When is it worth it to buy dividend-bearing stocks?

Question

TLDR: Is it ever worth investing in stocks to make profit off of dividends?

I did some research on dividends. It seems like it has a reputation for stable income, irrespective of the market fluctuations (sort of, since dividends drop the stock price). Some people even claim that professional investors invest in dividends because they make for stable portfolios.

I decided to give this a try; I invested a couple of thousand dollars over two years and monitored the results. I discovered that with a sufficiently diverse portfolio, you get around 2-3% per annum.

But:

• 2-3% is pretty low
• I live in a place with an inflationary economy; my money devalues by ~2%/year
• Given the tax brackets where I live and my income, roughly 50% of my ROI goes to the taxman.

After all this, someone I know made a comment that "why would you risk your money to make nothing?" which made me think:

On the flip side, when my experiment ended, my portfolio happened to be 30% up, so I made around 15% per annum on that. (But that's not something you can count on when you invest in stocks, and was not my intention.) It was a mixture of stocks (energy, technology, medical, etc.) mostly US-based.

Are dividends really worth investing for?

It seems that long-term investing was more worthwhile (at least in this case).

Answer 1

Yes, they are, and you've experienced why. Generally speaking, stocks that pay dividends will be better investments than stocks that don't.

Here's why:

1) They're actually making money. They can finagle balance sheets and news releases, but cash is cash, it tells no lies. They can't fake it.

2) There's less good they can do with that money than they say. When a business you own is making money, they can do two things with it: reinvest it into the company, or hand it over to you. All companies must reinvest to some degree, but only a few companies worth owning can find profitable ways of reinvesting all of it. Having to hand you, the owner, some of the earnings helps keep that money from leaking away on such "necessities" like corporate jets, expensive printer paper, or ill-conceived corporate buyouts.

3) It helps you not freak out. Markets go up, and markets go down. If you own a good company that's giving you a nice check every three months, it's a lot easier to not panic sell in a downturn. After all, they're handing you a nice check every three months, and checks are cash, and cash tells no lies. You know they're still a good company, and you can ride it out.

4) It helps others not freak out. See #3. That applies to everyone. That, in turn means market downturns weigh less heavily on companies paying solid dividends than on those that do not.

5) It gives you some of the reward of investing in good companies, without having to sell those companies. If you've got a piece of a good, solid, profitable, growing company, why on earth would you want to sell it? But you'd like to see some rewards from making that wise investment, wouldn't you?

6) Dividends can grow. Solid, growing companies produce more and more earnings. Which means they can hand you more and more cash via the dividend. Which means that if, say, they reliably raise dividends 10%/year, that measly 3% dividend turns into a 6% dividend seven years later (on your initial investment). At year 14, it's 12%. Year 21, 24%. See where this is going? Companies like that do exist, google "Dividend Aristocrats".

7) Dividends make growth less important. If you owned a company that paid you a 10% dividend every year, but never grew an inch, would you care? How about 5%, and it grows only slowly?

You invest in companies, not dividends. You invest in companies to make money. Dividends are a useful tool when you invest -- to gauge company value, to smooth your ride, and to give you some of the profit of the business you own. They are, however, only part of the total return from investing -- as you found out.

Answer 2

You should never invest in a stock just for the dividend. Dividends are not guaranteed. I have seen some companies that are paying close to 10% dividends but are losing money and have to borrow funds just to maintain the dividends. How long can these companies continue paying dividends at this rate or at all.

Would you keep investing in a stock paying 10% dividends per year where the share price is falling 20% per year? I know I wouldn't.

Some high dividend paying stocks also tend to grow a lot slower than lower or non dividend paying stocks. You should look at the total return - both dividend yield and capital return combined to make a better decision.

You should also never stay in a stock which is falling drastically just because it pays a dividend. I would never stay in a stock that falls 20%, 30%, 50% or more just because I am getting a 5% dividend.

Regarding taxation, some countries may have special taxation rules when it comes to dividends just like they may have special taxation rules for longer term capital gains compared to shorter term capital gains. Again no one should use taxation as the main purpose to make an investment decision. You should factor taxation into your decision but it should never be the determining factor of your decisions. No one has ever become poor in making a gain and paying some tax, but many people have lost a great portion of their capital by not selling a stock when it has lost 50% or more of its value.