It used to be much more unusual for a publicly traded company to not pay a dividend. Indeed, if you read books like Benjamin Graham and David Dodd’s "Security Analysis," the starting presumption is that investors should only invest in businesses that return a steady stream of income - this is why the authors focused most of their attention on bonds rather than stocks.
These days, of course, many of the largest and most-followed companies in the world do not pay dividends - partly because stock buybacks have supplanted dividends as the preferred way to return capital to investors, but also because more investors accept that management might want to reinvest that money back into the business itself. Nevertheless, there are still many companies that pay dividends and many investors that only want to buy these kinds of businesses. A major benefit of investing in dividend-paying stocks is that you can reinvest the dividends into more stock purchases.
It’s not just about high yields
One of the first things that income investors look at is the dividend yield of a stock. This is simply the per-share dividend of a company divided by the per-share stock price. Accordingly, higher yields represent more bang for your buck; with a higher yield, you are paying less money to secure an income stream than you would be with a lower yield.
So dividend investors should always buy the highest-yielding stocks, right? Not necessarily. If something is cheap, and everyone can see that it is cheap, then there has to be a good reason why this is the case. Generally speaking, a too-high yield indicates either that there are some underlying problems with the company, or that the market is anticipating a dividend cut in the near future, or sometimes both.
So a high yield is not as good as you might think. What, then, should dividend investors look at? I think that dividend history is a much better indicator of investment quality than current yield. True, past performance is no guarantee of future returns, but in many cases it can provide a great benchmark. For some older companies, dividend history stretches back many decades.
For instance, Exxon Mobil (XOM) has consistently increased its dividends since 1989, and to my knowledge, has never cut it during that period. Back then, it paid out 21 cents per share annually. Today, Exxon pays out $3.43 per share - a 1,633% increase! This kind of sustained historical performance should give income investors a good sense of security, as no manager wants to be the first to disappoint shareholders.
Of course, there is more to dividend investing than just looking at what has worked in the past. As with any stock, you still need to look at things like price-earnings ratios and other valuation metrics, but I think that with dividend yield and dividend history, you will be well on your way to success.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Warren Buffett and Charlie Munger on Discount Rates
- Warren Buffett: There Is a Big Difference Between a Great Stock and a Great Industry
- Investors Should Consider Adding Gold to Their Portfolios
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