Dividends, are they worth it?

[hng049]

Hi all, I'm a new investor and have a question to ask regarding dividends: Are they worth it? I'm a bit confused so let me give you an example:

Company ABC is trading at $10 a share and I decide to buy 1000 shares, so I have invested $10,000 into ABC. This year they have decided to pay 20c per share fully franked. That means I get $200 back in cash (no DRP). But as we all know the price of the stock will fall roughly by 20c so even though I have pocketed $200 into my account, the value of my ABC shares have fallen by $200. So it seems to me that I've got the same value as I had before by in two different forms now? Also a $10,000 investment just to get back $200 seems very low indeed [Lets assume term deposits at the banks are 1%, so I understand it's relative ] Why do people specifically look for high yielding dividend stocks? It seems you'd have to have A LOT of money to begin with to get a good return. Your insight is much appreciated!

 

[Bill M]

Hi all, I'm a new investor and have a question to ask regarding dividends: Are they worth it? I'm a bit confused so let me give you an example:

Hi and Welcome to the forum. I live solely off my dividends and interest income so to me (someone who is a self funded retiree) it really is worth it. I am a long term investor and I don't do the trading gig, all I need is the steady flow of income.

This is how important dividends really are. If you have 500K in the bank earning 3% you would only receive 15K a year in interest, you couldn't really live off that. But on the other hand if you bought into a few High Yield ETF's you could get returns of around 7% to 8% grossed up from distributions alone and that would pay you 40K a year.

It should be mentioned that being in the markets with any stocks puts your capital at risk and if you do not know how to manage that you could lose a fair bit of what you put in in the first place. I am in somewhat of a different situation from many people on ASF, I live off my Super and take a pension and I don't pay any tax on the dividends, in fact all the franking credits come back to me too. So yes it really is worth it for me, cheers.

 

[hng049]

It should be mentioned that being in the markets with any stocks puts your capital at risk and if you do not know how to manage that you could lose a fair bit of what you put in in the first place. I am in somewhat of a different situation from many people on ASF, I live off my Super and take a pension and I don't pay any tax on the dividends, in fact all the franking credits come back to me too. So yes it really is worth it for me, cheers.

Hi Bill, thanks for your insight! So for someone like me, 25 years old, earning a wage, it doesn't seem like investing for dividends (not specifically but just companies who give them out) would be as good as looking for capital growth shares? Example, I purchased $1000 (don't want to risk too much when I'm starting out ) in AMP which gives me roughly 175 shares, so after a year I'd get back approximately $40 based on previous dividends which is nothing haha. Even if I accumulate I'd have to put in a lot of my money to get a good return back, since AMP won't have as much growth as say a small market capital company??

 

[So_Cynical]

My annual portfolio returns are roughly split half dividends half trading profits, the trading profits are somewhat variable, this year has been very good, 2010/11 not so, 14 - 18% annual return of which 6 - 7% is dividends and franking credits.

Dividends are worth it if you are accumulating income, recurring income.

 

[Smurf1976]

Hi Bill, thanks for your insight! So for someone like me, 25 years old, earning a wage, it doesn't seem like investing for dividends (not specifically but just companies who give them out) would be as good as looking for capital growth shares?

Those buying shares to receive dividends usually intend that it's a longer term investment (years) rather than just buying, receiving the dividend, then selling the shares.

Going for dividends isn't a "get rich quick" strategy but it's potentially less risky to be investing in a solid business that is making a profit than investing in a junior company that may or may not be successful at whatever they plan to do.

As an example, suppose that you bought 250 shares in JB Hi-Fi 10 years ago.

The shares were valued at $4 each and were paying 7.2 cents per annum in dividends, a yield of 1.8%. So you invested $1000 in order to receive $18 a year in dividends at the time. That alone doesn't sound too impressive.

Since that time the company has grown and the actual dividends you would have received total $1356.50 with all of those dividends fully franked. So the dividends alone have been worth more than your original investment.

Today, the company is paying 90 cents a year in dividends. That's $225 a year in this example and represents a 22.5% dividend yield on your original investment of $1000. Meanwhile your $1000 worth of shares are now valued at $4880.

So that's an example of how it can work, buying and holding long term in a company that pays dividends and has ongoing growth.

Note that I have used JB Hi-Fi as just a randomly selected example here. I am not commenting on future prospects, simply noting what would actually have happened if someone had bought shares 10 years ago and held them until today.

