In this episode, learn about the four most common dividend misconceptions.
Also covered in this episode:
- Dividends are insignificant
- Dividends drop when stock prices drop
- Dividends are not guaranteed
- Share price drops when dividend is paid
- Bonus: Beating the stock market is not our goal
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In this episode we're going to look at the four most common misconceptions that people have about dividends. Hi, my name is Kamal Sarai and welcome to the Simply Investing Dividend Podcast. In this episode we're going to cover four dividend misconceptions. So the first one is most people believe that dividends are insignificant. So we're going to take a look at that. Next, we're going to take a look at what happens to the dividend when the stock price drops. So another misconception here is people believe that the dividend is going to get reduced or it's going to get eliminated. Then we're going to take a look at the third misconception, which is and we're going to talk about it in section three, so I don't want to give away anything here, but the title there is called Dividends Are Not Guaranteed. And then our final and fourth topic is what happens to the share price when the dividend payment is made. And there is a misconception there, misconception that people have about the share price automatically getting cut as soon as a dividend is paid. So we're going to see if that is or is not true. So we're going to cover all four of these topics in today's episode, but before we do that, very quickly I want to go over what is a dividend and what is a dividend yield? So a dividend is basically the company sharing its profits with you, the shareholder. So in this example, if a company is paying a dividend of $1 per share and you own a thousand shares, you will receive $1,000 every year for as long as you own those shares and as long as the company continues to pay that dividend. Now, the share price can go up and down. We'll take a look at it in this episode as well. That is irrelevant in this case, because the dividend is paid based on the number of shares you own. So when you buy those shares after that, the price can go up and down, but you will receive, as in this example, a dividend of $1 per share, and you can spend those dividends if you wish or reinvest them. The money is deposited directly into your trading account. So now let's take a quick look at a dividend yield. It is simply the dividend, the annual dividend, divided by the share price or your purchase price. So in this example, if the company is paying a dividend of $1 per share, an annual dividend, and the share price today is $20 and you happen to buy the shares of that price, well then your dividend yield is going to be 1 over 20 and we express that as a percentage and you can see that up on the screen it is 5%. So what does the 5% mean? Well, in this example, let's say you had $20,000 to invest in this company and the company shares are trading at $20 a piece. Well, 5% of $20,000 invested is equal to $1,000. So in this example, you would receive $1,000 for as long as you own those shares and as long as the company continues to pay the dividend. So the dividend yield is a very quick way to figure out what is the return on your investment while you hold on to those shares, again, the stock price can go up, price can come down, doesn't matter. The dividend yield in this example will be 5%. Okay, let's get to our first topic in this episode. So dividend misconception number one. Most people believe that dividends are insignificant. Well, let's take a look at three examples here so you can see. Lifetime brands. The annual dividend, as of this recording, is 17 cents a share. Micron technology has an annual dividend of 46 cents a share and Nike has an annual dividend of $1.36. So when you look at these examples here, it does seem like the dividend is insignificant, right? If you look at lifetime brands, 17 cents a share. You're not going to get rich off of 17 cents a share. And in this example, you have to hold on to those shares for a year, because that is an annual dividend, and then you receive your 17 cents. Micron technology is at 46 cents. Again, that doesn't seem like a lot. You would have to buy lots and lots of shares to get any significant amount of dividends. So in the beginning, yes, dividends may seem insignificant. However, you have to add in two other elements here. And then one of the elements is going to be dividend growth. Companies have a history of increasing their dividends, so the dividends start out small, but then they grow every single year. I'm going to show you some examples of those in this episode. And then the other thing is time. So the younger you are, the more time you have to invest, the better off you will be, because then you can compound those dividends. So when you get dividends, instead of spending that money reinvested back into companies and other companies that pay dividends, take those dividends and reinvest them back into other companies that pay dividends, and then you start to see a snowball effect. Now, this does take time. It takes years. Right, this is not a get rich quick scheme. You are not going to double your money in six months. This is a long term approach to safely and reliably growing your dividend income. So what happens when you have time on your side and you take advantage of dividend growth and you reinvest those dividends? Well then you can end up with extraordinary returns. I'm going to give you three quick examples in this episode, but if you're interested, I suggest you go back and watch episode seven. In episode seven, I give you all of the numbers, all of the data behind the extraordinary returns that I'm going to share with you