52. Dividend Investing
Transcript:
Evan Neufeld: Hello, and welcome back to the Canadian Money Roadmap podcast. I'm your host, Evan Neufeld. Today's episode is a little bit different, but we are talking specifically about dividend investing.
Jordan, welcome back. You're my dividend expert today. Okay, I’ll do my best. So maybe let's get started here. Let's jump right into what is dividend investing. I'm sure most of you listening have heard of it before, but we are going to demystify perhaps some of the aspects to dividend investing. Not necessarily make a recommendation for who it's for, or maybe even talk about the taxation side of things, but just so you have a better understanding of what is dividend investing and some of the benefits involved with it. So let's start it off, Jordan, what's a dividend?
Jordan Arndt: So a dividend is when you invest in a company that shares its profits through something called dividends. A dividend is something that would be declared by management, and they would distribute your portion of the profits based on your ownership of the company and a way of sharing their earnings with you. A dividend often shows the health of a company. You're typically not going to see a company in stress paying a dividend. So it can show some strength. You might notice (we don't want to get too much into taxation here) it's taxed differently than interest or capital gains, which is another type of income that you might receive from investing. Just know it's taxed differently. Dividends are often paid at regular intervals, whether that's quarterly or semi-annually. But essentially, it's a way that the company shares its profits with its shareholders.
Evan Neufeld: And so we typically in the investing world, we see that in publicly traded stock. So let's look at the biggest company in the world, Apple. Apple sells iPhones and online services. Now they're into video streaming and all that kind of stuff. They will take a portion of their profits and reinvest it back in the company. But beyond that, they'll also share some of those profits with you and that's through a dividend. So I mentioned Apple there, but what type of stocks would generally pay a dividend.
Jordan Arndt: At a general level, that's going be typically your more established companies, a company with stable earnings, something that they know they can predict what their earnings will be and thus be able to share it with shareholders. So think banks, telecommunications, large energy companies, consumer staples, Apple's a, a good example. Other companies just using some examples, we've got something like Proctor and gamble, 3m, Coca-Cola, McDonald's. Companies that have been around for a long time, fairly predictable, fairly established. With that might mean lower growth potential. You know, you're not going to see these companies like a Tesla that's kind of all over the place in terms of returns. It's going to be a little bit more stable, little less growth potential. But yeah, those are, those are some companies that you may think of when you think of dividends.
Evan Neufeld: Part of the reason why you're not going to see a dividend from Tesla? Well, maybe I'll be careful. You're not likely to see a dividend from Tesla anytime soon or a company like that. Any of these more high flying tech companies or electric vehicles or emerging technologies is because they are growing a lot and typically their technology or their product, or whatever is very expensive to produce. So if there are any profits at all, generally speaking, those would be reinvested. So those come from let's say a Gigafactory, you know, they're building some in Texas and one in China and one in Berlin, They aren't really at the stage of business maturity where they would say, okay, well, all of our growth is kind of baked in to what we're doing here. So if we have profits, we're just going to send them out to shareholders.
Just generally those more established companies, stable earnings, cash flows, profits, maybe call it old economy types of companies. Those are the ones where you're likely to see dividends. Doesn't really matter what sector they're in necessarily. There's no defining features of telecommunications or financials or whatever that determines that. You can generally find a dividend paying company in almost any sector in most countries, but that doesn't necessarily mean that company is better or worse. That's just what they've decided to do with their profits. So speaking of what those people have done with those profits or those companies have done with those profit.
there are companies that have increased their dividends pretty consistently every year. So those are growing companies you could argue, but when they grow, they've also increased those dividends over time. They've got a pretty fun name. Maybe you might have heard of it before Jordan take it away.
Jordan Arndt: Dividend aristocrats.
Evan Neufeld: Oh, well aristocrats, very fancy. Put on your monocle and invest with the aristocrats. What is that, what is that actually?
Jordan Arndt: It's just a company that has more than 25 years of consecutive dividend increases. So yeah, you know, we're talking about what stocks pay dividends, typically more established companies, stable earnings these dividend aristocrats kind of take that to the next level, 25 years in a row of consecutively increasing their dividend.
