yippiekiyeh

I was wondering if anyone would like to comment on the pros and cons on dividend paying and non-dividend paying stocks. If it is a pro then why don't all companies do it (pay out dividends). If it is a con then why do companies continue to pay out dividends.

LegendKiller

Companies that pay out dividends do so because they do not have any projects that meet the Net Present Value requirements. This means that cashflows of the new projects must meet a certain % return, subtracting the initial cash outflow. If this amount is positive they invest, if not, they dont.

The % requirement varies from firm to firm, depending on the riskiness of the firm and the individual project. Investors demand a certain return and if they do not get it, then it is not worth the dollars invested.


For example, if investors feel they can get 10% return from company A and 10% from company B, they need to keep those returns. However, if company B invests in projects that only return 8%, they are not optimizing the returns for investors. They should just give the money to the investors so they can invest that cash in other companies or projects.


To determine NPV, you need to discount the cash flows.


(Cashflow)/ (1+r)^n where "r" is the return, n is the year of the cashflow. If you have a $10,000 project that returns 5,000 per year for 5 years with a required rate of return of 10% you would do this.


-10,000+ 5000/(1.1)^1 + 5000/(1.1)^2+5000/(1.1)^3 + 5000/(1.1)^4


Once those cashflows are discounted you add them together. If the project is positive, then the company invests.

If a company doesn't pay out, then they plowback the earnings, retain them. Doing so should grow the companies value (ie Retained Earnings) and increase equity. This increases the stock price and results in capital gains (which, depending on the tax rate can be taxes more or less than dividends).

To determine the rate of return you can do this.

ROE*Retention %


To determine ROE you can do a DuPont decompostion.


That is

Financial Leverage (Assets/Equity)*Asset Turnover(sales/assets)*Net Margin (Net Income/sales) == ROE




The reason why Microsoft is now paying dividends is because they do not need the additional equity paid in since they do not have projects of positive NPV.


Is that enough


LK

dbax791

Wow. Hard to top LK's post he is right on.

But in layman's terms, when you buy stock in a company you are basically buying a share of the assets of the corporation (plants, equipment, people, brand reputation), and as an owner you are entitled to a claim against the earnings.

Like LK said, some companies feel that they can make better use of the cash and re-investing it in other projects, R&D or whatnot and eventually grow the earnings of the company. Shareholders are rewarded with capital appreciation thru higher stock prices. Many high-tech companies feel a strong need to reinvest and don't pay big dividends.

Other companies that are in mature industries (tobacco stocks are the classic example) may not feel that the cash they make can be used to grow the company, so they pay out their profits in the form of dividends.

From an investment perspective, it depends on what your goals are. Most younger people want capital appreciation, because there is a lower tax impact on capital gains. Some older folks who need income now prefer dividend paying stocks since it is regular cash income, but unfortunately taxed at regular income rates.

Merlin

This is a great question

LK gave a great textbook explanation of the situation. But as with most things real life has some additional nuances. Most companies in the US don't like to pay dividends because of a signaling effect. That is, as LK put it so well, dividends can be a signal that a company does not have the great growth opportunities anymore. In the USA a company going ex-growth can kill a stock. So most will resist it.

Also, thanks to previous US tax structures dividends were taxed at higher rates than capital gains. As such good company management rightly recognizes dividends as an extremely inefficient way or returning capital to shareholders. A better way of doing so is through share buybacks. But there are issues with that as well. Companies spend lots of money buying back shares simply to turn around and put them back in the via stock options.

And lastly and in my opinion most importantly, corporate CEOs are for the most part meglomaniacs. They see the large pots of cash as theirs and really don't want to part with it. They view it as their warchest and not your money. Think Tyco or Worldcom for public examples.

So bottom line is that there are several reasons that dividends are not paid, and most of those reasons are not good. LK gave a very good textbook explanation of the proper reason why, but understand how that good reason can be distorted to serve someone's needs.

As for me, I give preference to those that do pay dividends. For the most part they have more stable cash flows, which I like, but more importantly I invest to make money. And in doing so you have to choose to either put time on your side or on their side. By holding stocks that periodically send me checks I in effect get paid for waiting for them to go up in value. I think that is a good thing.

Remember that yield is part of your total return and that there has been munerous studies that show that companies that dividends tend to outperform over the long haul.

