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Youth Pays Dividends
4/4/2011 12:16:00 PM
The dividend-paying stock has long been a mainstay for those living on a fixed income. But these vehicles have been viewed as contrary to the temperament and long-term growth goals of young investors. After all, why invest in a stodgy utility when that money could be socked into shares of the latest highflier? The answer is that for every Google ( GOOG ) or Apple ( APPL ), there is a Pets.com, the poster child of the dot-com bubble.
The financial crisis has put a new shine on the stability offered by dividend-paying stocks. No longer just for widows and orphans, dividend-paying stocks can be powerful tools for those at the start of their investing life.
"Young investors have a tool that's available to them only when they're young: compound interest," said Sam Stewart, founder and chairman of mutual fund house Wasatch Advisors.
The same logic that underpins investing in any retirement fund--namely that $1,000 will grow exponentially over the course of a few decades--applies to dividend investing. But dividend-paying stocks carry the added benefit of providing real income. A dividend is cash in the pocket. That money can be then used to reinvest in the company through a dividend reinvestment program or to purchase other stocks.
This is not to suggest that dividend-paying companies don't deliver capital appreciation. Data provided by Sit Investment Associates shows that from December 1973 through December 2010 non-dividend paying S&P 500 stocks gained 2.3 percent per year, while the index's dividend-paying components clocked in an average yearly return of 9.2 percent. What's more, from 1930 through 2010, dividends accounted for more than 40 percent of the S&P 500's total return.
Experts say that although there's an exception to every rule, dividend-paying companies are generally more stable than their non-dividend paying peers. That's because the dividend payment itself--particularly a growing dividend--is a strong indicator of a company's future financial health in an era of inscrutable accounting practices.
"Companies can fake earnings, but you can't fake a dividend," said Rob Isbitt, chief investment officer of CWM, a registered investment advisory owned by Carson Wealth Management. "A dividend is cold hard cash. Companies have to pay it out and they can't pay it with money they don't have. That's the beauty of a dividend. It's real."
But how do young profit seekers choose a dividend-paying stock? Roger Conrad, editor of Canadian Edge , MLP Profits , Utility Forecaster and Big Yield Hunting suggests tried and true methods that have served investors for decades.
"Look for businesses that have a transparent growth trajectory," he said. "For example, it's easy to see how a major oil company will grow earnings over time because it's tied to growing energy demand."
Investors should also prioritize a company's history of growing its dividend over the dividend yield itself--in fact a dividend yield of over 5 percent should serve as a red flag. Avoid companies with substantial debt and a high payout ratio. Companies with a payout ratio of over 60 percent may not be reinvesting enough into the company's growth.
Young investors without the appetite or know-how to sift through a wide universe of dividend payers may be well served by a dividend-focused exchange-traded fund (ETF). A number of ETFs, such as iShares Dow Jones US Select Dividend ( DVY ), provide investors with one-stop shopping for dividend-paying companies.
But those who do wish to select individual stocks have a broad array of growth-oriented companies available to them, according to Paul Hogan, portfolio manager of FAM Equity-Income (FAMEX). The technology space, a favorite haunt for young investors, boasts a growing stable of dividend-paying names such as Microsoft ( MSFT ) and Cisco Systems ( CSCO ). Even up and coming semiconductor firms Xilinx (XLNX) and Microchip Technology (MCHP) pay dividends. Furthermore, many of these technology companies have extensive operations overseas, providing young equity-income investors with exposure to fast growing emerging markets.
But even the most compelling argument can fall upon deaf ears. Wasatch's Stewart notes that the real decision facing youth isn't whether to invest in a dividend-paying stock, but rather to invest at all. When faced with the choice of investing or spending, young potential investors often choose instant gratification.