Sunday, March 13, 2011

Stocks - Not just Capital Appreciation, it's the Dividends too lar, dummy!

Why you should invest in stocks that pay dividends?

This is why! (image credit: dreamstime)

Most property investors will tell you that buying a property is about two things - the rental and the capital appreciation. While you correct monthly rent, the property will hopefully (if it's a great location and demand is there), the property price will go up over the years beating inflation and making a good profit when you sell it. Ta-daa capital appreciation!

So what about stocks? Everyone seems looking for the next penny stock that rockets 100-200% but does anyone actually think about stocks paying dividends.

I think this may be a mistake and everyone's portfolio should have some dividend paying stocks.

Dividends are a way for the company to show of confidence saying : ' Hey, we are doing quite well and let's reward our faithful shareholders some money.'

On the flip side, it also can mean : ' We have money lying around but we do not know what to do with it or we don't have plans to expand so let's pay out dividends instead' - This seems to be very much the case for Malaysian Telcos such as Digi and Maxis where we have 110% mobile penetration in Malaysia (some people have 2 phones you see) and the mobile telephony infrastructure (in the profitable urban areas, at least) has already been set up. The higher growth areas would be Mobile Internet and that's where the capital appreciation for these stocks may (or may not) come in.

What to do with all that Extra Money
Coming back to the topic at hand - Basically, companies with huge cash reserves can do a few things:
1) Buyback shares
2) Acquire another company
3) Invest in capex to increase capacity
4) Pay out dividends to its Shareholders
5) Not do anything.. yet? (like in the case of Apple, Google, MFT)

So, if a company pays dividends steadily, more likely than not, it is a sign of the confidence that it is doing well and is willing to share the spoils with its shareholders.

The Numbers to Back Up
Consider this :

Take the S&P 500 and it's proven that dividend paying stocks outperform their non-paying cousins. Find the graph here from 1992 to 2004 in a study by Ned Davis Research.

Pay attention to the red lines where $100 grows to $2368 (10.1% per annum) versus non paying dividends stocks -$100 grows to just $395 (4.3% per annum). All this of course should be compared versus the market (blue graph) where $100 with the index ends up to $1475 (8.5 per annum)

Of course, there are a few key assumptions here : Reinvest the dividends made and also, do some research on whether the dividend payout is steady and has been increasing over the years.

In the Malaysian context, there seems to be little to no emphasis on such stocks and I am quite puzzled by this. Maybe, Malaysian investors are more impatient and would rather take more risky moves or generally, because most Malaysians are speculators ( I am guilty on this too!) rather than true investors buying a piece of business they really believe in and are willing to wait for their due returns. The fact that most investing houses make money from transaction costs and there are lots of people selling technical analysis tools to encourage trading maybe makes us more speculators than anything else!

Personally, I hold some shares in YTLPower since 2H2010 which even with its YES! broadband venture - has been paying steady dividend of over 5% and been reinvesting those dividends. Holding steady dividend paying stock can help diversify your portfolio. It's not the best performing stock but even with the recent market hit - it hasn't traded below 2% of what I bought it at. The lesson try not to put all your eggs in one basket.

So, what are you waiting for? Consider having some steady performing dividend paying stocks in your portfolio today!
Further reading:
  • The Extraordinary Power of Dividends - Morgan Hensel for the Motley Fool has a brilliant article on this -Read it here.
  • 6 Myths on investing Dividends - Including one myth that stocks are only for older people who need income - I say its an integral addition to any portfolio! Read it here.
  • Where Dividends Fit on the Financial Puzzle on FT (registration may be required)
Material Disclosure: Yes, I do earn stocks in YTL Power.

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