Skip to main content

Sound Advice: June 5, 2024

What You Need To Know About Dividend Stocks

At first glance, the appeal of stocks paying generous dividends is the sense that there will be a dependable flow of income while holding them.  Well, as you might suspect, there’s a lot more to think about before buying.

Stocks that pay generous dividends are typically those of mature companies with moderately growing profits.  When dividend yields are above average, the price-earnings ratios are usually low, i.e., their valuations relative to ongoing gains are relatively low. The reason for the low valuations is that investors do not expect the rate of yearly progress to change much.

The polar opposite of dividend stocks (which are also known as value stocks) are high growth companies that offer little or no payout with their shares. 

If all dividend stocks and high growth stocks would perform in line with expectations, the high growth stocks as a group would outperform the dividend stocks.  But the actual results over time show the exact opposite result. 

How can this be?

The reason is that there are always a few members of the high growth group that turn in disappointing results, which inevitably causes investors to bail out, often dropping the stock’s price by precipitous amounts. So even though most of these stocks will do well, the drag caused by the laggards will weigh heavily on the average of all held.

The opposite takes place with dividend stocks.  Not-so-hot news has already been built into current prices, so as more of the same is announced, there’s not likely to be much impact.  But when these companies report larger than expected upside surprises, they will jump.  And those jumps will tend to raise the average returns of the group about those of the high growth companies.

To take advantage of this apparent anomaly, it is essential to buy groups of at least two dozen of the dividend stocks. Always ensure that the dividends being paid are comfortably covered by the current level of earnings.

This approach will not work in every year, but over time it should be worthwhile.

These findings are based on a 20-year study of the Standard & Poor’s 500 in which we divided the universe into 10 deciles (50 stocks each) from lowest to highest dividend yields.  The highest long-term returns were from the group of highest dividend paying stocks. Returns descended in perfect order from highest dividends to lowest dividends.

A similar study divided the S&P universe in 10 deciles from lowest to highest price-earnings ratios. Although not in perfect order, the returns were highest for the stocks with the lowest price-earnings ratios and lowest for those with the high price-earnings ratios.

Each of the exchange-traded funds holding high dividend stocks that may be worthy of consideration should have at least two to three dozen holdings.  A variant from Vanguard, VIG, simplifies that approach by holding what appears to be the top third of dividend payers in the S&P universe. That ETF might be viewed as a hybrid market index fund rather than a high dividend vehicle.

N. Russell Wayne

Weston, CT

Any questions: please contact me at nrwayne@soundasset.com

203-895-8877

www.soundasset.blogspot.com

Comments

Post a Comment

Popular posts from this blog

Sound Advice: July 16, 2025

Fixed annuities are poor investments Fixed annuities are often criticized as poor investments for several reasons, despite their reputation for providing stable, predictable income.  Here are the key drawbacks and concerns:   High Fees and Commissions Internal Fees:  Fixed annuities can carry a range of fees, including administrative charges, mortality expense risk fees, and rider fees. These can add up to 2%–4% per year, significantly eroding returns over time. Commissions:  Sales agents and financial advisors often receive high commissions for selling annuities—sometimes as much as 5%–8% of the invested amount. This creates a financial incentive for advisers to recommend them, even when they may not be the best fit for the client. Comparison to Other Investments:  Mutual funds and ETFs typically have much lower fees and commissions, making them more cost-effective for long-term growth. Limited Growth a...
Post a Comment
Read more

Sound Advice: October 8, 2025

How many investors have outperformed the stock market over the last 20 years? Very few investors have outperformed the stock market over the past 20 years.   Data shows that only about 6% to 8% of actively managed equity funds in the U.S. beat the market over this period, with the vast majority—over 90%—underperforming the S&P 500 or equivalent broad indexes. Percentage of Investors Beating the Market Only 8% of equity funds investing in large companies managed to outperform the market over a recent 20-year span. About 94% of all domestic funds underperformed the S&P 1500 Composite Index from 2005-2024. Over shorter timeframes (5-10 years), typically fewer than 15-20% of fund managers beat the S&P 500, and performance persistence is rare. Why It Is Rare The S&P 500’s high returns have proven immensely difficult to beat, especially as indexing has become popular and markets have ...
Post a Comment
Read more

Sound Advice: November 10, 2025

The stock market indexes seem to be dominated by a handful of tech stocks, but how is the average stock doing? As of late October/early November 2025, the S&P 500 index excluding the Magnificent Seven stocks (the "Other 493") has delivered a modest year-to-date return of approximately 5.3% to 5.4%. That’s barely more than one third of the performance of the full, market-capitalization-weighted S&P 500 index, which was up around 15.1% to 16% over the same period.  (The Magnificent Seven stocks are Alphabet (Google), Amazon, Apple, Meta (Facebook), Microsoft, Nvidia, and Tesla.) Index Concentration and Market Breadth The S&P 500 Equal Weight Index underperformed the standard, cap-weighted S&P 500 by about 12% in 2024, reflecting the gap between the top performing giants and the rest of the market. Only sectors like utilities, industrials, real estate, and energy outperformed their cap-weighted peers, while tech and consumer-focused sectors were ...
Post a Comment
Read more