Evan Neufeld: So would these companies then be paying massive dividends if they're increasing them every year?
Jordan Arndt: The increase is pretty small typically. So we'll talk about dividend yield here in a little bit, which is a reflection of that. You're not going to see huge numbers, I guess, in that respect.
Evan Neufeld: These are generally single dollars or pennies, that kind of thing for dividends. But it's paid out based on the number of shares that you own. So it's a dividend per share kind of thing too, so let's jump into dividend yield there. That's just kind of a ratio or just a math equation that we can do here to figure out, okay, well, is this high relative to the price or not?
So, a dividend yield usually just means that you take your payment per share and you divide it by the share price. And so in some cases that could be as high as, you see stuff as high as like 10%, some are a bit higher than that. It seems a little sketchy, but really common is anywhere between half a percent and up to three and a half, that a pretty typical dividend range there for a dividend yield. But anything else to add on dividend yield?
Jordan Arndt: I don't think so. No, that makes sense. One thing, just to jump back to you know, what are dividends and just wrap that up. Dividends are not guaranteed. So we're talking about dividend aristocrats. They've increased their dividend for over 25 or at least 25 years. That doesn't mean the next dividend that scheduled to be paid will be paid. Management has to declare it and there has to be profits available and whatever else. Any company that's declared a dividend before does not guarantee that a dividend will be declared again.
Evan Neufeld: And there has been some weird historical events here recently that have impacted the ability to pay dividends for some of these companies. So think of large corporations that receive bailouts from the government think of airlines. I'm not remembering specifically here, but just generally speaking, there have been times where say an airline receives a bailout from the government to keep going. Part of the agreement with that bailout would be okay, you can't just turn around and turn this into dividends for your shareholders now, you just got to keep the lights on and make sure everybody has a job. And so sometimes companies can be restricted there. Whereas if you're holding that stock, it's like, oh my goodness, I bought this because of the dividend, it's not guaranteed. And things change over time too. Like if profits go down, think of even maybe 25 years ago, General Electric was one of the top paying dividend paying companies in the world. Now I'm not sure if they're even paying one. They suspended their dividend a number of times, even in recent years here. So, things change over time for sure. But yeah, those dividend aristocrats is kind of an interesting group of companies there. We talked about dividend yield but, you know, they could be paid monthly. Most of them would be quarterly, sometimes annually. But these dates are actually pretty important because you might be thinking to yourself, okay, well, if I know when they're going to pay a dividend, why don't I just buy that stock? Get paid the dividend and sell the stock the next day. Wouldn't that be nice.
Jordan Arndt: Yeah, that'd be a unique strategy or new strategy. Anyways, there's a few key dividend dates to keep in mind and we'll talk later about how the dividends affect the stock price, but just to highlight a few dates at first. So date of declaration, that's the day when the company's going to announce their intention to pay the dividend. They haven't actually paid it. It's just their announcing their intention to do so. They'll also on that date, they'll announce two other dates. They'll announce the date of record, as well as the date of payment. Now the date of record determines which shareholders are eligible for the dividend. So on that date, they'll take a list of who all owns the stock and, and those shareholders are eligible for that dividend. There's something else. We'll add another date here called the X dividend date.
Evan Neufeld: And you'll see that one listed, like if you're looking on financial reporting sites and what not, X dividend date is, is a pretty common one to see listed.
Jordan Arndt: That's two dates before the date of record and, and that's kind of the date that matters. So investors who own the stock before the X dividend date, get the dividend. If you don't own it before that date, you don't. Lastly date of payment is the date when you'll actually receive the dividend. But from an ownership perspective, if you're wondering, am I going to get the dividend or not? That X dividend date is the date you want to look at?