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yippiekiyeh

I was thinking about that in the same terms. Do companies that give out dividends tend to outperform those that don't... My other thought was the idea of getting a little $$ for investing correctly. Kind of a reward.

zippyjuan

If you are interested in investing in dividend paying stocks or jsut want to get started investing and don't have a lot of money, a good thing to look at are what are called DRiPs or Dividend Reinvestment Plans. I got started this way with a utility stock as my first purchase. The Motley Fool can tell you a bit about it here: http://www.fool.com/school/Drips.htm

Basically you are buying stock directly from the company- you do not need a broker and both the costs and initial investment are significantly lower. As I recall, the minimum purchase on mine was $250. Since you are not going through a broker, you do not have to pay a transaction fee (there may be some small fee- I think I paid $2.00 last year). Once you make your initial investment, an account is set up for you. When the dividend is paid, that money is not sent to you, but reinvested into buying more shares. you can add to or redeem your account at any time. Additional contribution limits can be as small as $25. Since the dividend is per share, it the price of the stock is up, you buy fewer shares- you get more if the price goes down. You are taxed on the dividends. As far as return, I was looking at the dividend as my return- any appreciation of the shares would be secondary- although my utility has gone up quite a bit in the last year. It can be a good low cost investment option. Generally look for companies that raise their dividend on a fairly regular basis- good ones can be things like Utility or tobacco stocks (although I am opposed to smoking). Beware of stocks offering too high of a dividend (% return).

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teoulmoon

sorry they layman answer to your questions is value (dividend paying) vs. Growth (non-dividend). You may first want to consider what tax bracket that you fall into. that way you can consider what type of control you would like to take when it comes to taxes on the growth of your account.
as far as long term performance, there hasn't been a really large discrepency in the long term performance of each. there are times when growth really is in favor and well as time when value is in favor.

good luck

zippyjuan

Value and Growth are not necessarily just dividend and non-dividend. A stock may be Value because it is percieved to be underpriced relative to similar companies or in a sector which is percieved to be underpriced relative to the rest of the market. It may or may not pay dividends. Growth stocks are considered that because of the growth of the company and stock value apreciation, not necessarily do they not pay dividends- some certainly do. Microsoft is a Growth stock that pays dividends. Dividend vs non-dividend paying stocks can be clearly defined. Growth and Value are subjective and may include both dividend and non-dividend paying stocks.

yippiekiyeh

I know about drips, but I would like to know about a list of drips that I can look into investing... that's always what I'm looking for!

zippyjuan

DRIP Investor is one place you may try. Sign up for their 30-day free trial, cancel if you want then and you can access their information, print their list of stocks, learn more. https://www.zdmcirc.com/zdmcirc/promo/voodoo/index.html

I found another site where you can get a listing free: http://stock1.com/stocka.htm
In the top right- hand corner is an alphabet box where you can choose a letter of the alphabet and it will list them by that letter. Click on the plan number for more details. Buy the DRIP directly through the company- don't pay someone else to buy them for you. Good luck!

yippiekiyeh

Excellent! Thanks ZJ

yippiekiyeh

New question regarding this topic:

I was reading that dividend stocks take a double tax hit... so wouldn't it be better to go after the non-dividend paying stocks instead?

dbax791

Not necessarily. The "double taxation" just refers to the the fact that the company pays taxes on its profits thru corporate income tax, then individual investors pay income tax on the dividends they receive.

So yes, the company's income is being taxed twice, but from an investor's perspective it is only taxed once as dividend income.

zippyjuan

Plus with the recent changes in tax rates on dividends, they could be lower on dividends than on retutns from other taxable investments.

LegendKiller

You also have to remember that instruments of similar risk take into account tax implications. For example, a municipal bond and a government bond. The muni isn't taxed for certain things while the government bond is. The muni has to have a tax adjusted return so there is no arbitrage for similar risk classes.

It really comes down to risk preference. With dividends you have to reinvest them (unless you have a drip as mentioned above), this risk threatens return. However, you are able to allocate dividends to areas of different investment, while stocks that do not pay dividends are concentrating on capital gains and thus have less diversification.

There are different theories that show how companies might be better favored in one strategem or another, "Bird in the hand theory" is one of those.

It all comes down to how risk-averse you are. If you prefer to have steady income, ability to reinvest freely and ability to diversify, then buy dividend stocks. If you prefer to hold out on taxes, concentrate wealth, and take advantage of compounding investments, then take non-dividend stock.

Remember that all stocks are adjusted for risk. If stock A has a return w/ divs of 10% and stock B is similar and has 8%, there is a reason why stock A has greater returns.


LK

John Fembup

This is all very interesting. I have a different question about it that perhaps someone here can answer.

Why do some companies pay a dividend of $0.01? Why not just pay zero? There must be some important reason to remain a dividend-paying company. Does anyone know what that is?

Jeffbx

Because the market loves when companies can pay dividends, even if it's just a small amount. That says the company is stable, making money, and has enough cash flow that they can pay the owners a little something.

