don’t flutter from fall skies like seasonal leaves. Dividends are paid out of cash flows, if there’s enough. Who has enough? It isn’t always those promising. No problem. Checking’s a piece of cake. We’ve got cake.
But paying isn’t the only issue. Dividends are paid by companies doing real business, in a rapidly changing environment. No one gets a free pass through macro chaos or the battle for market share. The fight for cash flow goes on everyday and everywhere. That includes “dividend aristocrats” like JNJ, with it’s’ 57 year history of consecutive dividend raises. How about an affordable, recession-proof, price-performing example that’s worth it, paying 4%? We’ve got that too.
Hoping to be paid regularly for the market risks you take isn’t rocket science. But it isn’t simply aristocratic standing either. Smart people get this wrong, routinely. We’ve got the right, in “4 Bullets to Savvy Dividends.” Make sure you’ll be paid, top and bottom–and enjoy.
knows dividends are like sisters. They’re part of the same whole, but different. The “rate” paid is calculated in dollars. The “yield” is that amount set as a percentage of the current share price. That was easy. As the share price rises, the yield falls. Why? The rate in dollars is fixed. The share price floats. Same thing with bonds.
When spotting a dividend, think bonds, and CDs. Any dividend should be compared to fixed income instruments. Like risk? Stocks are full of risk, while bonds and CDs aren’t. Investors deserve to be paid, well, for that risk. Oops–those risks. Be paid for your risk or get a T-shirt printed “Sucker.” But dividends have it over on fixed income. When reinvested they expand your share count and that can compound dramatically, or not. When share prices do nothing, dividends still add up.
Dividends are good, and common knowledge. Yet listen to even the most savvy sources talk about dividends. Routinely they’ll assure you that the “dividend aristocrats” are the place to look–obvious choices. Why? Mostly they cite consecutive years of pay-outs and dividend raises, and that’s it. That’s it? All else ranks a very distant, or completely forgotten matter.
What precisely do most dividend recommendation stories routinely ignore? The company paying. They say nothing about how shares are currently valued in a dynamic market. They often say little, or nothing, of a company’s current fundamental, and circumstantial health. Ever encountered a dividend story that mentioned whether the company’s stock is trading above its’ 200-day moving average? We haven’t–Fa King ever. Everybody seems to assume that if the company’s paid for years, it’s all good. They also routinely act as if all dividends are created equal, regardless of rate or yield. We’re covering the real questions to ask about dividend stocks.
Do you really care how many years a company has raised its’ dividend when it currently yields less then a CD? Why wade into a smoking chaotic trade war, like now, for less then you can get for sitting on the bench? Check the “5 Yr Dividend Yield Average.” Look for one averaging close to 3%, or more. AT&T(T) does, 5.5%, as does Verizon(VZ) 4.45%. Both can currently pay, but T is now stretching to do so. Checking’s simple.
1. Worth the Risk?
The worth of any dividend is relative to the alternatives. That primarily means CD’s and U.S. treasury bonds. Often it’s taught that the number of consecutive years a company raises it’s dividend is pivotal. It’s in fact irrelevant if that dividend doesn’t pay you for the risk of owning that stock, and for your exposure to crazy markets. Fact. A 2% dividend is not worth taking on both market risk, and individual issue(stock) risk, regardless of long-term compounding. Besides, their is no such thing as zero-maintenance dividend stock ownership. Can you hear the torpedo hissing? Circumstances change for all companies, and their stocks. That’s why we do the pains-taking research.
Certificates of deposit are almost risk-free. One year CD rates this very minute range from 2.15% APY, Ally Bank, to 2.3% at Capital One. No fluctuations, no trade war, tweets, research, or negotiating with the Chinese. Simply lock in your rate and be paid.
Unless hooked to a strong share price, a 2% dividend makes zero sense when the most risk-free asset in history, the U.S. treasury, is bouncing between 1.6% and 2%. CDs seem an even better option, as they are not subject to market fluctuation, or the countless risks individual stocks represent. For our dollar, only a yield of 2.8% or greater, is worth taking on the risks of stock ownership. Others feel differently, but then, that’s their dollar.
2. Worth the Price?
Dividends are only worth the work and risk when the underlying share price is reasonable. You don’t pay a P/E of 50 to receive a kicker. For our money the P/E multiple needs to be no greater than approximately 30% over the P/E of the benchmark S&P 500 index as a whole. Paying grossly over the benchmark P/E means paying too much. It means inefficient asset allocation, and unreasonable risk. At that point your’e not buying a dividend stream. You’re simply paying up, unless you’re getting true quality and growth.
Good dividend stocks typically have high PEG ratios, often above 3. Dividend payers are not growth stocks. Check Southern(SO); PEG 4.09, and a 4Q P/E of 14.7, paying 4% now, with good technicals. We think that’s attractive. On both P/E and PEG ratio, SO is currently one of the cheapest utilities. It also pays nearly 1% more than AEP, ED, or EXC.
Current S&P 500 P/E ratio 22.36, 10-24-19, 11:23 AM EST.
3. Can they Pay?
Dividends are paid straight out of free cash. Any dividends’ safety can be measured in two simple ways. The relevant metrics are the “Pay-out ratio,” which tells us how much of the company’s free cash is required to cover the dividend. A healthy rate is 30-35%. A pay-out ratio of 100% mean s that company spends every penny of free cash just to meet their dividend requirement. Not good, nor sustainable.
