Investing in Dividends For Dummies®
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Library of Congress Control Number: 2015951277
ISBN 978-1-119-12195-4 (pbk); ISBN 978-1-119-12197-8 (ebk); ISBN 978-1-119-12198-5 (ebk)
The purpose of the stock market is to enable companies to raise the capital they need to start or grow their businesses. Instead of borrowing money from a bank and paying interest on it, a company can sell shares of itself to investors. Over the years, the stock market has gone from being a respectable venue for investors to purchase partial ownership in companies to something more akin to a casino. Seduced by reports of individuals earning millions nearly overnight by investing in high-growth stocks, speculative investors poured money into many companies that offered nothing more than a promise of sales and profits, further inflating share prices. When the needle point of reality finally popped the bubble, the poor unfortunates who failed to cash out their chips early enough were blown away like dust.
Fortunately, the deflated bubble (along with some dividend-friendly tax legislation) brought many investors down to earth and back to the basics — investing in companies with a proven track record of earning profits and paying dividends. As they return to the fold, investors are beginning to realize what their parents, grandparents, and great-grandparents already knew — dividend investing offers a host of benefits that provide a safer and often more profitable way to invest in the stock market.
Dividend investing is nothing new. In fact, since 1602, when the Dutch East India Company became the first corporation to issue stock, dividends have been the primary way for investors to receive profits from their investments without dissolving the company or selling the investment. However, following a dividend-investment strategy is new to many modern investors who’ve been focused solely on growth investing. If you count yourself among this crowd or are just starting out and plan on investing in dividend stocks, you’ve come to the right place. Investing in Dividends For Dummies contains all you need to know to develop your strategy, find and evaluate potentially good dividend stocks, manage your portfolio, and avoid the most common and critical mistakes.
I’d love to be able to hand you a list of stocks and send you off with instructions to buy each one, but investing doesn’t work that way. Every investor is different. You have a unique personality, specific goals, and a tolerance for risk that’s different from your neighbors next door or across the street. Every company is different, too, operating in a specific industry, offering unique products and services, and being managed to varying levels of success. As an investor, your goal is to pair yourself up with investment opportunities that are a suitable match. That’s what this book is all about.
In Investing in Dividends For Dummies, I present the idea of dividend investing and lead you through a process of self-examination to determine the type of investor you are, identify your goals, and develop an overall strategy that can move you most efficiently (and safely) from point A to point B. I show you how to find promising candidates and how to then evaluate them by using time-tested criteria so that you choose the best stocks to meet your needs. I mention some historically well-performing stocks you may want to check out, show you various ways to buy and sell shares, and offer guidance on managing your portfolio after you’ve purchased some shares.
The best part about this reference book is that you decide where to start and what to read. I’ve written every chapter to stand on its own, so you can start at the beginning of the book or pick any chapter from the table of contents and dig in.
As you read, keep one important point in mind: Past performance of a stock is no guarantee of future returns. I know, I know — you’ve heard that one before. But it’s worth repeating. What it boils down to is this: If I mention a company in this book that I think is a potentially good dividend stock, don’t assume I’m telling you to buy it. You may want to look into it, but I’m not necessarily recommending it. After all, by the time you read this book, that stallion of a stock may be a bust. Whatever you invest your money in or spend your money on is entirely your choice. I provide some guidance in picking stocks that may be likely to outperform other stocks, but I provide no specific recommendations. Take all the credit for your good investment decisions, but take all the blame for bad ones, too.
While writing this book, I made a few foolish assumptions, mainly about you and how much you know about investing:
Throughout this book, you can spot icons in the margins that call your attention to different types of information. Here are the icons I use and a brief description of each:
Everything in this book is important, but some of it’s more important. When you see this icon, read the text next to it not once but two or three times to brand it on your brain cells.
Tips provide insider insight from behind the scenes. When you’re looking for a better, faster, safer, and/or cheaper way to do something, check out these tips.
This icon appears when you need to be extra vigilant or seek professional help before moving forward.
Investing has its fair share of highly specialized language and concepts that typically fly above the heads of mere mortals. Whenever I explain something highly technical, I flag it with this icon so that you know what’s coming.
In addition to all the material you can find in the book you’re reading right now, this product also comes with some access-anywhere goodies on the web. Check out the Cheat Sheet at www.dummies.com/cheatsheet/investingindividends for helpful insights and details about whether you should hire a financial advisor and considerations for building a nest egg. You can also find interesting companion articles at www.dummies.com/extras/investingindividends.
Investing in Dividend For Dummies is designed to appeal to a universal audience of intermediate and experienced investors at all stages of developing and managing their investment portfolios.
For the new dividend stock investor, I recommend you read the book from cover to cover starting with Chapter 1. More experienced divided stock investors who already know themselves and their goals and have an effective strategy in place to reach those goals may want to skip to Chapter 7, where I show you how to track down income-generating, dividend paying stocks, or Chapter 8, where I show you how to evaluate them.
