You buy, the price goes up;
you make money. You buy, the price drops; you lose money. It's that easy. No
rocket science, quite simple.
We call the end result capital
gains… or capital losses! It's the first thing most people have in mind when
they think about stocks. Indeed, looking for capital gains is a great way to
make or… lose money. However, it's not the only way, not by any stretch.
Have you ever heard of dividend stocks?
Imagine you buy a stock and
money comes in, even if it loses in value. That would be great, right? It's
like getting drunk without a hangover. Or eating cake without gaining weight…
Especially if you are retired
and don't have an income any longer. Wouldn't it be nice to have a steady income stream without thinking about price developments too much?
Some people appear to fuel an
erroneous perception of dividends. Contrary to common beliefs, companies don't
pay out sporadic dividends – here or there – because they had an extraordinary
profit this quarter or because they feel like being nice to their shareholders
next. Usually, the management follows a well-planned dividend payout strategy.
Imagine a company pays out a
dividend one year and then drops it the following year. The market would react
immediately and assume the company is not doing well. Hence, investors run
away, the price drops, the CEO gets a lower bonus and can't afford a new Ferrari
this year. Poor him!
Therefore, companies try to keep their dividend policy steady or grow their dividends slightly with each
installment. That's why dividend stocks can ensure a steady income stream, even
if their prices fluctuate. And that's why they are attractive to long-term
investors.
John Rockefeller said: “Do
you know the only thing that gives me pleasure? It's to see my dividends coming
in.” Of course, I think dividends shouldn't be the ONLY thing coming that gives
you pleasure (I won’t go into the detail…), but they can definitely contribute
to your personal well-being.
Just ask Dr. Google for great
dividend stocks; there are a lot of these. Many are huge, well-established
players, such as PepsiCo or McDonald’s, which offer dividend yields of around 3%. PepsiCo has grown its dividend payouts over the last two decades.
Their smallest dividend increase was 5%. I'm not necessarily a big fan of their
drinks, but their dividend is quite “delicious” and welcome.
Obviously, the dividend yield
and its growth – or lack thereof – are not the only parameters you should factor
in when you evaluate dividend stocks. It makes total sense to look at other
criteria, which you would consider when you assess other stocks as well:
earnings, revenue, leverage (debt), moat (competitive positioning), etc.
However, there is one variable
that is especially important when you look at dividend stocks: Cash flow.
Usually, when evaluating a stock, you would look at price-to-earnings ratios.
In case of a dividend stock, the price-to-free-cash-flow ratio may
make more sense. Dividends are paid out in cash. Earnings or profit, however,
are a non-cash accounting metrics. Hence, cash flow is more relevant when considering
dividend stocks.
In other words, free cash
flow is cash that is available; dividends are cash that leaves the company.
Earnings or profit, however, is not cash that comes in. In order to calculate
profits, you would for example subtract amortization and depreciation from your
earnings, because that's a cost. However, it's not cash “effective,” so it's
not cash that exits the firm.
Looking at dividend stocks,
you should ask questions like: How did the cash flow develop over the past few
years? What percentage of the cash flow does the company pay out in dividends? Is
the distribution rate too much of a burden? Is the dividend safe? What do they
do with the rest of their cash flow?
Give it a thought. Some
dividend stocks could be a great addition to your portfolio.
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