Monday, December 19, 2011

Why Do Online Trading Sites Promote Capital Gains over Dividends?

Online trading sites want you to think about stock price, not dividends!

 I have an account with e*trade and another with Ameritrade.  Both have discounted trading fees and some pretty good online research tools.

But in both cases, the firms promote stock price as the end-all to trading.  Dividends, if they are discussed at all, are hard to locate.

For example, in my e*trade account, when you click on the "account detail" section, it lists all the stocks you bought, and what you paid for them, and what they are worth now.  The overall gains and losses appear in green (gain) or red (loss) in both dollar amount and percentage.  They also list this information for daily gains and losses - which is really spurious data and should be ignored.

You might think this would be a good indicator of your overall portfolio performance.  But it neglects to include  Dividend data.

For example, if your stocks pay $2000 in dividends a year, which is credited to your account, and you use that $2000 to buy more stocks, it shows up only as a "cost" of the new stock.  Even assuming all your other stocks break even in price, if that stock you bought for $2000 goes down to $1500 in value, the e*Trade chart shows a net "loss" of $500 in your account, instead of an overall gain of $1500.

According to e*trade, dividends just don't count!

e*trade does have an "income estimator" that shows you how much dividends you are projected to make in the upcoming year.  However, it does not show how much you made, over the years, in dividends.  Dividends are reported to you as e-mails and as individual "transactions" to your cash account.   You'd have to get a calculator and spend hours calculating your actual dividend income.

And it is not a trivial amount, if you own a lot of dividend stocks.   I make about $1500 a year in dividends in this account, which is not concentrated on dividend stocks.  But needless to say, $1500 is not chump change, either, and yet e*trade does not account for it very well.

Ameritrade is even worse - providing no tools to calculate dividends to be paid or dividends received.

Why do these trading sites hype stock price and not dividends?  Well the answer is pretty simple.  Dividend stocks are the "buy and hold" kind of investments, which do not generate a lot of trading income for the site.  Whereas stocks bought based on share price tend to be the kind that are bought high and sold low - greed buying and panic selling - and these generate a lot of trades for the company and thus lots of income for them as well.

Are dividend stocks always a good deal?  We have discussed this here before, and the answer is, of course, "it depends".  A stock may pay a good dividend, and then reduce that dividend as business falls off - or it may go bankrupt entirely and leave you with nothing.  Bear in mind that even a 5% rate of return requires a 20-year payback on your investment, and if the company goes bankrupt in the interim, well, you are out of luck.  And companies do go bankrupt!

Someone asked me about Frontier Communications.  I bought some of this stock, based on its stellar dividend returns - of about 6% or so.  Lately, the stock price has been hammered, and the dividend rate, as a result, has skyrocketed to 15%.  Does this mean it is a good deal?  Well, the lowering of the stock price means that some investors believe that there is trouble brewing.  This complicated explanation on "seeking alpha" tries to sort it out.  Basically, investors are scared about pension liabilities wiping out the surplus the company had after being spun off from Verizon.  Perhaps no more sweet dividends!


Or perhaps the dividends will continue and you will make a lot of money.    It will all depend on Frontier's 4th quarter earnings reports - whether they continue to trend downward, or reverse course and rebound.  If the latter, the stock could be undervalued.  If the former, well, you might have made a bad bet.  And that is the problem with buying stocks, at least in the short-term - the value of the stock is dependent on a lot of data you have no access to.

It illustrates that dividend stocks are still risky bets - like all stocks - and the idea that your money is "safe" with a dividend stock is illusory.  A stock with a very high dividend rate may reflect only the risk involved in buying the stock.  Meanwhile, a stock with a lower dividend rate may reflect the lower risk perceived by the market.

While the Board of Directors may set the dividends, they don't set the stock price - and thus stock price can react to dividends.  Dividends go up - the stock price may go up as a result.  And as a result, most stocks that pay dividends tend to pay along the same lines - in terms of percentage rate of return per share.  Few stocks pay more than 5% in this era of 0.5% savings accounts.  Most good dividend stocks (established companies with good balance sheets) pay on the order of 2.5-5% or so.

I went through my portfolio of individual stocks from e*trade, Ameritrade, and Compushare, and calculated the quarterly and annual dividends, as well as the rate of return.  Again, this is an exercise that is fraught with peril, as the rate of return is based on today's stock price, not what I paid for the stock.  So the rate of return shown is not what I am getting, but what you might get if you bought the stock at that price and the dividends continued to pay out as they have historically.  Dividends are not guaranteed, of course, and while a stock may historically pay a certain dividend, there is no guarantee of such income.