Regardless of your experience, however, feel free to skip around and read whatever catches your interest. Each and every tidbit of knowledge and insight you acquire can only serve to make you a more astute investor.
Part I
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In this part …
Get the basics on the risks and rewards of dividend stocks as you prepare to become a savvy investor.
Find out what to look for as you invest and how to adapt as the holdings in your portfolio develop.
Discover stock market indexes and the interplay between dividends and market.
Understand what to look for when you’re looking for sound companies to invest in.
Delve into some of the reasons that the popularity of dividend investing tends to rise and fall.
Chapter 1
In This Chapter
Understanding dividend stocks and their benefits and risks
Preparing to become a savvy dividend stock investor
Knowing what to look for as you shop for dividend stocks
Monitoring and adjusting the holdings in your portfolio
For many investors, dividend stocks offer the best of two worlds: a healthy balance of risk and return. Investors receive the benefits of both share price appreciation and the ability to realize profits through dividends (cash payments) without having to sell shares. (Later in this chapter, I list more of the many benefits of dividend stocks, and in Chapter 3, I explain them in greater detail.)
In this chapter, I pack the essentials of dividend investing into a nutshell, starting with the bare basics, such as defining what a dividend is, and taking you to the very end — managing your portfolio after you populate it with promising dividend stocks. Along the way, I reference other chapters in this book where you can find additional information and guidance on each topic.
Dividend stocks are stocks that pay dividends — payments in cash (usually) or shares (sometimes) to stockholders. Through dividend payments, a company distributes a portion of its profits to its shareholders, typically every quarter or every month, and pumps the remaining profits back into the company to fuel its growth.
The percentage of total profits a company pays out in dividends to shareholders is called the payout ratio. For more about payout ratios and how to use the number in evaluating dividend stocks, check out Chapter 9.
Successful companies are profitable companies. They earn money, and they can use that money in several ways:
A company’s dividend policy generally reflects the board of directors’ and shareholders’ preferences in how to use profits. Two schools of thought govern their decision:
Other factors can also influence dividend policies. For example, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), which lowered the maximum tax rate on dividends from 39.6 percent to 15 percent, led companies making up the S&P 500 Index to boost their dividend payments. For more about how tax legislation can affect dividends, check out Chapters 3 and 11.
Receiving dividends is like collecting interest on money in a bank account. It’s very nice but not exciting. Betting on the rise and fall of share prices is much more exhilarating, especially when your share prices soar. Placing excitement to the side, however, dividend stocks offer several advantages over non-dividend stocks:
There’s no such thing as safe investing, only safer investing. You can lose money in any of the following ways:
Companies can trim or slash dividend payments at any time. Companies aren’t legally required to pay dividends or increase payments. Unlike bonds, where failure to pay interest can put a company into default, a company can cut or eliminate a dividend any time. If you’re counting on a stock to pay dividends, you may view a dividend cut or elimination as losing money.
Most companies try their best to avoid these moves because cutting the dividend may cause shareholders to sell, lowering the share price.
Potential risk is proportional to potential return. Locking your money up in an FDIC-insured bank that pays an interest rate higher than the rate of inflation is safe (at least the first $100,000 that the FDIC insures), but it’s not going to make you rich. On the other hand, taking a gamble on a high-growth company can earn you handsome returns in a short period of time, but it’s also a high-risk venture.
People often invest more time and effort planning for a weekend vacation than they do preparing to become an investor. They catch a commercial for one of those online brokerages that makes investing look so easy, transfer some of their savings to the brokerage or roll over their IRA (individual retirement account), and try to ride the waves of rising investment sentiment to the land of riches.
A more effective approach is to carefully prepare for the journey before taking the first step. The following sections serve as a checklist to make sure you have everything in place before you purchase your first dividend stock.
Every investor has a different comfort zone. The thrill-seekers crave risk. They want big returns and are willing to take big risks to get them. Riding the rollercoaster of the stock market doesn’t bother them, as long as they have some hope they’ll end up on top. On the other end of the spectrum are conservative investors willing to trade high returns for stability. Prior to investing in anything, you can benefit by determining whether you’re more of a thrill-seeker, a conservative investor, or someone in between.
In Chapter 7, I offer several methods for gauging risk tolerance, but regardless of which method you choose, you should account for the following factors:
Only you can determine the right balance of risk and reward for you and your goals. You can obtain valuable guidance from a financial advisor, but how you choose to invest your money is entirely up to you (at least it should be).
Tossing a bunch of ticker symbols into a hat and drawing out the names of the companies you want to invest in is no way to pick a dividend stock. Better approaches are available, as presented in the following sections.
The value approach is like shopping at garage sales. Investors hope to spot undervalued stocks — stocks with share prices that appear to be significantly lower than what the company is really worth. When hunting for values in dividend stocks, investors look for the following:
Low price-to-earnings ratio (P/E): P/E tells you how many dollars you’re paying to receive a share of the company’s profits. If a company earns an annual profit of $3.25 for each share of its common stock and the shares sell for $50, the P/E is $50/$3.25 = 15.39. In other words, you’re paying $15.39 for every dollar of profit the company earns. The P/E ratio provides a barometer by which to compare a company’s relative value to other companies and the market in general. (Head to Chapter 2 for more on common stock.)
