Four Burning Questions (and Answers) for Dividend Investors
We’re lucky to have very vocal readers here at D&I Daily. Our inboxes are brimming with criticisms, comments and questions for our staff.
And that’s excellent, because it means there’s a void in the marketplace for honest, unbiased information. By no means do we plan on ignoring that need, either.
So, every month, we take time out of our regularly scheduled commentary and research answers to your questions. While we can’t provide individual investment advice, we can answer your general questions.
Don’t be afraid to speak up! Drop us a line at feedback@DividendsAndIncomeDaily.com with your questions, comments and biting criticisms. We’re on the ready, eager to respond to each one.
Question: When watching stock performance, I seem to notice that the stocks in question start performing better a few weeks ahead of the ex-dividend date. Why not tell us further out what day the ex-dividend is? – R.M.
I wish it were so easy, R.M. If it were, we’d all be filthy rich in no time.
Yes, it’s true that sometimes stocks perform better ahead of an ex-date. But just as often, they don’t. In fact, buying a stock because you anticipate a short-term performance boost from an upcoming dividend payment is a surefire way to get burned.
Why? I don’t want to bore you with technicalities, but there’s a widely supported academic theory out there called “the efficient market hypothesis” (EMH) that says trying to time the market is a sucker’s bet.
Long story short, all publicly available information (like an ex-date) is already priced into the market, so there’s no sense in trying to get an edge by using it. Everyone’s already on the same page, and any price action is going to be based on new information, not old.
Instead of dubious shortcuts, the tried-and-true method is always best. Find good stocks that have solid fundamentals and hold them for the long term, while periodically rebalancing your portfolio. There’s no such thing as a free lunch, after all.
Now, the EMH doesn’t always fully pan out. Just looking back at the mortgage crisis proves that markets can’t always be efficiently priced. But when you’re talking about something short term and as cut and dry as a dividend payment, it holds up very well.
Question: Please let me know the best strategy to use when buying a stock for dividends. For example, like purchasing the stock one day before the ex-dividend date, then getting out the next day with hopes that I can get out even and still get the dividend. – J.M.
The technical term for this strategy is called “dividend capture.” And I hate to be so blunt, but it’s total malarkey and flat-out doesn’t work.
And the reason is simple: The price of a stock drops an amount equal to the dividend paid. So if the stock pays you a dividend of one dollar, the stock drops in price by – you guessed it – one dollar.
Of course, on a normal trading day this fluctuation is small enough that it gets buried by action stemming from elsewhere. But make no mistake, it’s there.
Again, just like I told R.M. above, there’s no such thing as a free lunch. Go for fundamentals and discipline, instead, and in the long term, you’ll do far better and be wealthier for it.
Question: I am desperately in need of a stock screener that shows stocks that have a 5%+ dividend yield with 10%+ dividend growth for 10 or 20 years. I want to turn $10,000 into a million at 27 years for my children. Please help! – V.N.
That’s a pretty tall order! But I think I can help you out by way of an example.
I’m not going to put together a comprehensive basket of stocks with huge yields. Why? Because there’s simply no need to chase yield in order to achieve the kind of value you’re looking for.
Instead, behold the amazing powers of “yield on cost” (YOC). I hold it in such high esteem that I devoted a whole article to it just last week, calling it “the ultimate number in dividend investing.”
Like I said then, “If you find a stock that grows its dividend aggressively over time, it barely matters what the initial yield is. As the dividends grow over time, so will your yield on the initial cost of those shares.”
Let’s take Raytheon (RTN), as an example. The stock does have a decent yield of 3.7%, but more importantly, it has a five-year average growth rate of 12.37%. That dividend growth plus reinvestment will make the value of your holdings in the long term skyrocket like nobody’s business
Here’s the breakdown. An initial cost of $14,840 for 186 shares of RTN at $53 per share means that, with dividends reinvested, the yearly income at 27 years checks in at $1,246,263.34 and the value of those holdings at 27 years will be $2,852,569.46.
Better than right-on-the-money, that’s well over the million bucks you were looking for.
Of course, you can’t put all your eggs in one basket, run with it for 27 years and expect to achieve that same result. But with a properly diversified and periodically rebalanced portfolio of dividend growers, you’ve got more than a fighting chance.
Before I sign off, Louis Basenese has one more for you…
Comment: I have no axe to grind on Pitney Bowes (PBI). Never owned it or would consider buying it, but it seems to me if you have the courage of your convictions (and I am not disputing the facts you have presented here), you would suggest a PUT option play on it. If the dividend does get cut, there would undoubtedly be a stock selloff. – M.C.
Sound the alarm bells! We’ve got a short-term trader in our midst. How dare he try to infiltrate our service intended for conservative-minded, long-term investors hungry for some more yield?
In all seriousness, you raise a perfectly valid point.
Even though I routinely focus on the merits of dividend stocks as long-term holdings, there’s no reason you can’t go one step further if you’re looking for a trading opportunity.
If I really think a stock makes for a terrible long-term investment, it stands to reason that buying put options on the same stock should lead to profits.
That being said, short-term options are notoriously risky. So if you’re going to buy put options on stocks we pan like Nokia (NOK), Best Buy (BBY) and RadioShack (RSH), I recommend you opt for LEAP options, instead.
These are options that expire one or two years from now. That puts time on your side. That’s important, since dividend cuts can take a few months or quarters to be announced.
Whatever you do, though, don’t sell a high-yielding dividend stock short. When you do, you’re responsible to cover any dividend payments, and that eats into your potential profits.
That’s it for this month’s Q&E edition! We’re looking forward to the next round, so remember to sound off with any feedback, ramblings, or questions to feedback@DividendsAndIncomeDaily.com.