Dividend Destroyer. The Illusion of a Payout.

MARCH 2, 2021

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It’s simple really. Buy, sit back, and be paid. Dividend joy. Dividends are, have been, and shall always be. They simply come to you. The dividend has no story. It’s frosting on top. It’s can’t-miss savvy. Even if that cake don’t rise, you still get paid. None of that is true.

Savvy investing requires managing dividends too, just like everything else. Investing’s the hardest dollar you’ll ever make. You may be thinking; “How do you mange automatic reinvesting–it’s automatic, and mandatory?” Auto-reinvesting isn’t the automated success it’s been sold to be. O.K., now we know what you’re thinking; “Standard wisdom says that forty percent of S&P 500 returns over time are from reinvested dividends.” Fine. Fact. Auto-reinvestment of dividends violates the most important fundamental rule of all. Recalling and abiding that fundamental rule is what investing is all about. That’s why we’re here.

Fact one. Dividends don’t ride on air. Dividends exist atop shares of stock, the stock of real companies, with real stories, and real fundamentals, ones constantly improving or worsening. That truth even applies to what many mistakenly treat as unchanging monoliths–the utilities, pharma, and the telecoms.

Stocks are also stories on a journey up, down, or sideways, and dividends are enticements to stay through it all, regardless. They’re payoffs for time spent and trouble endured, a reward for your fidelity, or potential loss. What risks face dividend plays? All risks. Savage volatility, slow or even failing turn-arounds or restructuring attempts, slow growth, no growth, or worse. Example:

IBM has been in steep decline for over eight straight years. In early 2013 IBM peaked at $218. It closed on Friday, 2-26-21, at $118.93. What would it look like if you had owned IBM all that time, happily collecting the dividend? You’d be looking at a one-hundred dollar loss per share. Further subtract from that figure eight years worth of inflation, say 2% per year, and lost opportunity cost. Taken together that means you paid for that dividend more than 100 times over. Dividends are supposed to be paid to you.

IBM’s five year return displayed above includes reinvested dividends yet ranks as brutal by any measure. Again, adjust that for a standard 2% inflation rate. IBM’s long term chart clearly tells the story. It’s an elevator ultimately going down.

IBM is far from alone as a negative-value dividend play. Example 2. Think AT&T(T) and it’s thrilling 7.46%(as of 3-1-21.) dividend yield. Telecoms have forever been viewed and used as prime income investing vehicles, and none more so than T. Yet what has T done for investors over the past five years? The following returns include reinvested dividends.

Dividends are set in dollars at an “annual rate.” The “yield” floats relative to the fluctuating share price. Annual dividends are paid quarterly, to “shareholders of record,” those having purchased shares on or before the “Ex-Date.” Those shareholders are paid on the “Pay Date.” Quarterly payouts equal precisely one quarter of the annual rate. On the “Pay Date” the underlying share price is adjusted downward by that exact dollar payout. Therein lies the issue. Dividends mean nothing when the underlying share price fails to recover that downward dollar adjustment. That means that IBM and AT&T shareholders have been “buying” their own dividends for years.

Such losing dividend plays pay with one hand while taking away with the other. Dividends only hold value when the underlying share price appreciates at least enough to pay for that dividend, inflation, and opportunity cost of ownership. IBM’s rich 5.48% payout sparkles until you realize that their share price remains in long-term slow motion collapse. That means that the fat 5.48% payout simply comes off the top of your position, to be shuffled back to you in cash or in now less valuable shares.

Investors pay when you initially purchase any stock. You pay again every time a dividend payer adjusts its’ share price down for that dividend. Shareholders lose anytime they sit atop any share price incapable of regaining that down-adjustment.

IBM’s fat payout fails to hide that it’s in a death spiral, one from which it likely will never recover. Red Hat couldn’t do it for them. No dividend saves shareholders from such a spiral, and the company knows it. Further, clever trading attempts to “capture” the payout are both risky and needless.

The shameless and less-than-rigorous may suggest that IBM and AT&T aren’t particularly representative. Hogwash. Companies slide into decline on a regular basis. Dividends remain both a flag of success, and out-sized dividends a banner of trouble. Think high-profile names Ford(F), Kohls(KSS), and Macy’s(M), all three having completely discontinued their payouts due to life-threatening trouble.

Even the healthiest companies experience share price declines. Some display questionable share price chop. Household name Johnson & Johnson(JNJ) has ranked as a “Dividend Aristocrat” seemingly forever. It raises and pays, and has done. Income investors play the long game and JNJ is a prime payer for many. Including its’ dividend JNJ has returned 17% over the last year, 30% over three, and 71% over the past five. Verizon’s numbers are very similar. Despite JNJ’s long-term record JNJ’s lost 5.6% over the past month, while IBM has lost only 2.89%. JNJ’s payout is half that of IBM’s at 2.55%. Why? JNJ’s decades-long track record of successfully meeting it’s payout commitment, and raising that payout. How do you handle the payout?

-Auto-reinvesting-

What’s the number one fundamental of investing? Buy low and sell high, or at least higher. The practice of auto-reinvesting dividends can often violate that very basic rule. Benefiting from dividends can be both simple, and smarter. If dividends are worth collecting, they’re worth protecting. Here’s how.

Auto-reinvesting dividends is easy and comes uniformly recommended. Yet it translates into buying additional shares at any price. Some will suggest it as a form of “dollar cost averaging” as dividends are paid in a set dollar amount. When shares are expensive you’re purchasing fewer. When shares are cheaper you’re buying more. All true, yet it’s a grab bag approach, and unnecessary.

Every stock position has a cost basis; the average price paid per share. Violating the cost basis of an existing position works against investing success. Share prices rise when a long position is working. Any auto dividend reinvesting can mean paying higher and again higher prices, violating your cost basis each time. Savvy investing does not include increasingly paying up. Savvy investing means simply taking the dividend payout in cash. Cash payouts mean you buy when you choose, on pullbacks, during corrections, or not at all.

Dividends have an important place in any portfolio. Yet dividend success isn’t automatic. Nor is the payout yield the primary concern. It’s up to us to ensure that we’re receiving actual value. That firstly means choosing a quality name, one with a at least a minimal record of share price appreciation–10% per year or more is achievable. Both VZ and even JNJ do that. It also means a name with a record of raising its’ payout.

Yet due diligence is pivotal. Check the chart. IBM’s collapse is plain to see. Track the performance numbers. Share price performance can’t hide. Even the big and good, or once good, go bad. Thus the complete suspension of a payout, again Ford, Macy’s, & Kohl’s. No payout will save us from a stock price in decline. Meanwhile, auto-reinvesting of dividends may be easy, but its a system programed to buy at any price. Savvy means buying at your price.

Fun flicks for the financially minded, or those with narcissistic personality disorder. Enjoy.

“I Care A Lot.”

As always good luck and savvy investing.

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Additional resources:

Investopedia.com.  Seriously Wonderful.  Fact.
http://www.investopedia.com/
Charles Schwab.  In Our Opinion, the best broker going.
https://www.schwab.com/public/schwab/client_home
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