   2.9

CD   2.6

JNJ   2.3

GNTX   2.3

I also have some PAYX but at a yield of 1.6 it does not make my top ten.

I would add I bought none of these specifically for yield except for PGN bought many years  ago for a 18% yield. I pay little attention to yield but in putting this list together I found it interesting many of the top ten are what I call battered or out of favor companies.

Dan Hess

Diane,

I'm sure I've read that article before, but I'm printing it out as we speak, and it will be my bedtime reading tonight.

>>Do you have dividend-paying stocks in your portfolio? <<

I'm not happy about my decision to sell Kimco some time ago.  It seemed over valued, but I think it would have been a better decision to hold on if only for the dividends, but that's water under the bridge.

I went to the PERT report to check the dividend yield in my exisiting companies.  Here are those with a yield over 1%:  CBH 1.3, GNTX 2.3, HD 1, TROW 1.4, PFE 3.9. 

Also some banks (non NAIC investments) HCBK 2.28, PFS 2.0, and OCFC 3.54 

I will be all ears as you proceed thru this workshop. 

Where do dividends come from?

Dividends are first paid from profits. Thus a company with no earnings would not be likely to pay a dividend.

Companies that pay dividends exceeding accumulated profits are actually paying a LIQUIDATING DIVIDEND. They are returning a portion of investor capital. These dividends reduce your cost basis in your investment and you are not taxed on these dividends until they reduce your basis to zero.

Companies will identify return of capital dividends at the end of the year when sending you Form 1099-DIV.

What is a payout ratio?

A payout ratio is a measure of the percentage of earnings being paid as cash dividends to shareholders.  It is calculated by dividing the annual dividends paid by the net earnings (on either a company or per share basis).

A payout ratio in excess of 100% is quite possible. Normally this will occur when a company pays dividends based on taxable income rather than book (GAAP) income as required by its corporate structure or when a company is maintaining a dividend payment rate during what purports to be a cyclical or temporary earnings decline.

One should be extremely cautious when investing in stocks with greater than 100% payout ratios.

What is dividend yield?

Dividend yield is a measure of the percentage of the stock price to be repaid to an investor over one year. It is most commonly calculated by dividing the most recent annual dividends by the current stock market price. But many places that post dividend yields may have alternative calculations.

Let’s look at the Microsoft announcement. They note that they used to pay an annual dividend. Now they would be paying a quarterly dividend. In addition they were paying a “special” dividend. Certainly the special dividend is part of the annual distribution to shareholders. But when considering yield as a criteria in stock selection, most people would choose to ignore this non-recurring payment.

If a company pays a quarterly dividend, it is very likely that at some point, the company would announce an increase in the dividend. Most investors would consider that amount to be a promise for future dividends as well. Thus in computing yield, they would take the current dividend amount and extrapolate that amount into the future rather that using historical figures.

BI’s Stock Selection Guide in Section Five uses an estimated payout ratio times estimated five year earnings and current stock prices to calculate expected annual returns from dividends.

At Value Line, I found a disclosed yield based on anticipated future dividends even though the company in question had never paid a dividend in the past. (And this will impact the yield shown on EAGLES at Manifest Investing.com)

The variation in dividend yield calculations isn’t as controversial or wide spread as the variation with PE ratios but it does make sense to know the basis of any calculation you intend to use during your stock studies. 

How is this different than bond yields?

The yield calculations are exactly the s

>>I bought Cemex when the yield was almost 9%; now it is under 2. But now I better understand what cement is all about. At first I bought CX for its income. I hold because I think the company can still grow.  <<

Diane,

Assuming the company didn't cut the dividend, then a reduction in yield indicates an increase in the price of the stock.  So for the yield to decline is a net positive for the shareholder.  Is that correct?

<< So for the yield to decline is a net positive for the shareholder.  Is that correct?>>

Only if it is because of a price rise and not a dividend cut.

I know you just want me to remind folk about the wonderful investing ideas people get when they go to the N.J. Investor Fair :)

It was shortly after my visit there that I bought my shares in May of '03 at around $20 a share. I see today where it is trading at $68. (And I did reinvest my dividends to take advantage of the 20% discount when taking the dividend in shares.)

Diane