Sunday, January 16, 2011

Dividend Stocks


Should You buy a Stock that Pays Dividends?

In my previous posting on this subject, I explored the difference between companies that pay dividends to shareholders and companies that retain earnings and create equity for shareholders.

In the stock game, as it is played on TeeVee and on various financial websites, stock price is king and nothing else really matters - what a stock pays in dividends, for example, doesn't seem to factor in.

But in terms of rate of return, you have to look at dividends seriously, as in many cases, the rate of return is quite healthy - 5% or more, which in an era of 0.25% savings accounts is not a bad rate.

It is not hard to find out which stocks pay good dividends.  MSNMoney has a listing, for example.  Others want to "sell you" a subscription for such a listing.  I am not sure why.

If you peruse the list, you may notice one thing - many companies that pay large dividends are dinosaurs.  And perhaps paying large dividends is one way they keep the stock price up, perhaps the only way.

For example Altria Group, which I posted about before, is a cigarette manufacturer, which would appear to a lot of people to be a dying industry - or at least a "mature" one.  Not a lot of R&D here, nor growth, other than through market consolidation.   But the company churns out dividends fairly regularly, although they have seemed to go down slightly in recent years.

Another company, Pitney Bowes, is one that I would personally hesitate to invest in, based on personal experience with their products (they introduced a new ink-jet postage meter in the mid-1990's, which, like most ink-jet products, was an utter rip-off for small businesses).  I also question the future growth of postage meters in general, in view of the utter death of letter-mail in the next 10 years and the movement to online postage (www.usps.com) for package shipping.  Unless they have new technologies up their sleeves, the long-term outlook for the company is dim.  But perhaps that is a good topic for another posting.

In the meantime, it is one of those huge old legacy companies with offices and facilities all over the place.  And no doubt, every day, in offices all across America, secretaries and clerks start the day by turning on the old postage meter - and sending out reams of mail this way.  But I am sure if you work for the company, you will notice that revenues are declining in the metering business, and the amount of postage sold may be leveling off and declining slightly, as more and more people get their utility bills online instead of through the mail.  It is not a growth business, but a legacy one.

And yes, they still pay dividends, for now.  But for how long - if this was their only business?  It is like the GM I worked for in the 1980's - with money-losing factories that people said "would never close".  The writing was there on the wall for everyone to see.  And bankruptcy for GM would have occurred in the 1990's if the gas glut had not given them a last gasp of the glory days in the form of the SUV orgy-craze.

AT&T is another dividend payer that makes me nervous.  I'm a customer of their landline, DSL, and wireless business, and if I said that AT&T was the General Motors of communications, it would not be a compliment.  It is a fractured organization, largely disorganized, with different branches competing against one another and unable to communicate with one another.  The landline, DSL and wireless services are all run as separate entities, and often they don't have complimentary things to say about one another.   Verizon seems to do a much better job in the wireless business, in terms of signal strength and technology (AT&T of course, managed to botch up their only golden egg, the iPhone).  Their landline business is another legacy concern, and as a regulated utility will generate profits - but many folks are disconnecting from landlines as the cost of even a simple phone line exceeds a very cushy wireless plan.

Verizon is also on the list and to me, might be a better bet (disclaimer, I already own AT&T stock).

HealthCare REIT is an interesting one as it was featured recently on CNN Money as one of the "top 9 stock picks" for 2011.  They invest as a Real Estate Trust in health care facilities - what seems to be a growth area in the next decade.  Hmm... growth and dividends?  Not a bad combination.

Of course, there are the usual roster of utility companies, which as regulated utilities without a lot of gee-whiz growth, tend to churn out dividends on a regular basis.

One oddball in the group is H&R Block, the tax preparation people.  While this seems like a perpetual business, three things could negatively affect their bottom line in 2011 and beyond.  First are new laws that make the tax refund loans (which make up a big chunk of their profits) harder to implement.  Second are inexpensive online services, like www.turbotax.com (my favorite) that are easy to use and will likely grow rapidly.  The third is most disturbing to their bottom line - tax reform.  If taxes are simplified as some are proposing, the use of a tax return preparation agency may become obsolete.

The rest of the list includes a smattering of banks and financial service industries and some consumer products companies such as Kimberly Clark, and most of the major pharmaceutical companies as well.

Having a number of these kinds of stocks in your portfolio is a good idea, although I am not sure I would invest heavily in any one of them.  Putting all your eggs in one basket, as I have noted, is never a good idea.  However, investing only in equity stocks - stocks that pay no dividends but increase in value - is probably a bad idea as well.

One nice thing about having  dividend stocks is that every quarter, when they pay out, you end up with some cash in your trading account.  And if you have a number of these stocks, the amount of cash can be significant - enough to buy some shares in some other company (further diversifying your portfolio) or enough to buy more shares in a company you already own.

If you goal is to buy more of the same stock, it may be worthwhile to explore a shareholder services program, such as those managed by Computershare.  These programs take your dividends and automatically invest them in more company stock, which in turn will churn out more dividends.  If you goal is long-term investing, it is not a bad idea, as the purchase fees are usually low ($1 in some instances) and you do take advantage of cost-averaging.  The only downside to this approach is that determining profit later on (when you sell) can be difficult, as you have to calculate your basis from a number of small purchases.

The nice thing about dividend stocks is that you do get something back from them.  At a 5% annual rate of return, you will get back your purchase price on a stock in 14 years - and that is in addition to any equity gain.  So, even if the stock tanks in value after a decade, at least you can say you got something back, in terms of those dividends over the years.  An equity-only stock, if it goes belly-up, leaves you with nothing to show but a hole in your portfolio.

Of course, one last word on dividend stocks and that is with regard to taxes.  Long-term capital gains from sales of equity stocks may be taxed at 15% (at the present time) whereas dividends may be taxed at your marginal income rate (which can be 10% to 36% depending on your bracket).  For many folks in higher brackets, equity stocks are a more attractive option, as the tax rate is lower.  But that being said, I think a good mix of the two is the best overall plan, at least for young and middle-aged people.

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