right now. So we're going to look at three examples Coca-Cola, home Depot and Walmart. Let's start with Coca-Cola. In episode seven, I show you how a $4,600 investment in Coca-Cola can turn into over $7 million, and that investment alone would provide you with over $200,000 a year in dividends that's annual dividends and all you had to do was buy those shares in Coca-Cola and hold on to them for many, many, many years. The other example of extraordinary returns is with Home Depot. And again in episode seven, I show you how we take $2,100 invested in Home Depot and that grows that investment over $10.8 million and that investment today would provide you with over $259,000 in dividends. And our last example is Walmart, and again in episode seven, I'm going to show you how a $1,650 investment in Walmart turns into over $29 million and that investment alone would provide you today with over $458,000 in dividends. So dividends are significant. They seem small in the beginning, but over time, they can provide you with extraordinary returns. So I'm going to share with you four more examples and we'll close off this topic. So in these four examples, we're going to look at four Canadian companies Canadian Natural Resources, fortis, bell and CIBC. Now, I'm not going to go over all of the numbers on the screen. You can see them yourself. And in these four examples we don't have to go back 20, 30 years. We just have to go back to 2012. So you can see the stock prices for each of those four companies back in 2012. You can see where the stock prices are today. I'll take one example to look at Canadian Natural Resources the dividend back in 2012 was $0.42 a share. Today the dividend is $3.40 a share. So the total return for Canadian Natural Resources since 2012, including dividends, has been over 235% return. So that is a fantastic return. Fortis, during the same period, has returned over 127%, bell has returned over 137% and CIBC has returned over 139% return, which is incredible. Now, even better than that is the dividend yield the dividend yield on cost, and you can see that up on the screen. Canadian Natural Resources today would provide you with over 13% return annually, regardless of the stock price. That's just the dividend, because we take the dividend today and we divide it by your purchase price back in 2012. And you can see, fortis is yielding today 7.1%, bell and CIBC are over 9%. We expect both Bell and CIBC to be in the double digits within the next three to six months. So those are fantastic returns. While you hold on to your shares, you never have to sell your shares. You don't have to eat into your capital investment. The dividends provide significant returns. Let's move on to our topic number two. The misconception here is a lot of people believe that as soon as the stock price drops, the dividend is going to drop. It's either going to get reduced or it's going to get eliminated. So let's take a look. Is that true or not? So we're going to take a look at Coca-Cola as an example and we're going to go back 40 years and take a look at the history of Coca-Cola's stock price and the dividend. Here we can see the Coca-Cola share price over the last 40 years and you can see the stock price has gone up, down, up and down, and on the screen you can see the stock price is shown by the blue line and we can see significant drops in the stock price. In some cases the stock price drops by $5 a share, $10 a share, $20 a share. So we can see significant drops in the Coca-Cola share price over the last 40 years. But what has happened to the dividend? The dividend is represented by the orange line and you can see that the dividend has gone up every single year. In fact, coca-cola has had 60 years of consecutive dividend increases. Let's take a look at one more example Johnson, johnson. Again. We're going to go back and look at the last 40 years. You can see on the screen here Johnson, johnson. Again, the share price is represented by the blue line. Again, the stock price goes up and down and we can see drops in the share price of $5 a share, $10 a share. We see significant drops in the share price over the last 40 years. However again same story as Coca-Cola we can see, the dividend, which is the orange line, has gone up every single year. Johnson Johnson also has had 60 years of consecutive dividend increases. So how can companies continue to pay the dividend and increase the dividend every year when their stock price drops? And the reason is that the dividends are not paid from the share price. The dividends are paid from earnings. So as long as companies have positive earnings over the long term, they might have one or two years where it goes down, but over the long term 10, 20, 30, 40, 50 years as long as the earnings are growing, then companies like Coca-Cola and Johnson Johnson can continue to pay dividends and can continue to increase those dividends year after year after year. So that's why the dividend is not tied to the stock price at all. Next, we're going to move on to our topic number three Dividends are not guaranteed. And guess what? This is not a misconception, this is a fact. Companies are under no legal obligation to pay you, the shareholder, a dividend, so they can reduce the dividend anytime they want, or they can cut the dividend, eliminate it altogether anytime they want, and that's what happened during COVID, especially in March of 2019 or 2020. Somebody can correct me in the comments. But when COVID hit, some companies reduced or eliminated their dividends, and so this caused a lot of fear and panic in the investing community, because if the dividends are not guaranteed, then what are we doing here? Why are we talking about dividend investing? So I'm going to answer that question. Let's