Divdend Investing

http://www.financialsense.com/stormwatch/2005/0408.html

Advantages: - They enhance investors’ returns over longer periods of time. Dividends make the difference between superior performances in both bull and bear markets. They can lower risk by creating greater stability in fluctuating markets, since dividend paying stocks hold up much better during periods of market uncertainty. They can also produce positive results when markets are unfavorable.

Long-Term Investment = Superior Terms

When the historical record is examined for investing in stocks, the attractiveness of dividends becomes more pronounced. In their landmark book “Triumph of the Optimists” authors Leroy Dimson, Paul Marsh & Mike Staunton show the terminal difference of reinvesting income to be monumental. Over a 101 year period, a portfolio of stocks compounded at an annual rate of 5.4%, handily beating the annual rate of inflation of 3.2%. The real return to investors was 2.1%.

However, when dividends were reinvested, the annual return rises to 10.1%. This is significant when time is considered. In their study a $1 investment in stocks grew to $198 without dividends and $16,797 with dividends. The accretion in wealth was 85 times larger through reinvestment of dividends. The authors found the impact of reinvested dividends to hold true in every equity market around the globe. Their conclusion: the longer the investment horizon, the more important dividends become in producing superior returns Jeremy Siegal came to the same conclusion in his new book “The Future for Investors.” He warns that the reason most investors don’t do well is that they overpay for stocks. Their enthusiasm for new fads or trends causes them to pay too high a price to get in on the action. He calls this fallacy of investing “The Growth Trap.” “The growth trap seduces investors into overpaying for the very firms and industries that drive innovation and spearhead economic expansion. This relentless pursuit of growth—through buying hot stocks, seeking exciting new technologies, or investing in the fastest-growing countries-dooms investors to poor returns.” [1] The biggest beneficiary of the latest technology is not individual investors. The biggest gains go to the entrepreneurs, the inventors, the venture capitalists, the investment bankers, and ultimately the consumer who buys a better product at a lower price.

The Advantages of Constancy Dependability
If investors looked at the advantages of dividends, they would find them to be the one true investment constant of the stock market. They offer investors multiple benefits from income, the ability to compound returns and tax advantages to greater stability. The first advantage of dividends is that they provide a steady stream of income. This income is steady and dependable. Dividends on most stocks are paid every quarter. The income provides a return you can count on regardless of stock market conditions or price fluctuations. These dividends can also increase over time providing investors with a greater source of income and an inflation hedge. You don’t get this with a bond. Bond values can erode with inflation, making the interest and principal worth less as a result of inflation.

Steady Income
Another advantage of dividend paying stocks is in addition to providing a steady stream of income, they also have historically produced higher total returns than non-dividend paying stocks. Dividend stocks have also been less volatile historically. They tend to fluctuate less and hold up much better in down markets. As shown in the graph below of Mergent’s Dividend Achievers, superior dividend paying stocks have not only outperformed the S&P 500, but they have also fluctuated less in down markets.

The reason is that dividends provide a cushion in times of market stress. In declining markets, investors gravitate to more defensive issues such as dividend payers in search of refuge in a storm. Good Corporate Governance In addition to income dividend paying, companies generally provide investors with better corporate governance. Once a company implements a dividend paying policy, they seldom abandon it. Dividend payments have to be included in cash flow and budget projections each year. Dividends more closely line up with company earnings and cash flow. Management is reluctant to pay out dividends—or increase them for that matter—if the earnings aren’t there. At a time when corporate earnings have become suspect, dividends become a reliable safeguard against management abuse of shareholder capital. You either have the earnings or cash to pay the dividend or you don’t. You can’t pay out false earnings. Studies have consistently shown that there is a direct link between good corporate governance and control with dividend payouts. What makes a good dividend paying stock? According to
Mergent, superior dividend companies have several attributes in common. They are as follows:

1) They are large and mature companies.
2) They are past their growth phase with no major expenditures.
3) They have strong cash flow and earnings growth.
4) They have good management with solid corporate governance.

Most companies, when they first start up, need to conserve all the cash they earn from operations. This cash is used to build and expand the business. Once the business becomes mature and a brand name is established with a dependable customer base, they have less of a need for major capital expenditures, which consume earnings and cash. Mature and established companies have less of a need to come up with revolutionary new ideas or new products to stay profitable. Another aspect that makes companies good dividend payers is lower R&D requirements. If they do have to spend money, they have large operating margins, which support that R&D effort. Good examples are drug and healthcare companies.

You’ll find that there is a common attribute to all of these companies. They tend to be in businesses that provide a product that people continually consume. They tend to have a strong brand franchise that engenders repeat business and customer loyalty. Because of this brand loyalty, they can charge more than their competitors. This is the reason they tend to enjoy higher profit margins on the things they sell. It is the higher profit margins that generate the cash that pays the dividends. Moreover, since they provide a product that people need and consume, customers keep buying their product, which means more growth in sales and earnings.