Getting Paid To Wait - The Truth About Dividends
‘…Even if the stock goes nowhere for a while, it has a good dividend, so you get paid to wait….’
This is a common phrase you hear about dividend stocks, but it is flat out wrong. You don’t get paid to wait. In fact, unless you hold the stock in a qualified account (e.g. an IRA), you actually have to pay to wait when you earn a dividend. Why then, do we emphasize dividend paying stocks at Coastwise as a core holding for those seeking growth and income over time? As noted in my San Diego Book Award Finalist The Power Curve (Buy on Amazon), it’s the fact that a company can pay a dividend – not that it does – which is so valuable.
The payment of the dividend itself adds no value, and often triggers a tax obligation. If company X trades for $50 per share and pays out $2.00 per share (4% yield) annually in dividends, all things being equal the stock will drop by the amount of the dividend upon the ex-date (the day after the date at which you need to own the stock in order to be paid the dividend). In this example, if the stock is trading at $50 per share and you own 1000 shares - a $50K position – all other things being equal, upon the ex-date you will own 1000 shares at $49.50 per share and have $500 in cash (for $50,000 total, only a tax bill to boot). You may choose to reinvest that dividend to own more shares, or just keep the cash. Regardless, beyond stock price movements up or down for the given stock, dividends certainly are not a way of ‘paying you to wait.’ Instead, it is just breaking up your ownership into two entities – stock and cash, formally only stock.
Why then do dividend paying stocks tend to outperform their non-dividend paying counterparts over time, and those which grow their dividends consistently perform even better? The payment of a dividend forces management to be highly disciplined about its financial management. The last thing a company wants to do is cut its dividend as that would invariably tell the investment community its operations were suffering, the stock likely declining precipitously thereafter. The power of a consistently increasing dividend is that ultimately it is a proxy for ever increasing earnings. In any given year there can be a disconnect between a company’s dividend and earnings growth, however over long periods of time, the two will virtually match each other. Thus, find a company that has increased its dividend year after year for decades, and you have found a company that has consistently increased its earnings over time. And since ultimately stocks are priced as a multiple of earnings, the ever increasing earnings are the magic sauce to price appreciation over time. Own the right dividend paying stock and you get paid over and over and over and over (also benefiting from dollar cost averaging when you buy more shares during periodic price declines) for years because the company is making money over and over and over and over – for years. Let these dividends and earnings compound over time and you will really get paid to wait.
More Wall Street Follies
On March 1st a slew of investment bank analysts changed their tune on PANW. JP Morgan downgraded the stock from Overweight to Neutral. Morgan Stanley changed their call from Overweight to Equal Weight. Of course all these helpful updates in analysis took place after the stock had already cratered nearly 25%. Just more examples of why most investors are wired – if not encouraged – to buy high and sell low, thus underperforming overall markets over time. Similarly, on March 14th Guggenheim upgraded DIS from Neutral to Buy. In Wall Street speak – since often the companies the analysts are rating are also investment banking clients who pay large fees for various services – Hold, or Neutral typically means…*wink-wink* Sell. But as an analyst who wants to keep his job, you will rarely utter the words, so instead Wall Street comes up with great jargon like “Equal Weight.” But in reality, while this analyst was at best neutral on the stock (certainly not telling you to buy it – that came later), the stock was rallying over 20%. That is a few good years’ worth of gains missed. As Buffett always says, in investing if you are following the crowds – or typical Wall Street investment banking analysts advice – you are likely making mistakes.