just hang on there for another minute, and we're going to cover that in this episode, so I'm going to repeat this again. So, during COVID, some companies reduced or eliminated their dividends, but most companies did not, and, in fact, some of most of them increased their dividends. So I'm going to give you an example. I've been a dividend investor for over 23 years, and my dividend income in 2019 was higher than it was in the previous year. My dividend income in 2020 was higher than it was in the previous year. My income in 2021 was higher than it was in the previous year. In fact, my dividend income has gone up every single year in the last 23 years. So, yes, some companies eliminated their dividend, and a good example that people like to talk about is Disney, general Motors and Boeing. They all cut the dividend to zero when COVID hit, so they stopped paying a dividend to the shareholders. Now the good news is, they've all restored their dividend. So Boeing, general Motors and Disney, as of this recording, are now paying out dividends. So that's the good news. But the bad news is there were some companies that eliminated dividends, but here's the fact most companies did not. Everybody likes to focus on the ones that cut the dividend, but most did not, and I'm going to talk about towards the end of this episode on how we select companies. So the goal is to try and not to select those companies that have the potential to cut or eliminate their dividend in the first place. So we don't want to be investing in those companies anyway. So let's take a look at the next slide here, and I hope this will provide you with some more confidence. Now, this is a very short list. The actual list is much higher. We have about 55 or 60 companies. I just couldn't fit them up on the screen at the same time, but you'll recognize some names here. You'll see Coca-Cola is there, colgate, palm Olive, stanley, black and Decker, procgrin, gamble, lowe's. So there's a lot of big name companies on this list. But what's fascinating is a lot of these companies here on this list have been paying dividends since the 1800s. That is incredible. Colgate Palm Olive has been paying a dividend since 1895. Coca-cola has been paying a dividend since 1893. Procgrin Gamble since 1890. So that is incredible. Stanley Black and Decker, since 1876, have been paying dividends. And even more important than that is our next column here, which is consecutive years of dividend increases. So if we take a look at Procgrin Gamble, that's 67 years of consecutive dividend increases and, of course, we've already covered Coca-Cola, johnson Johnson 60 years of consecutive dividend increases. Think about how many market crashes we've had in the last 30, 40, 50 years, how many market downturns we've had COVID 9-11, the financial crisis in 2008. But yet companies like these have not only continued to pay a dividend, but they've increased the dividend year after year after year. So, yes, dividends are not guaranteed, but when we look at a list of companies like this, we can have a high degree of confidence that they will continue to pay us dividends in the future. Okay, let's move on to our last topic in this episode. Thank you, I was going to say misconception. It may or may not be. We're going to take a look at in a couple of minutes. This is especially coming from the folks that don't invest in dividend stocks, that don't like dividend stocks. They will tell you that as soon as a dividend payment is made, the share price drops by an equivalent amount. So we're going to take a look if that is true or not. So, for this example, we're going to take a look at Walmart and, as of this recording, we're going to focus on the most three recent dividend payments that Walmart has made. So you can see them up on the screen here. April 3rd of 2023, walmart paid a dividend of 57 cents to the shareholders per share. May 30th also paid a dividend of 57 cents. September 5th also paid a dividend of 57 cents. So we're going to take a look at the Walmart stock price. So let's jump into that right now, so you can see up on the screen. Right now. We're using Yahoo Finance, we're looking at Walmart and its stock price and we're going to go back to April of 2023 and take it all the way up to September of 2023. So just a couple of months and you can see where it's marked by a D. So it shows you the dividend payment and, just like I mentioned, it was 57 cents. Then another one here 57 cents, and another one here at 57 cents. Now, if you'll recall from the previous slide, april 3rd is when Walmart made its dividend payment. So let's go ahead and take a look at April 3rd so we can see right here the dividend. Sorry, the share price on that day was $148.69. And when the dividend was paid we would expect the stock price to drop by 57 cents. And we do see a drop in the stock price, in fact a drop by more than 57 cents. It dropped to $147.23. So that is a drop of $1.46. Now again, most people may look at that and be concerned and say, hey, why did the stock price drop so much? Now you have to remember stock prices go up and down for many reasons. The dividend payment could be one reason why it came down, but then why did it drop by more than 57 cents? There is also market sentiment or investor sentiment. If there is something going on that day in the stock market, maybe with retail stocks, it may be a drag the price down for all of the stocks, or something in the economy Inflation number came out, or the employment numbers came out, or the Federal Reserve Bank made an announcement. Any number of reasons can drive the share price up or down. Nevertheless, we are not day traders, so we're not too concerned about the stock price, because you can see that immediately afterwards the