 

[hng049]

So that's an example of how it can work, buying and holding long term in a company that pays dividends and has ongoing growth.

So I'm in for the long run then!

What are your opinions on DRPs?

 

[Smurf1976]

So I'm in for the long run then!

What are your opinions on DRPs?

Something to consider is the psychological aspect. Using JB Hi-Fi as an example again, there were certainly some big drops in the share price over the past 10 years that would have (1) seriously tested the thoughts of those holding for the long term and (2) presented a trade the stock rather than simply holding.

Over $16 in 2007, then lost more than half its' value over the next year or so.

Hit $23 in late 2009, falling below $8 in 2012 then rising to over $22 within the next 18 months.

So shorter term trading is certainly a valid approach if you can get it right.

As for DRP's, personally I'm not keen on them simply due to it complicating the accounting when it comes time to sell and pay tax. I could do it certainly, but thus far I'm putting my time into other things.

 

[pixel]

So I'm in for the long run then!

What are your opinions on DRPs?

FWIW and my - I don't like DRPs because I prefer to buy a stock - even one I hold for dividend and franking credits - when it's pulled back to a price zone where the general market shows support, not when a dividend has been paid and the sp is - usually - well above the low support price point.
.
That aside, increasing my holdings by a couple of percentage points is hardly worth the effort. If I want to increase my exposure to a particular sector or stock, I much prefer to invest a reasonable portion - usually in the order around 5% - of my investment capital.

 

[shouldaindex]

Playing devils advocate here with some general observations:

Let's say you own your own business that you can sell for 10 times earnings vs a business next door that has offers to be bought at 20 times earnings. What does that infer the two businesses?

Let's also say your business can only reinvest 20% of those earnings before growth slowed and needed ideas for the rest vs a business that could reinvest 80%. What does that infer about the quality of the two businesses?

Let's say your business is purely domestic and has no opportunity to grow overseas vs a business that expands overseas and is growing it's % of earnings globally.

In those cases, dividend investing would generally choose the perceived lower quality company (Lower PE, Higher Payout Ratio, Fully Franked).

The benefit is that the level of quality is mostly made up of market perception (PE expansion / contraction), and history shows that tends to overshoot to both the negative and positive, so that is why studies show high dividend and low payout stocks (Low market perception, High management perception) outperform.

 

[Bill M]

What are your opinions on DRPs?

Same as smurf and pixel. I do not do the DRP's with my stocks.

Sure, you can save on brokerage but it can become a bit busy at tax time. Lets say you sold a holding you have held for 10 years, you most likely will have 20 to 25 separate capital gains calculations to do. Easy with the right software, not to good if you got to work it out yourself. Plus I would much rather buy extra stocks at the price I want to pay and not at the going price (which you don't know what it will be) at the time. I did it years ago but now don't touch them, cheers.

 

[Smurf1976]

Another way to look at it:

Buy dividend paying stocks and holding for the long term = you're the part owner of a business and intend making a profit from the ongoing activities of that business.

Buying stocks on the basis of short term trading = you're trading shares as such and intend making a profit from the movement in market price of those shares. The "business" being carried on here is that of you buying and selling of shares as such.

Both approaches, or a combination of the two, can be a profitable approach.

Something to understand with dividend paying stocks is risk and sustainability. If someone's paying a 20% yield then another way to look at that is "this stock is ridiculously cheap". There's quite likely a reason why it's so cheap - others have worked out that it's going broke or at best won't be paying anywhere near that level of dividends in the future. If it sounds too good to be true then it probably is.

 

[hng049]

The benefit is that the level of quality is mostly made up of market perception (PE expansion / contraction), and history shows that tends to overshoot to both the negative and positive, so that is why studies show high dividend and low payout stocks (Low market perception, High management perception) outperform.

Hi shouldaindex, thanks for your input! Can you give me an example of a company like the one you described?

 

[hng049]

Lets say you sold a holding you have held for 10 years, you most likely will have 20 to 25 separate capital gains calculations to do.

Hi Bill M, thanks for your reply, why would you have that many separate capital gains calculations to do? How does DRP complicate things at tax time?

 

[hng049]

FWIW and my - I don't like DRPs because I prefer to buy a stock - even one I hold for dividend and franking credits - when it's pulled back to a price zone where the general market shows support, not when a dividend has been paid and the sp is - usually - well above the low support price point.