Evan Neufeld: Perfect. Good summary there, Jordan. Okay. So then once you actually receive it, what are your options, or even before you receive it, I guess, there's a few options there. So one of the most common ways to build wealth over time is to reinvest your dividends. And you can do that automatically with some stocks depending on your brokerage. Anyways, look into it, it’s called a dividend reinvestment program or a DRIP. And what this does is it allows you to reinvest your dividends into additional shares. Let's just do some round math here. Let's say the share price is a hundred bucks and you get a dividend of a dollar. If you get your dividend of $1, you can't buy 1% of a share. So the way that a DRIP works is that you have to have enough of a dividend coming in to buy whole unit of that stock. So in my hypothetical here, you'd have to own a hundred shares. You get $1 per hundred shares. Now you've got a hundred bucks. So your dividend would then purchase one more share. You can also do it manually by receiving your dividends in cash. And then using that to buy something else, some other investments you could even use it just for your own income. Right and a lot of people do as part of their retirement income strategy or things like that. Maybe they've owned shares of these companies forever and ever, and now they actually spit out some decent money every month. It's yours. You can do whatever you want with it. So, there's a bit of a buzzwordy thing here, and I don't want to turn this into a kind of a click bait YouTube channel type of thing, but are dividends passive income? People are always looking for that elusive, passive income, something that'll pay you without you putting in much effort. I would say yeah.
Jordan Arndt: It would be tough to argue that for sure.
Evan Neufeld: The problem with it is that these dividends aren't huge generally. And so as a result, you have to have a lot of money invested for your regular dividends to be meaningful for you. Maybe some people listening have millions of dollars invested in dividend paying companies and maybe that is working for you, but for the vast majority of people, if you're starting out buying some dividend paying companies with a few thousand bucks, or even even a hundred thousand dollars, you can't expect dividends to make a meaningful impact and maybe even replacing your income for a long time. It could be part of your income strategy, but just being realistic here. It's going to be pretty tough to replace your working income with dividends until you have a huge portfolio built up.
Jordan Arndt: I think the other thing worth mentioning on that front is looking at total return versus just a dividend yield. So a dividend stock, even if it pays a dividend and there's a, let's just say a 2% dividend yield. You also still can benefit from capital appreciation of that share price. So Apple, maybe it's worth a hundred dollars today, but it might be worth 110 a year from now. What's the 10% return. Plus the benefit of the dividends, like of course can go the other way as well. And the fact that the share price can drop. And so just because a dividend is being paid does not mean the stock is necessarily a good buy or a good sell or a good holder or whatever. It's just worth considering a total return perspective and maybe a 2% dividend yield actually doesn't lead to much return for the share as a whole compared to a different option that maybe doesn't pay a dividend yield, but has historically maybe provided better total returns? Again, there's no one right answer there. It's yield isn't everything considered in the larger picture.
Evan Neufeld: Let's use an example here of maybe call it a sin stock Altria, which used to be known as Philip Morris. This is a cigarette company and they do e-cigarettes and things like that. These aren't particularly innovative businesses, but unfortunately their product is very addictive and they have sales like you wouldn't believe still because it's a global company. Now, if you look at their share price over even the last few months, it has really fallen off the face of the earth here, but they've got a yield, a dividend yield over 8%. What if that share price kept going up? Would that yield be 8%? No, it wouldn't. So this is kind of where the, the ebb and flow of those things work. Because again, that yield is just relative dividend versus price.
Jordan Arndt: As price goes down, yield goes up, assuming dividend stays the same.
Evan Neufeld: So let's go to the cautions here. When it comes to yield investing or dividend investing, high yield isn't everything, and it can be a bit of a trap, a yield trap.
Jordan Arndt: You know if a stock pays a much higher yield than its peers or comparatives or something like that, that's often a sign of trouble, not necessarily opportunity. In this example, As that share price drops, the yield gets higher. That's not necessarily good because if you look at your total return again, it's actually going in the wrong direction.
Evan Neufeld: Sometimes there can be companies that bait people into buying their stock by putting out worse than expected earnings or even a decline in profits or things like that and also increasing dividends. Be careful here, right? You're not necessarily jumping on a sinking ship, but increasing dividends doesn't always mean exactly what you think it might.