Starwood Property Trust is the largest commercial REIT in the country. It currently pays a very fat 7.74% dividend. What’s it’s pay-out ratio? 144%. That means it doesn’t generate enough free cash to pay. It’s been that way since Q4 last year. That means it’s meeting it’s huge dividend requirement out of capital.
The same metric in reverse is the “Coverage ratio.” The coverage ratio tells us precisely how many times a company can cover the current dividend. A healthy ratio would be 250% or above. That means the company can cover the current dividend pay-out 2.5 times. That’s considered “safe.”
4. Share Price Stable?
On Saturday 10-12-19 Barron’s released their list of top five dividnend paying stocks. The list featured Nucor(NUE) 3.2%, Johnson & Johnson(JNJ) 2.8%, Illinois Tool Works(ITW) 2.8%, Pentair(PNR) 2%, and W.W. Grainger(GWW) 2%.
Barron’s just selected JNJ as one of their five best dividend plays. What does Barron’s say about JNJ? They offer a quote from a fund manager. “We’ve always considered J&J a high quality diversified healthcare name.” Then they mention JNJ’s 2019 EPS estimate of $8.62sh. Eight days later came the report about the FDA, asbestos, and the baby powder recall. Shares dropped 6.22% instantly. The concerns about baby powder were well established prior to the recommendation.
What else did Barron’s offer? Nucor; high-quality steel producer. They say it’s a cyclical, commodity-driven business, at the peak of production for this business cycle. “But it can pay.” Why. It always has, and it raises. They don’t mention steel’s secular decline in America, or savagely unfair and illegal international competition, primarily involving the dumping of subsidized steel into the American market by the Chinese.
Barron’s doesn’t mention that NUE shares are down -6.9% over the past year, with reinvested dividends. Dividends that don’t even pay for themselves are not a dividend. Nor is owning a company in unfathomable trouble. JNJ currently faces greater than 100,000 lawsuits, on three fronts; opioids, talcum powder, and their antipsychotic Risperdal. Maybe it all works out. Do you really want to bet on it and wait? Is it smart?
mystery has existed over JNJ’s massive legal vulnerabilities. Over the last year JNJ has returned -3.19%, with dividends reinvested. It’s down 7.17% over the past 6 months. Barron’s list also includes Pentair, a maker of water filtration systems and products. PNR has returned 9% over the past year, with reinvested dividends, 0% over 3Y, and -7-9% 5Y. It that worth waiting around for?
Again, dividend stocks are routinely recommended solely on number of consecutive years a company has paid and raised. Commonly no questions are asked concerning underlying share price performance. What is the end result when evaluating dividend plays in that way? PNR, yield 1.74%, returning 0% 3Y, and -7.9% 5Y. Or you get JNJ, and 100,000 lawsuits, asbestos baby powder headlines, and a -4.7% 1Y return, with reinvested dividends.
Barron’s did include ITW and W.W. Grainger. ITW has by far done the best in this group of five, up 31.4% over the past year, with reinvested dividends, now at 2.67% due to the now higher share price. GWW has returned 16.3% 1Y, 63.4% 3Y, and 47.4 5Y, with reinvested dividends. However, GWW’s current yield is 1.83%.
No dividend play works forever. None work when the underlying share price performs poorly. That’s the point. But Southern Company(SO) is working now, and seems likely to for some time. SO’s averaged a 13% total return over the past five years, including it’s now 4% pay-out. That average has been skewed upward by the 16.99% share price move over the past six months. Yet SO remains both cheaper than the S&P as a whole, and other utilities, and supports a higher dividend than most any stock. Under the Trump Administration, the EPA is not likely to tighten regulations which could effect SO’s plants yet using coal.
But would a 1.83% dividend matter were it not for the underlying shared price performance? Would it really matter to you how many dividend raises they’ve voted through when the total payout is 1.83%, after 48 linked years of nonstop action? GWW share price $317.34, 12.4% YTD. As an industrial, that’s impressive. Good luck and good investing.
Jam of the Day
That Investing Journey
Thanks for Reading.
Images sourced from Pixabay.
Pixabay.com is simply amazing–a sprawling compendium of joy. Thank you Pixabay. If you also know love and use Pixabay’s lavish resource, please take time to donate to them at Pixabay.com. We do, truly.
Investopedia.com. Seriously Wonderful. Fact.
Charles Schwab. In Our Opinion, the best broker going.
STOCKJAW.COM EARNESTLY THANKS YOU FOR YOUR INTEREST AND WISHES YOU THE VERY BEST. THE WORLD BEING WHAT IT IS, WE MUST POST THE FOLLOWING: ALL CONTENT ON STOCKJAW.COM IS PURELY FOR GENERAL EDUCATIONAL AND ENTERTAINMENT PURPOSES ALONE. ANY ACTION TAKEN BY ANY READER IS THE SOLE CHOICE AND RESPONSIBILITY OF SAID ACTOR.
Be careful. Do the work. Have patience, with yourself. Never put your dreams away.
2 thoughts on “4 Bullets To Savvy Dividends”
I love the KISS principle. Great explanation and…. WOW, the jam of the day was awesome!
Thanks so much Fitz. We’ve been talking dividends a lot. I think we finally got close to covering it. Sj