The advantages of dividend stocks (dividend growing stocks in particular):
* Dividend stocks are good in a market going side way as you can collect dividends.
* It requires less time, effort and knowledge to trade.
* Simplify trading stocks: buy dividend growing stocks and sell stocks when their dividends are decreased.
* For last 10 years, S&P 500 has about a total return of 3% (1% appreciation + 2% dividend), so dividend is 2/3 of the total return. However, the decade before last decade is quite different. I expect our decade would follow last decade with dividend as an important part of the total return.
* It could be self fulfilling prophecy as more folks retire and follow dividend stocks.
The disadvantages:
* A swing trader like myself pays little attention to dividends but quick potential appreciation. However, I have a portion of dividend stocks for the reasons above.
* Market timing could steer us to stay in cash to escape from market correction and recession when all stocks fall with the tide.
* Ensure the dividend is sustainable in the future. A high payout ratio could indicate problems.
* Harder to diversify as most dividend growing stocks belong to the following sectors: utility, bank...
* Miss some good stocks that do not pay dividends.
* We should adjust our portfolios to the stocks favorable in the current market: dividend stocks in side way market, momentum stocks in market up, and value stocks in market bottom...
* Dividends in the retirement accounts except Roth will be taxed as ordinary income when it is withdrawn. Usually ordinary income tax rate is higher than dividend rate as it happens currently.
* You can receive income by selling some stocks. Eventually the tax rate of long-term capital gain will be less than dividend.
* Double taxation: first the profits are taxed in the corporate level and then at your individual level. It is better for the company to appreciate the stock by buying own stocks, reducing debts... as usually (not currently) tax on long term capital gains is less than dividends.
For some reason, it seems foreign stocks have higher dividend rates.
* Most likely, after 2013 the dividend tax rate is higher than the long-term capital gain rate.
Your dividends will be taxed fully but your capital gain only taxed on the gain when you sell the stock. Most likely the stock price after dividend is the same minus dividend the next day.
To conclude, if you're a retiree and/or with little time and knowledge in picking stocks, dividend stocks are for you.
The premium on dividend stocks is the highest in the last 40 years. It indicates it is popular now due to 1. more income seekers, 2. prolonged bear market, and 3. easy to maintain. The premium is the extra cost you pay for the stock price when two stocks have same valuation metrics (P/E, P/Cash Flow...).
Even so, try to pick stocks with good fundamentals and learn market timing for best time to buy and sell.
For the last 10 years, the average return of stocks is about 2.5% with 1.5% dividend, so dividend is more important. It is expected to so so rather than the historical 8%.
When income tax is more important to you, you may want to take advantage of the low rate of long-term capital gain in 2011 and 2012 and keep the losers for 2013. Dividend has the same rate, but the impact is far less.
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Random thoughts on the same topic.
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Total Profit = appreciation + dividend - taxes - inflation + covered call
The bank stocks before the big plunge were in one of the sectors giving most dividends (utility is #1). See what happened to them. Some like Lehman Brothers lost all of their values.
Appreciation is a prediction and not a sure thing. I count on 5% average for the last 20 years. In 2009 the return of S&P is about 24% and dividend about 2%. Inflation is about 3% average. Covered calls are used to increase return when you have a stock that you do not expect to appreciate a lot in the near future.
Stocks with increasing dividends have better potential in appreciation than companies doing the reverse. We buy stocks looking for total return - not only the dividend yield.
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Skip stocks with high payout ratio (i.e. dividend/profit). It indicates something wrong, and/or the company will reduce dividends in the future.
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No (almost except for social security payment) Federal tax in 2010 to 2012 if your tax bracket is 15% or less. It is same for long term capital gain and dividend. However, you can control capital gains by selling the gainers only.
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Some stocks like partnerships may return part of the capital, so do not count them as dividends. DRIPs and some partnerships give good dividends, but they may give you nightmare in preparing tax returns. The potential appreciation for commercial REITs could be limited by on-line retailers.
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If you insist a dividend-giving company is superior and necessary for your expenses, why save some cash for your expenses (which is not taxable but dividends are) and select the best company you can with or without dividend?
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Do not be fooled by the CEOs/majority owners to attract you by boosting up the dividends. Watch out for high pay ratio (dividend/profit) and poor fundamentals.
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Most stocks with good dividends indicate a matured company or the company feels the stock owner can use the money better than the company. A fast growing company should not give dividend as it is like braking the growth of a company.
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Most likely you will not find ten baggers in DG stocks. They are smaller and newer companies needing cash to plow back to research and product development.
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Market timing for dg investors.
