“With anxiety about the market running high and yields on bonds and CDs exceedingly low, dividend-paying stocks and funds have become the darlings of savers.” Walter Updegrave, Money Magazine, October 2012
Asset bubbles are a long term economic reality, dating back to the tulip bulb mania centuries ago. At the end of last century, the new normal was “technology stocks cannot fail.” Then there was the real estate mania in the middle of last decade. You were considered un-American if you didn’t buy a home. After all, low interest rates along with easy access to cash made buying a home as easy as buying a car.
Where do Dividends Come From?
When a company has profits, they have several choices regarding those profits.
1. The company can pay the cash to the investor in the form of dividends. Then the investor can spend that money in any way he chooses. That option leaves the company with no funds to reinvest in the growth of the company. If the firm doesn’t reinvest in their growth, the company will not prosper.
2. The corporation can take all of their profits and reinvest them in growth opportunities and acquisitions. If the company invests its capital wisely, the company will grow and it’s stock price increase. This benefits the stockholder with higher value. When the investor sells this growing company, she receives the benefit by receiving a higher price for her stock. This profit is called a capital gain.
3. The company can combine options 1 and 2. The company can take part of its profits and give them back to the investor in the form of a dividend and reinvest the rest in the growth of the company.
So you see, whether a company pays a dividend or not has little to do with your long term return. You either receive the company profit along the way as a dividend, at the end of your holding period, as a capital gain, or a little of both. The important point for investors is to invest in growing companies while paying a fair price.
The only difference between dividends and capital gains is in the timing of payments and tax treatment.
Advice for Investors
Invest in stocks and funds that are fairly valued with good growth prospects. If the company is profitable and growing, the investor benefits either through dividends or capital gains. Check out the free, How to Invest and Outperform Most Mutual Fund Managers ($9.99 value) to learn more about investing.
Are Dividend Stocks Headed for a Fall?
Whenever an opportunity is touted as “can’t miss”, look very carefully before you leap. Every investment has risk and the job of the investor is to understand that risk and invest accordingly. The response to the question, “Should I invest in dividend stocks now?” is quite simple, it depends. If the stock is fairly priced and has good growth prospects consider investing. But high dividends do not automatically equal a good investment.
Have you invested in dividend paying stocks or funds? How are you making your money grow?
image credit; google images from investment truth