Dividends: a Lifetime Income for a Few Hours of Work
What Dividend Stock Should You Invest In?
Don’t be charmed by high dividend yields, it is the best way to lose money. If you want to build a lifelong stream of income, you should favor a safe, recurrent, forever lasting and growing dividend. So you should invest in a strong company, with recurrent earnings, with a competitive advantage, with free-cash-flows growth and a low payout.
There are a few questions to consider before committing capital in dividends paying companies. All the answers are in the company’s financial statements, there is no need to look elsewhere. Why does the management pays out a dividend? Is the company financially strong? Can the company auto-finance the dividend with its operation without negatively impacting its operation in the future? What is the probability of the dividend to be maintained or to be increased? Is the dividend increasing because of growing earnings or higher payout ratio? Do free-cash-flows comfortably cover the dividend (if the company pays out more than its earns, there will be a problem down the road)? Is the number of shares decreasing or at least stays still (you don’t want to be taken from one hand what is given to you from the other hand)? It doesn’t worth it to overlook these questions. It’s just a few hours of work for a lifelong stream of income.
Dividends and Long-term Performance
What the management decide to pay out as a dividend isn’t reinvested back into the business to grow the value of your shares. Also, dividends are double taxed, a first time as corporate earnings and a second time as your personal income. The remaining finally goes into your pocket and you can reinvest it back (and pay some more taxes) or spend it (and pay some more taxes). Therefore, I believe dividends are a drag to performance. But dividends paying companies offer you the convenience to earn recurrent earnings to finance your lifestyle.
I haven’t yet been interested by dividends. I favor the “highest overall gain with the lowest risk” combinations I can find. However, if I were investing for dividends, I would like a company that reinvest their growing free-cash-flows tax-free at high returns on capital to increase indefinitely the value of my shares. They would ideally redistribute capital tax-efficiently through share buybacks when they can do it at reasonable prices. I would prefer a very low dividend payout. I wouldn’t mind having a small dividend yield but a great potential for capital and dividend appreciation. And as always in investing, I would be patient and wait for the perfect opportunity.