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TLDR: Is it ever worth investing in stocks to make profit off of dividends?

I did some research on dividends. It seems like it has a reputation for stable income, irrespective of the market fluctuations (sort of, since dividends drop the stock price). Some people even claim that professional investors invest in dividends because they make for stable portfolios.

I decided to give this a try; I invested a couple of thousand dollars over two years and monitored the results. I discovered that with a sufficiently diverse portfolio, you get around 2-3% per annum.

But:

  • 2-3% is pretty low
  • I live in a place with an inflationary economy; my money devalues by ~2%/year
  • Given the tax brackets where I live and my income, roughly 50% of my ROI goes to the taxman.

After all this, someone I know made a comment that "why would you risk your money to make nothing?" which made me think:

On the flip side, when my experiment ended, my portfolio happened to be 30% up, so I made around 15% per annum on that. (But that's not something you can count on when you invest in stocks, and was not my intention.) It was a mixture of stocks (energy, technology, medical, etc.) mostly US-based.

Are dividends really worth investing for?

It seems that long-term investing was more worthwhile (at least in this case).

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ashes999
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  • Did you look at REITs? They may pay more but are required due to their tax structure. – JB King May 13 '14 at 00:24
  • @JBKing I've never heard of REITs. I'm located in Canada. – ashes999 May 13 '14 at 01:39
  • http://www.dividenddetective.com/canadian_reits.htm would be a link about the difference between US and Canadian REITs with more on the Canadian ones. – JB King May 13 '14 at 01:41
  • Could you invest in RRSPs? Those do have some tax advantages that may be worth noting. – JB King May 13 '14 at 02:05
  • If you're buying Canadian companies, you're paying too much tax. Maybe you've ignored the dividend tax credit? In Ontario the highest tax rate will be 35% and the lowest is -2% (BC is actually -7%). If you buy US companies that pay dividends, hold them in a RRSP and there is no withholding tax. – brian May 15 '14 at 23:48
  • @brian I'm a complete amateur with no prior background in finance or investing. I'll take a look at your tips, thanks. – ashes999 May 16 '14 at 13:44
  • @ashes999 - If you are new to investing I would be very careful of blindly following advice about buying a stock just because it pays a dividend - you may lose a lot more than the dividend amount. – Victor May 16 '14 at 21:47
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    @Victor did you read my question in entirety? I certainly did not lose more than the dividend amount. – ashes999 May 16 '14 at 21:59
  • @ashes999 - and because you didn't lose more than the dividend amount this time you think it is a sound strategy? – Victor May 17 '14 at 00:26
  • This is not the appropriate forum for extended chat. – ashes999 May 17 '14 at 01:25

3 Answers3

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Yes, they are, and you've experienced why. Generally speaking, stocks that pay dividends will be better investments than stocks that don't.

Here's why:

1) They're actually making money. They can finagle balance sheets and news releases, but cash is cash, it tells no lies. They can't fake it.

2) There's less good they can do with that money than they say. When a business you own is making money, they can do two things with it: reinvest it into the company, or hand it over to you. All companies must reinvest to some degree, but only a few companies worth owning can find profitable ways of reinvesting all of it. Having to hand you, the owner, some of the earnings helps keep that money from leaking away on such "necessities" like corporate jets, expensive printer paper, or ill-conceived corporate buyouts.

3) It helps you not freak out. Markets go up, and markets go down. If you own a good company that's giving you a nice check every three months, it's a lot easier to not panic sell in a downturn. After all, they're handing you a nice check every three months, and checks are cash, and cash tells no lies. You know they're still a good company, and you can ride it out.

4) It helps others not freak out. See #3. That applies to everyone. That, in turn means market downturns weigh less heavily on companies paying solid dividends than on those that do not.

5) It gives you some of the reward of investing in good companies, without having to sell those companies. If you've got a piece of a good, solid, profitable, growing company, why on earth would you want to sell it? But you'd like to see some rewards from making that wise investment, wouldn't you?