Trying to be right most of the time and there is no perfect timing (I did have several but they were mostly due to luck), and we should not be too greedy.
For dg stock investors, it is not bad to ignore market timing and buy more when you see bargains. We need to be trained to buy (i.e. emotionally detached) when everyone is selling.
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Is it a big joke the guy tells me his investment is doing better when the stock loses half of the value so the dividend yield is doubled (=dividend/stock price)? It is like moving to the other side of the house when this side has a leak in a rainy day.
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Do not sell the stock when the dividend is cut. It is too late and many times the stock lose so much value and it becomes a value stock esp. when the problem is fixed.
Do not fall in love with any stock.
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There are sectors that all value investors including DG lovers should not touch unless they have expert understanding. They are financial/bank (due to quality of the mortgage), miners, bio. drugs (due to pipeline and expiration)... Also you may want to skip emerging companies esp. the smaller ones unless you trust their financial data.
If you follow the above guideline, you will not buy BAC, C, Leh.Brothers.... It could save you some big bucks, lost sleep and even a marriage.
* Another way to screen DG stocks besides looking for dividend growth: Dogs of Dow.
(c) TonyP4 2011. Written 5/26/2011. Updated 11/10/2011.
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Disclaimer: All my posts are for informational purposes only. I'm not a professional investment counselor. Seek one before you make any investment decision.
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Norman writes:
ReplyDeleteTonyP4 – As a retiree, I am able to be in the 0 tax bracket for dividends if I want to be. Most sectors have dividend growth stocks in them, not just financial and utilities. Examples would be INTC, MCD, SJM, PG, JNJ, CAT, LMT, NOC, GD, PEP, KO, COP, and T, VZ, CTL. I agree that a rainy day cash position is necessary for the market cycle and emergencies, mine varies from 15% -30% of portfolio. I drip and hold forever, hopefully. I try to hold one market multiple in each sector:
seekingalpha.com/user/531750/instablog
I am leery of financials, especially in this secular bear market.
Your blog has some very good points brought out. Thank you for writing it.
Norman
Hi Norman,
ReplyDeleteYou may want to keep some ETFs for dividends, diversification, ... and they have the same tax rate (could be lower in the future as long-term capital gain will not be treated as ordinary income.
For some with a lot of assets, maintaining a 0 tax rate may not be good in the long run.
Just keep on investing what you're comfortable on.
On fee on foreign dividends.
ReplyDelete*
The following countries do not charge foreign taxes (check to be sure they haven't changed).
Argentina
Brazil
Hong Kong
India
Mexico
Singapore
South Africa
United Kingdom
Canada charges a foreign tax if you hold the company in a taxable account. They do not charge a foreign tax in a tax deferred account. So, Canadian companies are best held in tax deferred accounts if you want to maximize the benefit of the dividends.
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"Note - A cash distribution fee of up to US$0.02 per Depositary Receipt may be deducted from the gross dividend by BNY Mellon, although currently this fee is set at US$0.005. The cash distribution fee is disclosed in Telecom's Deposit Agreement under Section 5.09"
Tony: That's from NZT web site. That's where I think my $17 is going -- to BNY Mellon for all their hard work pushing the send button. Nice work if you can get it!
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London, that's same explained to me from my broker at one time. Another broker does not have the fee, and most likely it was deducted from the dividend. So, we really want to look at the effect of the foreign tax as part of the total return.
I do not know what is the 'per receipt' means. If it means per stock quantity, then the higher the stock price should have less foreign tax implication. The list of no foreign tax countries is a good start.
I do not trust the accounting of most small companies in emerging market. A 'fundamentally' sound company could be a ripoff.
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The tax credit is not really a credit, but it tries to prevent taxing the foreign dividend twice. If I were wrong, please correct.
I've been using covered calls and profited from it. Here are hints from my personal experience.
ReplyDelete* Some brokers charge a lot on options and some far less. It could eat up a lot of profits.
* The best time to sell covered calls is you expect the market will go down from now to the date the option expired. During the last correction, I've about 6 covered calls and only one was executed (actually at an advantage to me comparing to the price 5 days after the execution).
* You may consider to buy back the stock at the strike price to avoid run-away profit.
I was lucky that my covered calls on IDCC. It expired last Friday without being executed and was up 25% or so yesterday and another 12% today. Hence, covered calls could loose big gains and you should be careful in taxable accounts.
From my memory, my largest account beats my dividend portfolio by a wide margin. Just curious whether it is just luck or my good skill (sorry for self-promoting haha), I have a quick test with some estimates.
ReplyDeleteTime frame: last 5 years.