In reality tho, unless you're buying thousands of shares of stock the dividends don't make a huge impact to the investor.

renovation

this is very true - i have a wide range of stocks i own. some pay dividents and some don't some I personally own the paper shares (keep in a safety depost box at my bank) and some are held by the broker house i use. i will give this advice to members - if your wanting to get into stocks only invest what your willing to loose. i have made money on stocks and right now im like 45% in the whole. on money i have invested in the last 5 years and i feel good im only down that much.

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guiseppewv

Companies also like to brag that they have been paying a dividend for X number of quarters. If they are going through a tough time they will not eliminate their dividend because in the long term it is better to pay out a penny per share than to not be able to say you have been paying out a dividend for 40 consecutive quarters.

zippyjuan

Adding a dividend, if your company did not have one before also gets your stock tracked (and perhaps bought) by dividend stock funds which could increase sales of your stock- raising its value.

clutchy

yeah i'm with you on this. If they're paying a penny it's b/c they don't want an interruption in their consecutive payments.


I've been trying to buy dividend stocks as a strategy and it's kindof backfired but they'll probably return to paying them eventually. for the time being i guess i'll just have to deal w/ the excessive capital appreciation.

I overall just like the idea of getting dividends and then using the earnings to buy more stock. It's somewhat of an autopilot strategy since i'm not a "market timer" it works out better for me.


BAC went from .4 to .01
GE went from .3(i think) to .1
ING went from $1.00 per half year to nothing
CIT went to nothing
FTR is still paying .25 which i'm surprised about/ thx kevster.
HIG went from something to .05 now. but i bought it at $5/share so i'm not complaining.

i need to diversify my personal stash... but i guess that's what the 401k is for.

I'm looking at utilities next although the ones i've been watching having grown much so i may avoid them during the "recovery."

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LK was treated unfairly

thanks X

guiseppewv

I think you need to avoid companies that are:

a) have a high dividend (north of 6%) b/c chance are their stock has plummeted and they haven't gotten to cutting their div but they will as soon as they report their next div

b) companies that pay out >80% of their net profits via their dividend. There are companies that are paying out 105% of their div if they pay it at the same amount as last quarter. This is not sustainable.

clutchy

i wish i'd known that about a year ago lol

oh well it's fine now so no big deal.

guiseppewv

How do you think I learned? I got burnt once and then I learned! Sometime you have to get burnt to learn.

ray

Dang, aside from GE (though, GE Capital used to be very profitable for them) and FTR it looks like you went heavy on banking/financial stocks. Diversifying out would have helped spread the risk. Think of companies like Johnson & Johnson or even Coca-Cola for nice steady dividend payouts.

clutchy

they were the most volatile at the time which i wanted and it's worked out pretty well, but yes i'm trying to diversify out of banks. Although they've been tanking recently so i'll probably hold out for awhile.

i also don't buy stocks that are above $20 atleast i try not to.

guiseppewv

The price of the shares should be irrelevant to what you buy to a certain degree. I know we all aren't going to be buying brk.a anytime soon b/c of the ~$100k price tag. You need to look at the quality of company. If you have the chance to buy 100 shares of xyz at $10/share and they are a mediocre company or you have the chance to buy 1 share of abc and they are a blockbuster company then I would hope that you would buy 1 share of abc.

clutchy

yeah... i actually try not to operate that way although i will agree that's probably a better way to buy. I try to buy undervalued companies but i rarely will put down more than $20 on a share. Especially now. There's lots of value in the under $20 category and i'm trying to suck that up right now.

this is just for fun though, my 401k is blasting right past my personal stuff.

cocojambo

Some of America's largest companies like Procter & Gamble, Walmart, Johnson & Johnson, Merck, Eli & Lilly all have grown to valuations in excess of $100 billion each. To grow further than this point will prove challenging, thus these companies like to reward their shareholders by giving them a portion of their net incomes.

You should really be looking at investing in dividend aristocrat stocks such as

* Exxon (XOM) – 27 years
* Clorox Co (CLX) – 32 years
* McDonald’s Corp (MCD) – 33 years
* Wal-Mart Stores (WMT) -35 years
* Coca-Cola Co (KO) – 47 years
* Johnson & Johnson (JNJ) – 47 years
* Procter & Gamble (PG) – 53 years

The S&P 500's Dividend Aristocrats is the most prestigious list of dividend paying stocks in the world that are tracked by S&P 500 Index. The Dividend Aristocrats Index is a list of companies that have consistently grown their dividends for at least 25 consecutive years. The index is so strict that if a company misses even 1 year of growing its dividend, it is eliminated from the Dividend Aristocrats Index.

Read more about it here S&P 500 Dividend Aristocrats - the best Dividend Paying Stocks in the Market

JackHammer

Con Ed stock ED is pretty good along with Chimera (CIM).

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