price went up even higher, way higher than the $1.46 drop that we saw on April 3rd. So anyway, that's, it is what it is. Let's move on to the next payment. The next payment was on May the 30th, so let's move on to where is May the 30th on this graph here? Okay, so here we can see on sort of the before May 30th. So it's stopping here. On May 26th the stock price was $146.42. And again we can see the stock price did drop, but only by 36 cents, even though the dividend payment was 57 cents. So in this case the stock price dropped by 36 cents, but it wasn't equal to the dividend payment, it only dropped by a little bit. So again, you have to ask yourself why? Why didn't it drop more? Why just a little bit? Again, I don't know. Stock prices are driven by many, many variables. So let's leave it at that. Because the next day the price went up and then it went up again, and it went up again and it went up and it went incredibly high. By what are we looking at here? June 15. So within a few days the stock price went even much higher. Okay, let's take a look at the last dividend payment here on the screen, which was September the fifth. So let's see if we can see that up on the screen here. Here we go. So we can see on September 1st the stock price was $161. And the dividend payment was made on the fifth and the stock price dropped by $1.30. So again, it dropped. But what happened after that? It went back up again. So during this period, we would expect and again these are I call them non-dividend investors because I've spoken to many of them and they will tell you right off the bat as soon as a dividend payment is made, the stock price dropped by an equivalent amount because the company is taking that money out of its bank account to pay the shareholders, and that's what a dividend is. So because that money came out of the company's bank account, the company's value has dropped by an equivalent amount. So in this case we saw that the first payment, yes, it dropped by more than 57 cents, but the second one didn't. And then the third one, yes, it dropped by more than 57 cents. Well, total, on this graph, we've had three dividend payments 57 cents times three is $1.14. So, all things considered equal, we would expect that the stock price right here at the beginning was $137. We would expect that the stock price after three dividend payments would have dropped by $1.14. And does it? No? In fact, the stock price increases by over $26 a share, which is a 19% increase, which is a fantastic increase in such a short period of time. So what I'm trying to demonstrate here is that the stock price does not always drop by an equivalent amount. And even if it does and like we saw three payments, we saw three tiny little drops over the long term it does not seem to negatively affect the stock price, and we're long-term investors. We think in terms of decades. So let's take a look at Walmart since 1993 and you can see a tremendous increase in the stock price. And look at all the dividends that have been paid every single quarter since 1993. And the stock prices continue to go up, up and up. In fact, walmart has had 50 years of consecutive dividend increases. So I'm not too concerned and I've been doing this for over 23 years I'm not too concerned about the immediate drop in a stock price when a dividend payment is made, because in the long term the stock price continues to go up. The dividend, an increasing dividend actually supports a higher stock price. Because when the dividend goes up, the dividend yield goes up and that attracts investors to that stock. And we've seen examples in today's episode with Johnson Johnson, with Coca-Cola and now with Walmart that over time the stock price tends to go up with every dividend increase. Dividends provide consistency, reliability and stability. Compared to dividends, stock prices can be fleeting and unpredictable and you can see that dividend sorry. Stock prices go up and down all the time. Now, eventually dividends can cover your living expenses. Without dividends, you're only hoping for stock prices to continue to rise, and hope will not cover your living expenses. So I know there are stocks out there that don't pay any dividends. So if you invest in them, that's fine. But then you have to keep hoping that the stock price is going to stay up or it's going to be up when it comes time for you to sell, to take some income or money out of your investment. So beating the stock market is not our goal here. Our goal is to cover our living expenses, regardless of stock market conditions. So let me share with you one last example here. We're going to look at a hypothetical return over the next five years, let's say, for the stock market. So we're going to compare the stock market return to someone who has their own stock portfolio but no dividends, and they're only concerned, in this example, about beating the stock market. So in year one, let's say the stock market does 2% and then this person does 2.5. Well, congratulations, you've beat the stock market, that's great. In year two, stock market does 5%. And let's say this example, this person here their stock portfolio returns 6% and again, no dividends, just the share prices have gone up. They picked the right stocks and they beat the stock market. That's fantastic, and that could also be an index fund, an ETF or a mutual fund. But in both year one and year two they beat the stock market, which is great. Now look at the next three years. Let's say in year three, the stock market has a return of negative 7% and this person achieved a return of negative 6%. Well, congratulations, you beat the market, but your portfolio is still down. In year four, this stock market returned minus 8% and this portfolio did minus 5%. Again, you beat the