Ask The CFP®
“Patience is the companion of wisdom.” – Saint Augustine, 335 – 430 AD
Question: What are dividend-paying stocks?
Answer: Most investors look for two things from investments; growth of principal and/or income. A dividend is income because it is a return of surplus to stockholders. Dividends occur when a company’s board of directors decides to distribute a portion of the earnings to its shareholders. With cash on corporate balance sheets at all time highs, dividend stocks deserve a thoughtful look.
Stocks that pay cash dividends are in essence sharing their profits with investors who have equity ownership in a particular company. Dividends are a reward, as in the statement “our efforts finally paid dividends.”
My first exposure to dividend paying stocks was at age nine when my Mom explained that we’d fund our back to school shopping trip with dividend checks received on stock left to her by her parents. To sharpen my math skills, Mom had me add up the dividend checks and it was right around $25.00. My next task was to choose on how to spend the money. I still remember the lunch box, book bag, and shoes we purchased that year. It was a great economics lesson at an early age.
Historically, dividends have been an excellent way to create wealth. Going back to 1960, 79.5% of the total return of the S&P 500 index is attributed to reinvested dividends and the power of compounding. Albert Einstein stated, “The most powerful force in the universe is compound interest.”
To illustrate this concept when speaking to schoolchildren I’ll ask them; “Would you rather have $1000 today or a penny doubled every day for twenty days?” Even the cleverest student is likely to choose the $1000 because a quick glance at the math shows that after 10 days, that penny is only worth $10.24. What could it possibly be worth in twenty days? The answer is $10,485.76, leaving whoever selected the $1000 short by more than $9000 of what he or she might have had.
To illustrate how dividends are measured, a stock trading at $50 per share paying a quarterly dividend of fifty cents per share would have a stated yield of four percent (0.50 cents x 4 quarterly payments = $2.00. Dividing $50.00 by $2.00 equals 4 percent yield). Dividends are declared and quoted in terms of percentage yield or the amount per share. This sounds much more complicated than it actually is.
Dividend paying companies tend to be solid and well established. In contrast, growth oriented companies generally retain their excess earnings using profits to help sustain growth. Companies with a reliable history of paying and increasing dividends must maintain strong balance sheets, and demonstrate by accumulating cash their ongoing commitment to shareholders. As investors enter retirement and have a greater need for reliable income, dividend-paying stocks may help meet that need. Investigating stocks with a reliable history of raising their dividends may be especially important in a time where the outlook for interest rates remains uncertain. Stay focused and invest accordingly.
Dividends are not guaranteed and will fluctuate. Past performance may not be indicative of future results. The S&P 500 is an unmanaged index of 500 widely held stocks. The performance noted does not include fees or charges, which would reduce an investor’s returns. Investing involves risk including the possible loss of capital. This information is general in nature, it is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or solicitation to buy or sell any particular investment. It is not possible to invest directly in an index. Past performance is not indicative of future results. Opinions expressed herein are those of the author and subject to change at any time.
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Darcie Guerin, CFP®, is Associate Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email email@example.com. www.raymondjames.com/Darcie