Jordan Arndt: Yeah. I guess if you are trading individual dividend stocks, which we wouldn't necessarily recommend, but if you are looking at the dividend and the dividend yield is not the only thing you should be looking at, how stable are the company's fundamentals. Can they continue this? Why is the share price going off a cliff. Is there a reason for that? Is the dividend payment going to be consistent in the future? There's just a lot more to consider than just oh, 8%, that sounds great. Maybe not though, right. The other thing to another ratio for you is, is the payout ratio, which is just how much of a company's earnings are they paying out. Let's say they're paying out a hundred percent well, that means every dollar of earning, they pay it out to shareholders, let's say is a 200% that means, for every $1 of earnings, they pay out $2 in dividends, which in that case they'd be having to borrow to do that. That's not a sign of stability. Right? Like how is that possible? And so maybe it's juicing a dividend yield today, but just be careful of some of those metrics.
Evan Neufeld: Looking at those companies, you know, 80% feels pretty high. Lots of these things are industry dependent too. As far as payout ratios go and even the age of the company and things like that. Getting up really close to a hundred percent, I would say would be something you want to be leery of. Anything less than that it’s like okay, great. But you'd hope you'd see some share price appreciation too if they're reinvesting there. If they're return on equity is actually pretty good.
Jordan Arndt: If it looks too good to be true, it probably is.
Evan Neufeld: So how do you actually buy dividend paying companies. If dividend investing is something that sounds interesting to you, you've done a little bit of research, you've listened to our podcast or maybe some others. How can you actually buy these things?
Jordan Arndt: You could buy individual stocks like you buy any other individual stock if that's what you choose to do. You can also buy it through a, you know, build product, like a mutual fund or an ETF that has a mandate to invest in specifically dividend paying companies. So you can buy it on a pooled basis where you'll invest in a collection of dividend stocks. Again, you could do that geographically, you know, they'll be Canada focused ones, they'll be US focused ones, they'll be globally focused ones. There's a couple different ways you can get access to dividend paying stocks.
Evan Neufeld: Yeah. One of things that people might look at with a mutual fund or an ETF, they might fall into that yield trap. And because those products will own a wide swath of dividend paying companies and in many cases they might own higher quality dividend paying companies based on the rules or the management style or whatever the case may be. They may exclude perhaps the cigarette companies or the sketchy junior oil and gas company. The yield on those products might be lower than many individual companies that you could own, but again, there is a benefit to diversification of business type, business idea, geography, all sorts of different things. So again, even if you're looking at an ETF or a mutual fund, don't get tricked by thinking that yield is the only thing there. These are companies that are, again, you hope that you're buying the concept as opposed to as much yield as you can possibly get.
Okay. Let's just let wrap up with a, a little summary of dividend investing. All in dividend investing is essentially just buying companies that are willing to share their profits with shareholders and prioritize that over reinvesting in their own company. So receiving a dividend, it's like receiving income that will typically get paid on a pretty regular basis. They're never guaranteed of course, so you can't really bet the farm on this and assume that it'll be there forever. But if you're looking for some of those more established companies, that may be a pretty good bet. If you're looking for dividend paying companies dividend yield, this is the thing that will inform how much of a dividend is paying relative to the share price. Again, don't get tricked into thinking higher is better. In some case, yeah maybe and other times, maybe not. When you receive a dividend, you could have it set up to automatically reinvest and buy more shares of that company or that ETF or that mutual fund. With mutual funds it's a lot easier, with ETFs it's a little easier, yet with individual companies it all depends. And your broker will be able to help you out with that. You could also just take them in cash and use it to buy something else, either in the real world or another investment or something like that. So as a result of that, of course it is passive income which is pretty cool. Again, just to keep in mind there that your portfolio will have to be pretty significant for you to have meaningful passive income via dividends. And so that's just our caution to not seek out the highest yield possible because you have to keep in mind those things like your payout ratio. You can find that info online through things like Yahoo finance or Morningstar, I believe you can find dividend payout ratios relatively easily. You could even just Google the company that you're interested in. But again, if it looks too good to be true, it probably is. Jordan, did I miss anything else about dividend investing? It's a good summary. Well, thanks so much for listening today, folks, and we'll see you in a couple weeks.
Thanks for listening to this episode of the Canadian Money Roadmap podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Neufeld is a Certified Financial Planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals inc.