6) Dividends can grow. Solid, growing companies produce more and more earnings. Which means they can hand you more and more cash via the dividend. Which means that if, say, they reliably raise dividends 10%/year, that measly 3% dividend turns into a 6% dividend seven years later (on your initial investment). At year 14, it's 12%. Year 21, 24%. See where this is going? Companies like that do exist, google "Dividend Aristocrats".

7) Dividends make growth less important. If you owned a company that paid you a 10% dividend every year, but never grew an inch, would you care? How about 5%, and it grows only slowly?

You invest in companies, not dividends. You invest in companies to make money. Dividends are a useful tool when you invest -- to gauge company value, to smooth your ride, and to give you some of the profit of the business you own. They are, however, only part of the total return from investing -- as you found out.

Patches
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    Just to clarify, at the scale I invest ($1000-$2000), we're not talking about "a nice check every three months." We're talking about $20 every year, out of which the tax man eats $10. – ashes999 May 13 '14 at 01:58
  • The principle is the same, regardless of how big your portfolio is. As for the taxes, well, take it up with your representative. :-) When you sell, you'll be taxed on your capital gains. There is a argument about taking returns in dividends vs. capital gains, and some people get quite heated about it. The thing is, unless your country dis-proportionally, and excessively, taxes one over the other, it shouldn't affect your decisions on which company to buy. – Patches May 13 '14 at 02:13
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    @ashes999 When investing, you have to always look at things from a perspective of percentage-change not monetary change. If you invest small amounts of money, you can't expect it to grow an outrageous amount, or everyone would be rich. Dividends are nice because you can keep reinvesting the dividend and receive a larger return on the next dividend because it compounds. So look at things in the long term, and keep investing to create a larger portfolio. Maybe look into an IRA it taxing is a problem? – Sam May 13 '14 at 04:02
  • -1 - "It helps you not freak out. Markets go up, and markets go down. If you own a good company that's giving you a nice check every three months, it's a lot easier to not panic sell in a downturn." So if you get 5% dividend but you stock drops 40% that is no reason to panic - yes you have just lost 35% not 40%. I would never panic sell, I would have a plan of how to manage an investment before I ever buy into it. – Victor May 13 '14 at 07:29
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    Think again about not 'faking' the cash they return as a dividend. As Victor pointed out: Enterprises can and do take loans so they can declare a dividend. – emican May 13 '14 at 12:31
  • So to summarize, companies that give growing dividends yearly are a good indicator of companies that will grow in value; dividends themselves are not that useful, but compound over the years. Is that right? – ashes999 May 14 '14 at 01:31
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    @ashes999 - you need to check where the dividends are coming from firstly. If earnings per share are more than the dividend per share - that's a good sign. If dividends are growing every year due to earnings also growing every year - then that's a good sign too. But if dividends grow but earnings fall - that might be the start of trouble to come. You just can't look at dividends in isolation. – Victor May 14 '14 at 08:16
  • @ashes999 they are a good indicator, but that is not their only value. As I said, they're part of the total return. – Patches May 16 '14 at 20:50
  • @Victor psychology is a big part of investing -- especially managing one's own. I'm glad you never feel fear; it'll help you make money. Meanwhile, if I had the stock in your example, and thought the fundamentals were still good, I'd not only not sell, I'd back the truck up. And notice at that price point the dividend would be 8.3%. This is the difference between trading and investing. In trading you're looking to buy low and sell high, lather, rinse, repeat. In investing you're looking to buy great companies at great prices -- and hang on to them as long as they remain great. – Patches May 16 '14 at 21:15
  • @Patches - firstly I didn't say I never feel fear - I said I would never panic sell because I would have a plan before I buy. Secondly, if a stock falls by 40% there is likely to be something fundamentally wrong with it, so dividends may not be 8.3% if the company needs to cut them. By the sounds of it you are the one looking to buy low (when the price is on the way down) in the hope that in the long term the price will go back up - sometimes this does not happen. What happens if you buy at 40% down from the highs and a few months after it falls another 40%? - buy another truck load I suppose. – Victor May 16 '14 at 21:42
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    @Victor if the company is still great, then yes, I would buy more. Of course, you are right that usually if a company drops that far it's for a reason. But you have to look no further than 2008 to find loads of great companies cut off at the knees for no explicable reason; everyone was simply in the mood to sell. Having a plan before you buy IS a good idea. In my answer I was not giving a comprehensive investing guide, but rather answering the OP's question on whats so good about dividends -- and one is that it makes it easier to stick to the plan when the market's gone splat on the price. – Patches May 16 '14 at 22:24