S&P 500 annualized return = 4% (2.5 appreciation + 1.5 dividend)
S&P 500 with stock dividend over 2% = 2% (-1 appreciation and 3 dividend).
From the above, S&P is 100% better than dividend stocks. Very rough test.
i compile the following data for the returns in bull market and bear market based on S&P 500. It includes about 2% dividend and does not include inflation and taxes.
ReplyDeleteBear market. 1960-1980. 6%.
Bull market. 1980-2000. 17%
Bear market. 2000-2010. 4%.
To my surprise, the bull market's compound return is about 65%. It cannot be right. Would some one verify it if s/he has time. I use the S&P 500 at 1-3-1980 and S&P 500 at 1-3-2001 and divide it by 20 years and add 2% for dividend.
My suggestion of a better comparison. Compare the total return of a ETF that favors on dividends (at least one I know but I forget the name) and the SPY ETF for the last n years (5, 10, 15, 20, 25, 30, 35, 40... etc). We may not have a ETF older than 10 years. If you have a database, you can separate S&P500 stocks into the lists, one with dividends less than 2 and one with 2 or higher dividends. However, it is harder to handle survival bias. Some sites like wisetree, morningstar.. could provide these comparisons.
ReplyDeleteComparing bear market like 2000 to 2010 is more relevant to current market. I suspect dividend stocks will not beat the market in bull market.
Data and statistics never lie. We have to draw our conclusions based on facts, not from personal biases, and not for our luck in picking some good stocks in each area.
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I like to use ETFs to compare as they take care of the survival bias, luck and skill in picking stocks. Some financial companies like Lehman Brothers are not included in testing as they do not survive. I bet LB was paying good dividends at one time. Hence, it would make that group look better in performance.
DG Investing is very old. However, it is more popular in last few years. It could be due to the ageing population and folks are looking for income. Investing could be very beneficial if we lead the herd for my observation. The herd psychology is another topic.
ReplyDeleteI've been testing a lot of investment strategies. Dogs of DOW worked pretty well before 2008. There are some screens that perform ok for DG stocks on historical data base. The major problem in testing DG screens is 1. they do not automatically include dividends and 2. survival bias.
Very good chance the following will happen in 2013 and after.
ReplyDeleteDividend tax will be increased. Most likely it will be the same as ordinary income.
Long term capital gain tax will be higher but most likely it will be less than dividend tax.
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I'm taking advantage of the 0 tax rate with 15% tax bracket (most of my incomes I can control). The dividend part is fixed or not to vary a lot. The l.t. capital gains I can control by selling all the gainers last year, this year and the next.
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Dividends have been doubly taxed, first at the corporate level and second at the holder's level.
Companies should select what they do with the cash for the average tax situations of their stock holders. Most likely they will use the cash to boost up the stock price if long term capital gain is more favorable. Instead of dividends, they can plow the cash into buying back stocks, decreasing debts, boosting up research/product development, buying another companies...
I have a summary of advantages and disadvantages of DG investing.
ReplyDeletehttp://bit.ly/ppc5tc
Following the basic rules, you can avoid some of the pitfalls as some of the experienced DG lovers do or did like:
1. Avoid some sectors like financials (remember C, BOA, Lehman...). Most of us do not or cannot afford the time to evaluate the quality of the loans/mortgages of the company.
2. When you sell when your dividend stock cut dividends could be too late or in the wrong time if the stock turns around. The fundamentalists know the stock is turning bad, then the TAers follow the trend, and it will be too late for you when the company cuts dividend.
I'm more in value now as there are good value stocks around, but it does not mean I do not switch to other stocks like DG or growth. You also need to look at the market in general.
If we have a global recession (quite possible), then the best DG or the best value stocks would lose big time with the flow of the tide.
I have tools and spend time to test which class of stocks are good for current market. I have tools to time the market: my own and subscribed newsletter. It does not always work. However, it works more time than it fails.
If it is a bubble (a mild one), I would sell all DG stocks and buy them back at better prices when the bubble burst. However, we're still debating whether it is a bubble or not and the timing.
ReplyDeleteMy prediction it could be a mild bubble and will be burst in later part of 2012. Be selective on dg stocks on the forward P/E which has been proved to be a better indicator than the trailing P/E. If it is lower than the market, the average P/E for the sector, and/or the historical (5 year) P/E, you may want to keep it. P/E is one metrics among many
When a strategy is headlined, its effectiveness will be reduced.
ReplyDeleteDG stocks have been headlined due to many retirees seeking income. According to WSJ, its premium on dividends is the highest in last 30 years.
Hence, in addition to dividends, the buyers should also concern its fundamentals and watch out for the bubble and the market in general.