A good P/E ratio is one that’s lower than the P/E ratios of comparable companies. As a general rule, investors look for P/E ratios that are lower than the average for a particular index, such as the S&P 500 or the Dow Jones Industrial Average (DJIA). See Chapter 2 for more about these stock market indexes; Chapter 9 explores P/E ratios in greater depth.
The growth approach to investing in the stock market focuses on a company’s prospects for generating future earnings. These companies are expected to see their revenues and profits grow at a pace faster than the rest of the market. As such, this approach tends to be more speculative than the value approach. Growth investors may pay more for shares than their past results or actual performance justifies.
With the growth approach, value isn’t the key variable. Although P/E ratios remain important, growth investors are willing to pay a higher price for shares than value investors. Because growth investors look to share price appreciation for returns, they’re more likely to focus their attention on companies that don’t pay dividends. They want younger companies that reinvest their profits to accelerate the growth rates of future earnings and revenues. If the company continues to exhibit strong growth, the share price should move significantly higher. Growth investors are well advised to consider the following:
The goal of income investing is to obtain a steady and relatively secure income stream. When purchasing equities, focusing on income means buying stocks that pay dividends. Because most growth companies don’t pay dividends, most income investors are basically value investors that not only want to buy at a good price but also look for a high yield and a history of rising dividend payments. The income investor looks for companies well equipped to not only continue paying dividends but to also increase the cash amount of those payments.
This book should give you the tools to manage your portfolio by yourself. However, if you do decide to hire an investment advisor, I urge you to consult a qualified professional with a track record of successfully investing in the stock market for several years.
Experienced investment advisors can offer you a wealth of advice and information on most areas of financial planning, including taxes, insurance, and strategies that have been successful for them. They can also function as a sounding board when you need feedback on a stock you’re thinking of buying or selling and help steer you clear of potential pitfalls.
If you don’t want to pay a fee for an investment advisor’s advice, consider joining an investment club where you can pool your capital to create a more diversified portfolio than you can on your own. You can also bounce ideas off fellow club members before making any investment decisions. The extra eyes and ears may have information about a company that convinces you to move forward or step back from a particular transaction. They also provide a good source of investment ideas you may not have previously considered.
A good dividend stock isn’t just one that pays a high dividend. The strength and consistency of the dividend are very important, along with share price and the company’s prospects for a rosy future. Before you can evaluate and select dividend stocks, however, you need to identify a few promising candidates.
Wherever you find stocks, you can find dividend stocks:
www.google.com/financehttp://finance.yahoo.comMany stock listings include both a dividend column and a dividend yield column. If the company hasn’t paid a dividend, you see something like 0.00 or a hyphen (-). Some listings show only the previous and current share price and the single-day and year-to-date gain or loss. In that case, you need to dig deeper to find out whether the company pays dividends and the amount of the most recent payment. With most online stock listings, you simply click the ticker symbol for more information about the company.
Companies in certain industries, such as utilities and telecoms, are more likely to pay dividends than companies in other industries, including technology and biotech. The biggest reason for this tendency is that some industries have larger, more established companies, compared with industries that have a higher concentration of smaller, growth-oriented companies.
As you begin investing in dividend stocks, you may want to focus your efforts on the following sectors:
Prior to the mortgage meltdown that started in 2007, real estate and financials would have been at the top of the list. Both sectors were traditionally good for dividend stocks. The fiscal crisis caused many to cut or eliminate their dividends. Since then, some financial and real estate companies have resumed paying dividends, but many have not.
Eeny, meeny, miny, moe is no way to pick dividend stocks. Savvy investors carefully inspect the company reports — balance sheet, income statement, and cash flow statement — and crunch the numbers to evaluate the company’s performance, at least on paper. As you prepare to evaluate a company, research the following figures or calculate them yourself by using numbers from the company’s quarterly report. (Chapter 9 shows you how.)
Don’t evaluate a company based on one value. The numbers work collectively to paint a portrait of the company’s current financial status. For additional guidance on interpreting these values, see Chapter 9.
Numbers paint a fairly detailed portrait of a company’s current financial status and can even be used to some degree to forecast the company’s future performance. Numbers, however, provide no context. They may indicate potential problems or opportunities, but they don’t reveal what’s causing those problems or making those opportunities available. They provide little indication of the company’s management philosophy or expertise; or outside factors, such as the state of the economy, what’s going on in the sector, and what analysts and investors think of the company’s prospects.
To find out everything you need to know to make a wise decision, you have to do some research. Here are some suggestions to find out more information about the companies you’re thinking of investing in:
Blogs may provide insight, but never base an investment decision on a blog or comment from an investor. These people may have an agenda that conflicts with yours. Some people talk up stocks on Internet chat boards and blogs to raise the share price on the stocks they own so that they can cash out.