Hi Pixel, so for example if I wanted to buy more stock of a company I already own, would it be best to buy on the ex-dvidend date? Assuming someone who doesn't do a lot of technical analysis and doesn't know how to read charts that well

 

[Smurf1976]

why would you have that many separate capital gains calculations to do? How does DRP complicate things at tax time?

Capital Gains Tax (CGT) is payable on the profit made upon selling the shares. There's a little bit of complexity, nothing major, but in short if you buy the shares for $1 and sell for $3 then CGT is payable on the $2 profit that you made.

That's a very easy calculation if you buy 1000 shares in company XYZ today and sell them 3 years later.

It's a lot more effort to work it out if you've received 6 dividends along the way and reinvested them. Now you've got the original shares plus another 6 smaller lots all bought at different prices. Since you need to pay CGT based on the difference between the buy and sell prices, that means you've now got 7 calculations to do instead of 1. And you'll need to apportion the cost of selling (brokerage) between them all too.

That the dividends are taxable income, which may or may not be franked (tax already paid at the company tax rate), is another dimension to it. You won't have received any actual cash, it went straight into buying more shares, but there are still the tax implications to consider along the way.

It's certainly quite possible to do it, it just adds more account work which takes time.

Personally, I'd rather take the dividends as cash and either invest in something different or, if I did want to buy more of the same stock, do it in one go of a decent size rather than a few shares every 6 months.

DRP as such is simple and straightforward, it's taxation which brings about the complexity.

 

[pixel]

Hi Pixel, so for example if I wanted to buy more stock of a company I already own, would it be best to buy on the ex-dvidend date? Assuming someone who doesn't do a lot of technical analysis and doesn't know how to read charts that well

Without doing a little more detective work, your chances of finding a reasonable accumulation point will be more or less haphazard. Sure, nearly all dividend-paying stocks will drop on ex-div day. The question is, how quickly will they recover, or for how long will they slide lower?
Checking out the price behaviour around past ex-div days will give you some valuable clues. No guarantees, to be sure, but you most definitely will improve your chances of getting a better deal than buying, say, on ex-div day or blindly accepting what you get under a DRP.

Checking that much of a chart isn't Rocket Science. All you need is a list of the last few years' ex-div dates and a chart. Zoom into each ex-div date and count the days to the Lowest price level where - in hindsight - you would wish you had bought this stock for best advantage, either cum or ex the respective dividend. If the majority of, say, the last six times falls in the same ballpark, you won't go wrong too often if you buy with a similar offset the next time. Always assuming of course, your reason for adding more of the particular share is still sound.

 

[shouldaindex]

Just to answer an earlier question, if you do a screen of Gross Dividends 7%+, Payout Ratio Under 66%, PE Under 13 you come up with some companies like RFG, SMX, CLH, CCV (not recommendations, just illustrations).

 

[hng049]

Thanks everyone for your inputs into my questions!

 

[Bill M]

hng049, just thought I'd add to the dividend story. This is a true story.

Back in the year 2000 there was an IPO called The Australian Pipeline Trust (ticker APA). The IPO was for $2 a share and I got my Mother interested enough to buy into the IPO. I bought some too.

At that time the distribution was going to be around 10% per annum, some of it was capital returns as well as income. Over the years it turned into just income and no more capital returns.

This is an infrastructure company and it has bought out other companies and has expanded over the last 15 years. It has also changed names and it is still ticker APA but it's full name is APA Group (Stapled Securities). It's dividends have slowly increased over the years. APA last traded at $8.68, not too bad going up from $2.

The dividend for the last 12 Months was 75.75 cents per share. That means that for shares that we originally paid $2 each for are now paying us close to a 38% dividend/distribution per annum on original outlay. My Mother never sold her shares, unfortunately I did, too early. With all the things that has happened like the Twin Tower attacks and the GFC she held through. Now in her very old age she is using those dividends to pay for her aged care. Dividends are very important in creating wealth.

 

[hng049]

That means that for shares that we originally paid $2 each for are now paying us close to a 38% dividend/distribution per annum on original outlay. My Mother never sold her shares, unfortunately I did, too early. With all the things that has happened like the Twin Tower attacks and the GFC she held through. Now in her very old age she is using those dividends to pay for her aged care. Dividends are very important in creating wealth.

Hi Bill, that's a great return! I certainly understand more about dividends now. I just need to accumulate more shares for dividends to make a decent return. I've got about 40 years till retirement so plenty of time