Hey everyone, it’s Finance Fridays again. This new series about things “outside the norm” of The Philosophy continues. Since we’ve talked about Taxable Accounts and Being Tax Efficient, it’s now time to start talking about What are Dividend Stocks?
What are “Dividend Stocks”?
In general, Dividend Stocks are stocks held in companies which are considered financially stable and mature. This usually means they are “large cap”, a market capitalization of more than $10 billion. These stocks are expected to continue to raise steadily for the foreseeable future while still paying their stockholders a dividend. This dividend may also increase over time.
What’s a dividend?
A dividend is basically a payment the stockholder receives from the company for holding that stock.
For example, let’s say you hold 100 shares of stock at “Big Co.” and it pays $2 a share in dividends a year. “Big Co.” would pay you $200 that year.
The dividend does not have to be cash however. It can also be in stock or even property. However, I think for most investors, you will see your dividend in cash.
What other terminology do I need to know?
Well, at the very least, I think you should know:
Dividend Coverage Ratio aka “Dividend Cover”
(Earnings Per Share / Dividend Per Share)
This is the ratio between the earnings of a company and its net dividend to shareholders. Essentially, this helps people calculate if a company has enough earnings to cover its dividends.
In general, you want this ratio to be above 2 (considered “good”). If this ratio drops below 1.5 too often, then that is considered risky.
(Annual Dividends Per Share / Price Per Share)
This is a ratio of how much dividend is paid out relative to the current share price.
For example, let’s say you own 1 share of Big Co which costs $100. It paid a dividend of $2. So then $2/$100 = 0.02 = 2% Yield
Divided Reinvestment Plan (DRIP)
Some (not all) corporations allow you to reinvest your dividends back into the company. Basically, you take your dividend and reinvest it into the company for shares (and fractional shares). This is usually offered on a quarterly basis. It can be performed internally when offered through the company, or may be managed by a brokerage firm.
When through a Company-Offered DRIP, a discount on the shares may be available
It is important to know that stocks bought via a Company-Offered DRIP needs to be rebought by the company, and do not go to the general stock market.
A common misconception is that if you utilize a DRIP that you are not taxed because no cash exchanges hands. Unfortunately, this is not true. You are still taxed because a cash dividend was issued and then reinvested. However, you are not subject to capital gains until the stock is sold.
Wait a second… DRIPs sound like compounding to me…
The idea of reinvesting your dividends is the same idea as “keep the change” from Jack Bogle. When he created his index fund, instead of taking profits for himself, he allowed investors his index fund to reinvest profits. So you buy more of the dividend stock every year, it pays dividends which buy you more stock, and the cycle continues.
Your compound interest is at work.
What about taxes?
If you receive more than $10 in dividends, the company will give you a 1099-DIV form which you will need to report come tax time.
Here’s a link to a copy of the form straight from the IRS: 1099-DIV
The boxes that are important are 1a and 1b because they are taxed slightly differently as ordinary dividends and qualified dividends, respectively. Without getting too crazy, the number in 1a will be taxed at your ordinary income tax rate whereas the number in 1b will be taxed at slightly lower rate.
From the IRS.gov:
The maximum rate of tax on qualified dividends is the following.
- 0% on any amount that otherwise would be taxed at a 10% or 15% rate.
- 15% on any amount that otherwise would be taxed at rates greater than 15% but less than 39.6%.
- 20% on any amount that otherwise would be taxed at a 39.6% rate.
So what do you think about dividend stocks?
I like them. However, I consider them to be outside of The Philosophy. The cornerstone of your portfolio should still be index funds and bonds.
Nonetheless, if you want to dabble into dividend stocks in a taxable account, that’s a consideration, because dividend stocks are tax efficient. Some consider dividend stocks to be a part of their portfolio, but I don’t think that’s a great idea. Owning individual stocks is still significantly more volatile than owning an index fund.
Is it likely that your investment in Microsoft will all of the sudden go poof? Well, no. However, you never can tell.
Ok, well if you were going to invest in dividend stocks, which ones would you choose?
Well, the stocks that may pay the highest dividends can also be pretty volatile.
If I was going to invest in dividend stocks, I’d probably stick with what people consider to be “blue chips”.
*Blue chips are companies with ~3%+ dividend yields and 100+ year operating history. I’d also add a 20+ year history of paying dividends.
I’m a simple man, so I would try to invest in things I understand:
It has been around for a long time. They make stuff that people use all the time. Just to name a few:
- Acuvue contacts
- Johnson Baby Products
In the current digital age, we continue to replace things with something digital. “There’s an app for that.” right? However, I don’t think there is any way to “make an app” or any replacement for the items above. As long as humans stay human (and not cyborgs), I think we will need the products above.
Their ticker symbol is JNJ. As of 8-18-2017, the yield is 2.44%.
It has also been around for a long time.
They make a bunch of stuff also:
“adhesives, abrasives, laminates, passive fire protection, personal protective equipment, dental and orthodontic products, electronic materials, medical products, car-care products (sun films, polish, wax, car shampoo, treatment for the exterior, interior and the under chassis rust protection), electronic circuits, healthcare software and optical films” (from Wikipedia)
Once again, I don’t think any of this stuff can be replaced by this digital age. If the age of Robots with Artificial Intelligence hits, then potentially the human jobs that would require some of this equipment may change. However, I believe that by that time 3M will have pivoted into making products for the Robot AI, right?
Their ticker symbol, as you would expect is MMM. As of 8-18-2017, the yield is is 2.23%.
This is a like another Johnson and Johnson, since they make a bunch of similar stuff:
“wide range of cleaning agents, personal care and hygienics products. Before the sale of Pringles to the Kellogg Company, its product portfolio also included foods, snacks and beverages” (from Wikipedia)
- Head & Shoulders
- Old Spice
Their ticker symbol is PG. As of 8-18-2017, the yield is 2.95%.
Well, what can I say about this. I like Coke products.
How many beverages do you think Coca Cola sells? maybe 50? 100?
Nah. Coca Cola has more than 3500 beverages and 500 brands.
Here are a few common ones:
- Minute Maid
Their ticker symbol is KO. As of 8-18-2017, the yield is 3.14%.
Any other comments?
All 4 of the companies above have 50+ year histories of dividend increases.
You may also notice that all of the above companies offer Dividend Reinvestment Plans (DRIPs). To be honest, I wouldn’t buy a dividend stock in a company that didn’t offer a DRIP.
Wait, no technology companies?
Well, for dividend stocks, I would plan to buy and hold, reinvesting with DRIPs.
Also, APPL doesn’t offer a DRIP. So I would really only consider Microsoft.
Dividend Stocks are interesting.
However, I would not consider them to be a cornerstone of your portfolio.
Once you have maximized your 401k/403b/457 and your Roth IRA and are looking into a taxable account, you can consider dividend stocks.
I like: Johnson and Johnson, 3M, Procter and Gamble, and Coca Cola for their 50+ year history of increasing dividends and DRIPs.
Sensei’s note: I don’t currently own any dividend stocks. However, if I did, I would buy those 4 companies.
Just a friendly reminder: I’m not a financial advisor, and I’m certainly not your financial advisor. This post is meant to be educational mostly. If you truly want to invest in dividend stocks, I would recommend that you do more research and draw your own conclusions.
Agree? Disagree? Questions, Comments and Suggestions are welcome.
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