  • @Patches - are you sure that a company that is great one year will always be great? Have you forgotten what happened with Enron and other companies like it, how do you know that a fall of 40% is due to market conditions or company fraud? And even if it is due to market conditions, how do you know the falls will stop at 40%. How much capital do you have to keep buying more and more as the price progressively moves lower. You are in the end hoping the price goes up after you buy and that is gambling. Oh yes, and there is no guarantee dividends will continue. – Victor May 17 '14 at 00:42
  • @Victor sigh Ok, you win. You've successfully convinced me that my point about dividends making it easier to handle ordinary market fluctuations actually means all and sundry should to hang on to Enron till the bitter end. What else could one expect someone who says such nice things about dividends to do? OK OP, new plan: avoid all companies with dividends, and sell when you have a down day. You'll be rich in no time! – Patches May 17 '14 at 18:28
  • @Patches - No that is not what I have been saying, so stop being condescending. All I have been saying is that you shouldn't look at dividends in isolation. If you do you will get in trouble at some point. Just because a company pays a high dividend does not make it a "great" company! – Victor May 17 '14 at 21:17
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    @Victor We agree on that -- and I neither said that you should look at dividends in isolation, nor did I say that just because a company pays a high (or any) dividend that that makes for a great company. In fact, I specifically said the opposite: "You invest in companies, not dividends." My answer was specific to the OP's question: "are dividends worth investing for?" I said yes, and gave him a seven point breakdown of why. As for me being condescending, it's well deserved. I simply applied the same out-of-context generalizations and preconceived assumptions to you as you did to me. – Patches May 17 '14 at 23:00
  • @Patches - your first line says it all "...stocks that pay dividends will be better investments than stocks that don't." This is by no means true, some companies that don't pay dividends are more healthy and better than some that do. And your first point claims that companies who pay dividends are "...actually making money" even if their balance sheets are full of miss-information and fraud. By this logic you would have continued to buy stocks in Enron whilst its stock price was plummeting, as long as it kept paying dividends. This is why your answer is dangerous to someone new to investing. – Victor May 17 '14 at 23:36
  • @Victor how conveniently you left out "Generally speaking...". Or is it that you do not understand averages across populations? And yes, dividend paying stocks, as a group, out perform non-dividend paying stocks, as a group, over the long term. That's true even if the group contains Enron. – Patches May 18 '14 at 00:42
  • That's the problem, most new to investing will skip over "Generally speaking..." as well, especially when combined with the rest of your answer. They will think all they have to do is buy high dividend paying stocks and they will do well in the stock market. If you were an adviser giving this as advice you would be sued many times over. – Victor May 18 '14 at 21:16
  • Reason 5 is nonsense. A dividend takes money you had invested in a company and makes it no longer be invested in that company, forcing you to act to keep it invested. If you want to keep your money invested, dividends are an annoyance. – David Schwartz Nov 19 '21 at 09:04
  • @DavidSchwartz no, it takes a portion of the money the business made as a profit on your money, and gives it to you. The only time when dividends aren't good is if the company is growing fast into a large market, and needs the all the profits it generates for capital investments to keep up with the growth. That's not the case for most companies. Take Apple and the giant pile of cash they're just sitting on. They're doing nothing with it. They need to up their dividend. Companies, like trees, can't grow to the moon. But both can produce a lot of fruit. That's what dividends are. – Patches Nov 30 '21 at 02:04
  • @Patches Apple could just as well use the money to buy its own stock. That would make each existing share of stock represent a higher percentage of future revenue without forcing all their stockholders to pay tax on money that was already invested in the company just to keep it invested. Sure, dividends are good compared with doing nothing with the money. But you have to compare them to the best option other than dividends to make a fair comparison and that's not what you're doing. – David Schwartz Dec 16 '21 at 21:25
  • @DavidSchwartz In theory, yes. The actuality is not quite as tidy as all that, however. Buybacks lend themselves too much to management shenanigans, examples: 1) it covers for overly generous stock option compensation plans, since the dilution is hidden by the buyback, 2) covers for stagnant earnings, since it raises earnings per share even if the absolute earnings don't change, and 3) so many buybacks seem to happen when the shares are richly valued, instead of cheap -- all else being equal if the company has a p/e of 50, it'd be better if they bought treasuries with that money. – Patches Dec 21 '21 at 20:24
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You should never invest in a stock just for the dividend. Dividends are not guaranteed. I have seen some companies that are paying close to 10% dividends but are losing money and have to borrow funds just to maintain the dividends. How long can these companies continue paying dividends at this rate or at all.