market, but your portfolio is still down. And in year five, same thing they beat the market, but the portfolio is still down. So what am I trying to get at. In this example on the screen you can see that in five years this individual beat the stock market. Every single year they outperformed. So on paper that looks great, looks fantastic. However, in real life, if this person is now retired, could be 55 years old, 50, 65. Let's say they're retired, they don't have any other source of income and they're relying on their investment portfolio. Well, in year three, four and five, their portfolio is going to be down. It's negative returns, it's actually shrunk in value. But now, if you're relying on, say, the 4% rule or you need to cover your living expenses, be it for transportation, shelter, food, anything, you are now going to have no choice but to sell your stock, some of your stocks, in order to get some money out of the portfolio. And selling your stocks when they're down is the worst time to sell. But if the market is down for three years in a row, you're going to be in trouble. Now I know some people will argue that hey, we've never had a market down three years in a row. This is unrealistic. Well then I would argue that well it's. The future is unpredictable. No one could have predicted 9-11. No one could have predicted COVID. We never thought the economy was going to shut down. Certain events could happen again in the future. They may or may not, but as investors, we need to be prepared for those types of events. So if there is a market downturn for one year, two years, 36 months maybe, without dividends, you have no choice but to sell your stocks some of your stocks in order to take income or money out of your portfolio. And so that puts you in a very difficult situation, because now you're eating into your own capital, and as dividend investors, we never want to eat into our capital. Okay, so beating the stock market is not our goal. Our goal is to cover our living expenses, regardless of market conditions, and we want to make sure that that dividend income that we're bringing in every year is growing every year. So does that mean that you should now go out and buy any stock that pays a dividend? And the answer is no. There's a couple of more things we need to check, because we want to invest safely and reliably. So how do we do that? We invest in quality dividend stocks when they're priced low. So how do you know, when you're looking at a stock, if it's a quality stock and how do you know when it's priced low. For that I've created what I call the 12 Rules of Simply Investing. You can see the 12 rules up on the screen here. This is your checklist. You want to make sure that a company passes all of the 12 rules before you invest in it. If it fails even one rule, skip it, move on to something else. This is what's going to ensure that you're investing in quality stocks, stocks that have a high probability of being able to continue to pay you dividends and to grow those dividends over the long term. So let's take a look quickly at the rules here. Rule number one do you understand how the company is making money? If not, skip it, move on to something else. Rule number two 20 years from now, will people still need its product and services? Rule number three does the company have a low cost competitive advantage? Rule number four is it recession proof? Rule number five is the company profitable? Rule number six does it grow its dividend? Rule number seven can the company afford to pay the dividend? Rule number eight is the debt less than 70%? Rule number nine avoid any company with recent dividend cuts. Rule number 10, does the company buy back its own shares? Rule number 11, is the stock priced low. So we look at three things there the PE ratio, then we look at the current dividend yield to the company's average dividend yield and then we look at the PB ratio, the price to book value, as well. Rule number 12, keep your emotions out of investing. So, for those of you that are interested, I've created the Simply Investing course. It's an online course. It is split up into 10 modules and we cover everything that you need to know, from start to finish, to become a successful investor. Module number one the investing basics. Module two we cover the 12 rules of Simply Investing with real life examples. Module three you'll learn how to apply the 12 rules and I provide you with a Google sheet that you can fill in. It automatically highlights which companies fail which rules. Module number four using the Simply Investing platform. Module five placing your first stock order. Then we look at building and tracking your portfolio. Then you learn when to sell, which is important, just as important as knowing when to buy, and especially if you have mutual funds, index funds, etfs, we talk about reducing your fees and risk. In module number nine, I'm going to give you your action plan to get started, and in module 10, I answer your frequently, most frequently asked questions and, for anyone who's interested, we also have the Simply Investing platform. This is a web app. It took about two to three years to build and in this app we cover over 6,000 stocks in the US and in Canada and we apply the rules to all 6,000 stocks every single day so you can immediately see which companies to consider for investing and which ones to avoid for now. So if you're interested, write down the coupon code SAVE10SAVE10. It's going to save you 10% off of the Simply Investing course or the platform. If you enjoyed today's episode, be sure to hit the subscribe button, hit the like button as well, and we have new episodes out every week and for more information, take a look at our website, simplyinvestingcom. Thanks for watching.