How should I think about stock dividends?

Question

I'm a 19 year old college student looking at some potential long-term investments, but am first reading as many books as I can, since this sector isn't the field I study.

I am reading a book and a section of it refers to investing for an income, which is referring to the dividend payout each quarter. I am wondering who actually invests their money only in companies that actually pay out a guaranteed return (through dividends) and how important that really is for long-term investors. I see that the % yield is usually low and it doesn't really seem like a huge return on an investment with the low capital of a college student.

For example, Microsoft is valued ~$44. If I take $6,000 I get about 136 shares, but their dividend is $0.28 per share annually. That's only ~$38 annually with my shares, which doesn't seem like something really worth factoring into my investment. Can someone help me understand differently?

EDIT: I realize dividend rates are not guaranteed and can indeed fluctuate, but am comparing to larger-cap companies that have a likelihood of guaranteed & static dividend rates.

Answer 1

At 19 years old you can and should be investing to see your money grow over the years. Reinvesting the dividends does get to be pretty significant because they compound over many years. Historically this dividend compounding accounts for about half of the total gains from stocks.

At 70 years old I am not investing to see my money grow, although that's nice. I am investing to eat. I live on the dividends, and they tend to come in fairly reliably even as the market bounces up and down. For stocks selected with this in mind I get about 4% per year from the dividends.

Answer 2

DRiPs come to mind as something that may be worth examining. If you take the Microsoft example, consider what would happen if you bought additional shares each year by re-investing the dividends and the stock also went up over the years. A combination of capital appreciation in the share price plus the additional shares purchased over time can produce a good income stream over time. The key is to consider how long are you contributing, how much are you contributing and what end result are you expecting as some companies can have larger dividends if you look at REITs for example.

Answer 3

Different stocks balance dividend versus growth differently. Some have relatively flat value but pay a strong dividend -- utility stocks used to be examples of that model, and bonds are in some sense an extreme version of this. Some, especially startups, pay virtually no dividends and aim for growth in the value of the stock. And you can probably find a stock that hits any point between these. This is the "growth versus income" spectrum you may have heard mentioned.

In the past, investors took more of their return on investment as dividends -- conceptually, a share of the company's net profits for the year reflecting the share's status as partial ownership. If you wanted to do so, you could use the dividend to purchase more shares (via a dividend reinvestment plan or not), but that was up to you.

These days, with growth having been strongly hyped, many companies have shifted much more to the growth model and dividends are often relatively wimpy. Essentially, this assumes that everyone wants the money reinvested and will take their profit by having that increase the value of their shares. Of course that's partly because some percentage of stockholders have been demanding growth at all costs, not always realistically.

To address your specific case: No, you probably aren't buying Microsoft because you like its dividend rate; you're buying it in the hope it continues to grow in stock value. But the dividend is a bit of additional return on your investment. And with other companies the tradeoff will be different. That's one of the things, along with how much you believe in the company, that would affect your decision when buying shares in specific companies.

(Personally I mostly ignore the whole issue, since I'm in index funds rather than individual stocks. Picking the fund sets my overall preference in terms of growth versus income; after that it's their problem to maintain that balance.)

Answer 4

Dividends are actually a very stable portion of equity returns, the Great recession and Great Depression notwithstanding:

However, dividends, with lower variance have lower returns. Most of the return is due to the more variant price:

So while dividends fell by 25% during the worst drop since the Great Depression, prices fell almost by 2/3.

If one can accumulate enough wealth to live only off of dividend income, the price risk becomes much more manageable. This is the ideal circumstance for retirement.

Answer 5

I would say the most important thing to consider is the quality of the company relative to the price you pay for it. No dividend also means that you will not pay taxes on dividends.