The Common Stock Dividend ...

Constancy Amid Change

by John R. Kinkead, The Naples Money Managers

Volatility is the only sure thing when it comes to investing in the world’s equity markets. Environmental concerns, international skirmishes, central bank action along with breaking industry and company news all contribute in moving these markets feverishly up and down. 

Just a matter of years ago, we were searching for faster ways to trade securities. Now with the dominance of high speed security exchanges, ultrafast strategies, and high-frequency trading firms, additional price pressure is being applied to securities accentuating their volatility. In fact in 2020, “speed bumps” will be incorporated into trading infrastructures globally with the intent to equalize trading fairness between entities.

After dealing with excessive fluctuations in the market, many investors continue to search for consistent strategies for their holdings. One of the simplest ways to accomplish this today is to own stocks that make regular quarterly payments out of their profits to their shareholders called dividends. The word dividend has its origin in its Latin root “dividendum” meaning a “thing to be divided”.

Over the past three years or so, we have watched ultra-fast growing companies like Facebook (FB), Amazon (AMZN) and Netflix (NFLX) lead the markets with their stock growth. Though these companies do not pay a dividend to shareholders, many popular mutual funds like Vanguard U.S. Growth fund (VWUSX), American Funds AMCAP fund (AMCPX) and others have piled into these stocks for the capital appreciation.

While growth stocks can be a crucial component in a well-rounded investment strategy, dividend paying companies may offer consistency over time due to their dividend. Reliable dividend stocks like Illinois Tool Works (ITW), Colgate-Palmolive (CL), Cincinnati Financial (CINF) and 3M (MMM) have a long history of rewarding shareholders with quarterly payments from their profits. In fact, these companies have consistently paid dividends for over five decades. Stocks that pay dividends are usually some of the strongest companies out there. These companies have shown an incredible business resilience as they pay their dividends in both easy and difficult economies. 

More importantly, these companies issue regular dividend hikes. For an investor seeking stability through volatile markets, rising dividends naturally make these stocks very attractive. Quarterly dividends can also take the pressure off the investor’s expectation of share price appreciation when the markets track sideways. As an investor, it is much easier to be patient in a volatile market when you are receiving recurring income from your stocks.

Since there are a myriad of companies that pay a dividend, the “dividend payout ratio” can help us sort through them for quality. Just because a company pays a dividend doesn’t mean that it will continue to do so over a long period. In order to toss out the stocks that pay yet may be vulnerable in their operations, we can make a quick and easy calculation using their dividend per share divided by their earnings. This easy to use ratio can guide us in the sustainability of the company’s income stream to shareholders by comparing how much of their earnings are kept in the business and how much are returned to shareholders:

Let’s use Johnson & Johnson (JNJ) stock as an example. Let’s say that their annual dividend is approximately $3.80 per share. We’ll divide that number by their approximate earnings per share of $8.70 for the year (Q318, Q418, Q119 and Q219). The ratio shows us that out of the money earned from the sale of their products they have distributed about 43% to their shareholders from their profit. The rest of the money earned goes back into the company for operations, research, payroll and much, much more.

Here we see that Johnson & Johnson distributes almost half of its earnings as dividends which is in line with well-established companies that are leaders in their field. When a company distributes much more of its earnings in the dividend, say 80%, the company may struggle with consistent payments not to mention an annual increase in the dividend

Consider adding stocks to your portfolio that deliver repetitive earnings, have low debt, a great product base and pay their shareholders as they wait for anticipated growth.

This material does not purport to contain all of the information that a prospective investor may or should consider when making investment decisions. This material should not be viewed as a current or past recommendation or a solicitation of an offer to buy or sell any securities or investment products or to adopt any investment strategy. Past performance does not guarantee or indicate future results.