What Presidential Primaries Teach Us About High-Dividend Stocks
The New Hampshire primary results are in. Some candidates have dropped out, and supporters are scrambling to find a winner.
The same thing is true with investors. As of Feb. 11th, the Standard and Poor’s index of 500 stocks is down 10.51% for the year. What about bonds? Well, here are some current yields for various types of bonds:
10-year Treasury Bonds 1.64%
10-year AA Corporate Bond 2.77%
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Stocks are down, yields are low. Like the current political environment, people are running toward an investment that might perform better in these financial conditions: high-dividend stocks.
The Play-doh analogy
I’ve used the Play-doh machine analogy to describe a company that can generate earnings. Here it is again: a firm puts capital into the business. Capital may be cash, equipment or building. That’s the play-doh you put into the plastic machine.
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You turn the Play-doh machine crank to move the material through the machine. In the same way, a business uses capital to make a product or service. Finally, the Play-doh shape comes out of the other end. In finance, profits (earnings) come out the other end.
What makes high-dividend stock attractive?
High-dividend stocks can produce higher earnings than companies of comparable size (measured by revenue). These companies can also generate reliable and consistent earnings, compared to the overall market.
Using the Play-doh example, these companies can turn the crank and produce more earnings- consistent earnings.
So, what’s the benefit to an investor? Well, really two things:
- Higher earnings mean a bigger potential dividend payment to investors. If you reinvest that dividend into your mutual fund (or in another investment), you get the great benefit of compounding. Compounding is magic- check out why here.
- A company that generates earnings can retain those earnings. The more profit you can generate, the more funds you can keep to grow your business. You can use the added capital to buy assets or to purchase a competitor. These steps help management create a more valuable business.
Several types of companies tend to generate high levels of dividends. Utility companies, for example, provide a service that everyone uses: gas or electricity. Since the revenue stream is predictable, smart managers can generate consistent earnings.
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Businesses that dominate the market for their products can also generate high levels of earnings. Proctor and Gamble is a good example. P&G dominates the market for many of their products. Tide laundry soap is a good example.
These companies have more control over pricing their product. As a result, they can generate higher earnings and pay more in dividends.
Investments with high-dividend stocks
This Morningstar link points out several mutual funds that focus on high-dividend stocks. While you gain more income, these stock’s prices may not increase at the same rate as other companies.
I’ve blogged about beta as a measure of risk. High-dividend stocks may have a lower beta, on average than other stocks. Less potential for big increases- but less downside risk.
Take a look at these stocks in times of volatile markets and low interest rates.
As always, this post is for informational purposes only. Consult a financial advisor, tax expert or an attorney for specific advice.
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Ken Boyd
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
Co-Founder: accountinged.com
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