An interesting strategy to use during ambiguous and turbulent times (in the market) is investing in businesses (stocks) that pay dividends. Because once we invested in a price that we are satisfied with, even if the stock market drops further, we would still receive dividends that we can take to reinvest while waiting for the stock market to return to normalcy and for the stock price to rise accordingly.
Actually, the principles of investing in dividend stocks are the same for doing general businesses and the usual stock investment. Note, the dividend that the company pays out comes from its yearly profit. So the more profit a company makes, the more dividends it can pay. Naturally, if the firm does not make any profit, then it wouldn’t be able to pay out dividends as well.
The most common mistake that investors who invest in dividend stocks make is the fact that they only look at the Dividend Yield; for example, if at the moment, this stock has a price of 100 Baht, and it pays a 5 Baht dividend, that means the Yield is 5. If we purchase it at this time, then our dividend will beat the bank savings interest. So this makes us purchase the stock. However, in the next year, the company stops giving out dividends because the business is making a loss; hence the stock price falls as well, causing us to lose altogether.
Therefore, when we are selecting dividend stocks, we must first and foremost, select good companies, and then examine at the 3 following factors:
1. How well can the company make profits and continuously sustain it?
Look at whether the profit figure grows each year (at the very least, it should not decrease; so that we can be confident that the company’s ability to pay dividends is not lower than the last year)
(You can see the Revenue and Net Profit figures on Jitta FactSheet)
2. Are the dividends that the company pays taken from the actual profit?
Look at the percentage of the dividend compared to the profit figure. Because a company with good management will not overpay dividends that exceed the profit figure (because the company should reserve some money for business expansion or emergencies).
Try to avoid companies that continuously pay dividends of more than 100% of their profit, and investigate where that dividend money came from: past profits, borrowed money, from increasing stock capital, for example.
Wherever this money comes from, it will be gone one day, because it didn’t come from the yearly profit. When that day comes, the company will be unable to pay us dividends.
(You can see the All Dividend to Net Profit figures on Jitta FactSheet)
3. How often does the company pay dividends on record?
Look at the past years and see how often the company pays dividends, whether it pays equal amounts every years, pays more, or skips some years.
We should select companies that have a good record of dividend payments for a long period of time, and the amount should increase every year, according to the profits as well.
(You can see the Dividend Declared Per Share on Jitta FactSheet)
Generally, if you pick companies with high Jitta Scores, they will satisfy # 1 and 2 anyway. The only thing left to look at is number 3: the historical dividend payments.
After selecting companies that pay reasonable dividends that fulfill the 3 criteria above, we then come to look at the Dividend Yield; it is is within the level that we are satisfied with, then we can happily invest in that company (at the very least, the Yield should not be lower than 5%).
For example, Company A has passed criteria 1-3 and pays a dividend of 5 Baht, with a current price of 100 Baht. The Dividend Yield is then 5%. If we like this company, then we can purchase it because we can be confident that in the years to come, Stock A should pay dividends of no lower than 5 Baht and we would thus get a return of no lower than 5% every year.
If, say, we want a Dividend Yield of 10%, we can also calculate the price that we want to buy that stock in. For example, if Company A pays a 5 Baht dividend, if we want a 10% Dividend Yield, we would have to buy this stock at 50 Baht.
The best thing that comes out of investing this way is that if we have the opportunity to invest in good companies with growing profits that pay increasing dividends every year, we will not have to sell our stocks. We will have a growing passive income every year. while our wealth (stock value) will also increase as well.
For example, Sherwin-Williams’ stock, a stable and long-standing company that has increasing long-term profits and very little debt.
In the picture is SHW’s yearly dividend payout. We can see that from 1979-2012, SHW has increasing payouts every year, and these dividends are from the company’s profits. Let’s say in 1987, we had the opportunity to invest at $2.8 and receive at dividend of $0.14 (5% Yield). After that, we receive increasing dicidends every year, and hence increasing yields in every year, too.
For example, in 1994, SHW paid a dividend of $0.28 (10% Yield) -when compared to the $2.8 we invested in, and in 2001, SHW paid $0.58, that is a Dividend Yield of 20.71% of our invested capital. Until 2012, when SHW paid $1.56, a return of 55.71% from our invested $2.8.
If we add up all the dividends together from each year, you will find that we already received the invested $2.8 back since 1998. After that, it is just our growing wealth (this is one concept of how to build Passive Income)
Aside from dividends, the value of SHW will also be higher in each year, because there is noway that in 2012, SHW’s stock will have the same $2.8 price while paying out a $1.56 dividend. If we calculate the dividend yield at 5%, then SHW’s price in 2012 should be lower than $31.2 surely.
Therefore, investing in the long-tern in businesses that are great will generate increasing dividends and stock values. This is no different from any good real-estate investment with tenants that pay you rent while the property price rises constantly.
Personally, I don’t really think too much about dividends. I’ll consider them as an added bonus, because according to the principles, if we invest in good businesses that have good management, the way profit is being used will be for the benefit of the investors anyway, whether it’s being used for business expansion, for paying out dividends, or purchasing other stocks… any purpose would increase the wealth and stability in the long-term anyway.s
Therefore, always remember that investing in good companies will increase our passive income in the long-run, and to never only look at the dividend policy when making investing decisions. Importantly, we we invest in good companies that have good dividend payouts, we do not have to be too concerned with the stock prices in the market -just keeping tabs on how the company is performing, how the revenue/profit/dividend is increasing, we would be happy and just hold on to the stock without any qualms.