More Stock Questions Answered: Dividend Payers

Here is another installment of questions answered:

In regards to stocks with dividends, as long as the dividend doesn't change, then does it really matter what the stock itself is valued at currently?

You are on the right track there. The only additional statement I would make is this: As long as the dividend doesn’t change and as long as the ability of the company to pay that dividend doesn’t change, then it doesn’t matter what fluctuations the value of the stock experiences. This is an important distinction. If a company makes $10 of cash (per share) and pays $1 of cash in dividends (per share) then you would agree that it is acceptable. However, if the company starts tanking and now they only make $0.50 of cash and still pay $1 of cash in dividends, they are in trouble. That extra $0.50 per share must come from somewhere, and that somewhere is either by borrowing money or selling off their assets.

Whether or not the share is worth $5 or $10, we are getting our dividend based off of the number of shares and not the value of the share, correct?

Once again, you are getting this. The dividends you get paid will depend on the shares you hold, not on the price of the stock on a given day. And, of course, the shares you hold will depend on the price of the stock when you bought it. So if you bought 100 shares of Company A at $10 per share and they pay $1 per share of dividends ($100), you are getting a 10% return. Well, as it turns out, shares in Company A fall to a price of $1 per share! As long as they can keep paying you your $1 per share in dividends, then you are still getting 10%. The same would be true if the price of Company A grew to $100 per share.

It would still make sense to buy the stock while the value is low though, because then we can get more shares for the same amount of money. I think my wife was concerned at first when she saw the loss of value in the stock from when it was first purchased to what it is valued at now, and my only answer to her at that time was, "Our nation just went through a big old financial meltdown and we still haven't even dropped below our principle in loss, I'd say that is pretty dang good." Now I think I can help explain what is going on better though (assuming you respond to me e-mail, confirming that what I understand is indeed correct).

Yeah, when you are only holding stock in one company, a meltdown will affect your whole portfolio. That doesn’t necessarily mean that it’s time to sell the stock though. And it isn’t always cause for alarm. I would wager to guess that your wife's risk tolerance is very low. Investing in stocks requires a higher risk tolerance than many people find comfortable. Anyway, the effects of a market crash like we experienced recently can be neutralized a bit better by holding stock in more than one company, and preferably more than one industry. That spreads out the risk. I’ve heard it said that a fully diversified portfolio can be accomplished through a minimum of 28 different stocks in different industries. My goal is 35.

So does the thought process behind dividend stocks differ from non-dividend stocks in that way?

Yeah, the thought process is different for non-dividend stocks (often called “growth” stocks or “value investing.”) I would be classified as an “income investor” because I buy dividend-paying stocks and don’t worry as much about growth of the company. Others are “value investors” who buy stock based on the assumption that the company itself is valuable and will appreciate regardless of current income through dividends.

Loss is acceptable with a dividend stock as long as you make enough from dividends over the time period in which you own the stock to cover any losses accrued. If we were to sell the stock today then we would take a loss. However, if we hold onto it for the next year and the market recovers then we will have been earning interest all this time so that even if the stock never returned to its original value when we purchased it, we would still have made money. Correct me if I am not getting it exactly.

That logic makes me happy. Once you find a good company with a sustainable dividend, you can think of it like a certificate of deposit with a maturity date of your own choosing. It’s not as safe as a CD because of the illiquidity (the ability to get your full principal back at any time), but with a strong company your interest rate is almost as reliable.

Keep those questions coming!