STOCK
SYMBOL
PRICE
DIV. Q
DIV. Y
% ROR
Avis
CAR
10.61
0
0
0
Morningstar
MORN
57.61
0.10
0.40
0.69%
Caterpillar
CAT
88.19
0.46
1.84
2.09%
United Technologies
UTX
72.195
0.48
1.84
2.66%
Costco
COST
82.31
0.24
0.96
1.17%
Disney
DIS
34.81

0.60
1.72%
BYMOF
BMW
48.25

1.843960
3.82%
ExxomMobil
XOM
79.79
0.47
1.88
2.36%
Intel
INTC
23.185
0.21
0.84
3.62%
Kraft Foods
KFT
36.33
0.29
1.16
3.20%
Kaiser Aluminum
KALU
43.09
0.24
0.96
2.21%
3M Company
MMM
78.57
0.55
2.20
2.80%
Stanley Tools
SWK
63.19
0.41
1.66
2.59%
FMC
FMC
83.98
0.15
0.60
0.72%
Kellog
K
48.86
0.43
1.72
3.52%
Raytheon
RTN
45.71
0.43
1.72
3.77%
Wal Mart
WMT
57.99
0.365
1.46
2.52%
Campbell Soup
CPB
32.67
0.29
1.16
3.56%
Dominion Resources
D
50.60
0.4925
1.97
3.91%
AT&T
T
28.78
0.44
1.76
6.11%
Berkshire Hathaway B
BRK.B
74.955
0.00
0
0
Rockwell Holdings
ROC
37.41
0.00
0
0
Cree, Inc.
CREE
21.14
0.00
0
0
Archer Daniels Midland
ADM
27.495
0.175
0.70
2.55%
Pfizer
PFE
21.295
0.22
0.88
4.12%
SAIC
SAI
12.02
0.00
0
0
Southwest Airlines
LUV
8.385
0.0045
0.018
0.21%
Corning
GLW
12.73
0.075
0.30
2.35%
Magna International
MGA
32.03
0.25
1.00
3.13
Dow Chemical
DOW
25.95
0.25
1.00
3.86%
GE
GE
16.895
0.17
0.68
4.04%
Syntroleum
SYNM
1.005
0
0
0
Vestas Wind Systems
VWSYF
10.25
0
0
0
CEMEX SA
CX
4.83
0
0
0
Bank of America
BAC
5.025
0.01
0.04
0.80%
Fannie Mae
FNMA
0.196
0
0
0
Ford Motor Company
F
10.03
0.05
0.20
1.99%
Eaton Corp
ETN
42.12
0.34
1.36
3.23%
Winn Dixie Stores
WINN
9.31
0
0
0
Bristol Myers
BMY
34.37
0.34
1.36
3.96%
Frontier Communications
FTR
4.89
0.1875
0.75
15.34%
Altria Group Inc.
MO
29.32
0.41
1.64
5.59%
Boeing Aerospace
BA
71.20
0.44
1.76
2.50%
Lufthansa
DLAKY
11.50

0.8911
7.75%
Cirrus Logic
CRUS
15.14
0
0
0


What is interesting about this analysis is that most companies seem to pay dividends that come out to about the same rate.  In other words, investors are setting the stock prices based on perceived stability and risk, as well as potential for growth in the price, and also the rate of return in terms of P/E and also dividends.

Note also, that some companies, such as Bank of America and Southwest Airline pay token dividends that are sort of pointless.

There are other companies that pay no dividends, either because business is very bad (Fannie Mae, for example) or they are the kind of high tech company that pays no dividends, but instead puts all its cash back into R&D.  These types of companies make money for you, only when the share price goes up.  The share price is really just an indication of what some other chump will be willing to pay for it.  So you have to hope some other chump will take those shares off your hands at a higher price than you paid.  These types of stocks are generally the riskiest and most volatile, and usually represent high-tech companies or startups.

Other companies, like Berkshire Hathaway, never pay dividends.  Rather, the value of the stock is based on the value of the company's holdings and retained earnings.  Ironically, Berkshire Hathaway invests in a lot of dividend-paying stocks, but does not pay dividends itself!  Go Figure.

So what do I take away from all of this? Well, for starters, it is a pain-in-the-butt to calculate rate of return on your portfolio using the online tools provided by the trading firms.  You have to sit down with a pencil and paper and crank out a lot of numbers.

Second, while dividends are nice, buying a lot of dividend-paying stocks is not a guarantee of income.  You can still lose your shirt.  Third, the very stable and secure stocks that pay regular dividends tend to have share priced bid up in the marketplace to the point where the rate of return falls within a certain range, proportional to the rates of return on other investments (savings, bonds, etc.).

Fourth, by accident, more than design, most of my stock holdings are in dividend-paying stocks.  But until today, I had no real idea of how many of them paid dividends or at what rates.  This is a foolish way to invest, of course.  And it illustrates why stock-picking, for amateurs, is never a good idea.

I think I will dump some of my "dog" stocks before the end of the year and perhaps invest in some more dividend-paying stocks.  But I think I had better do more research, first!

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