Dividend Stocks: Pros and Cons
Many investors love dividends. The logic is simple: “I’m getting paid - so it must be a good investment”
Sounds reasonable. But in practice, things are more complicated.
First, the pros
1. Dividend-paying stocks generate cash flow. This can be especially important for older people. They need income right here and now.
2. A sign of a mature business. Dividends are usually paid by companies that have:
- stable profits
- a clear business model
- steady demand
This reduces the risk of “surprises.”
3. Lower volatility (often)
Dividend-paying companies:
- are less likely to get caught up in hype
- fall less on news
- attract calmer investors
4. At good dividend-paying companies, dividends grow year over year. This sets them apart from bonds.
Now, about the downsides
1. Dividends are not “extra income”
A company doesn’t create money out of thin air. When it pays dividends, that money is part of the profit the company has earned. When a portion of profits is paid out as a dividend, the market factors this payment into the stock price, and the stock price may fall by the same amount, or it may not rise by that amount.
You’re simply receiving a portion of your own money in a different form.
2. Taxes. Taxes on dividends from U.S. companies, for many jurisdictions where shareholders are based, amount to 30% and are withheld at the source. This significantly reduces the real return on dividend-paying stocks.
3. High yields - may be a sign of trouble
A dividend yield of 8-10% looks attractive. But this often happens because the stock price has fallen and the market is already anticipating problems
And while an investor buys “yield,” they may end up with a declining business.
What to look for when choosing
When selecting dividend stocks, in addition to the dividend amount, consider:
- Payout Ratio. This is the portion of a company’s profits that it pays out as dividends. The lower this ratio, the better. But it should definitely not exceed 100%.
- Revenue and profit growth. Dividends are usually paid by large companies that have no room for further growth. However, it’s better if they show some growth, even if it’s modest.
- Adjust the dividend amount for taxes.
Good luck with your investments
The AVI Team
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