Would you keep investing in a stock paying 10% dividends per year where the share price is falling 20% per year? I know I wouldn't.

Some high dividend paying stocks also tend to grow a lot slower than lower or non dividend paying stocks. You should look at the total return - both dividend yield and capital return combined to make a better decision.

You should also never stay in a stock which is falling drastically just because it pays a dividend. I would never stay in a stock that falls 20%, 30%, 50% or more just because I am getting a 5% dividend.

Regarding taxation, some countries may have special taxation rules when it comes to dividends just like they may have special taxation rules for longer term capital gains compared to shorter term capital gains. Again no one should use taxation as the main purpose to make an investment decision. You should factor taxation into your decision but it should never be the determining factor of your decisions. No one has ever become poor in making a gain and paying some tax, but many people have lost a great portion of their capital by not selling a stock when it has lost 50% or more of its value.

Victor
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    It would be good to know what the down-votes are for - unless you think the only thing to consider when buying stocks is the dividend yield ! – Victor May 13 '14 at 21:53
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The existence of dividends should be irrelevant to your investing decisions. The difference of performance between dividend-paying and non-dividend-paying stocks can be described within the Fama-French 5 factor model (none of those factors are dividends). It just so happens that dividend-paying stocks tend to have exposure to factors that increase long-term stock returns, but there is no reason that this must be the case going forward. There are also many stocks which have exposure to these factors but do not pay dividends, which a dividend strategy would erroneously exclude.

For a longer explanation without reading academic papers, I recommend this Youtube video by Ben Felix

Lily Warner
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  • This answer doesn’t have much content apart from “go read these other two links to learn about this theory that’s not explained here.” There’s some “5 factor model” what are the five factors? A reader shouldn’t have to go to a link to understand your answer. – quid Nov 17 '21 at 06:23
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    I think the answer does highlight the important points of this model, e.g. that none of the factors are dividends and that it's really correlation rather than necessarily causation that ties together dividend-paying and returns. – GS - Apologise to Monica Nov 17 '21 at 08:25
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    The existence a dividend is irrelevant to performance unless share price increases (compounding). It's the financial health of the company that makes it a good investment, not the dividend. Share price appreciation is the driver of total return. Here's a YouTube video that explains it. The guy is a bit bombastic but he tells it like it is. – Bob Baerker Nov 17 '21 at 14:09
  • @GS-ApologizetoMonica this answer doesn’t highlight anything except the fact that dividends are not one of the five otherwise unnamed factors to this one model which isn’t mentioned in the question – quid Nov 17 '21 at 17:36