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What Are Dividend Paying Stocks And Are They A Good Idea To Own?

With bonds paying so little interest and stocks enduring some historic bouts of ups-and-downs, once again we’re hearing about the supposed virtues of “Dividend Paying Stocks.” Kevin Grogan explains the pros and cons.

Transcript

Tim Maurer
Hello, Tim Maurer back with another episode of Ask Buckingham, a new video podcast designed to bring clarity in the midst of confusion by connecting your great personal finance questions with straightforward answers from industry thought leaders. Today’s question will be answered by Kevin Grogan, Managing Director of Investment Strategy for Buckingham Wealth Partners. And Kevin, with bonds paying so little interest and stocks enduring some historic bouts of ups and downs, once again, we’re hearing about the supposedly virtues of dividend paying stocks. What distinguishes a dividend paying stock from the remainder, if it doesn’t appear obvious?

Kevin Grogan
Right. So, a dividend paying stock is a stock of a company that’s bringing in positive earnings and has decided to pay out some of those earnings back to the stockholders in the form of what’s called a dividend. So a dividend is essentially an income stream. And so there are some companies that pay out dividends, others that do not. The companies that don’t pay out dividends, retain what’s called retained earnings on their balance sheet.

Kevin Grogan
So what that is, is basically the company reinvesting in the company, as opposed to distributing the income back out to shareholders.

Tim Maurer
Now, one of the things that concerns me a little bit is I tend to see these put up next to fixed income instruments. I mean, you mentioned that they do create necessarily a stream of income, but oftentimes they’re compared to bonds. And right now people are looking at bonds and saying the interest rates are so low, why don’t we look to dividend paying stocks in order to recreate a portion of that income stream? Is that an appropriate move?

Kevin Grogan
We don’t think so. So we do not view dividend paying stocks as replacement for fixed income, because there’s a couple of issues. Number one, the price of the stock that you’re holding can move around a lot, even in normal times, which is certainly right now, is anything but normal, but even in normal times, dividend paying stocks and any stock can move around quite a bit and be quite volatile.

Kevin Grogan
So that’s kind of the first aspect. But then the second thing I’ve mentioned that it’s sometimes a misconception is it’s not that the dividends themselves create value. So when a company pays out a dividend, typically the stock price comes down in proportion to the dividend that pays out. So paying out a dividend doesn’t create value. It just moves value from the company’s cash into the investor’s cash but then the investor’s stock price declines proportionally, roughly speaking, along with how much dividend was just paid out.

Tim Maurer
Interesting. So should investors make buying decisions based on the dividends attached to particular stocks at all? Is it something they should look at?

Kevin Grogan
So we don’t think so. I should mention too, that within the stock side of our portfolio, we own pretty much every traded stock that’s out there, there are plenty of stocks that we hold within our portfolio that pay dividends. So it’s not that we’re opposed to stocks that pay dividends. It’s just that we don’t view them as a replacement for fixed income.

Kevin Grogan
And so one way to think about dividend investing is just kind of another form of value investing. So if you decided to buy stocks that had a high dividend yield, that’s not that different than buying stocks that had a high earnings yield, so earnings divided by price or cashflow divided by price. These are all forms of value investing, but we don’t think that that dividend investing alone is the only thing you should look at when considering what’s a value investment versus not.

Tim Maurer
So we’re not so much opposed to dividend paying stocks, just not going after them and replacing another asset class that might be inappropriate.

Kevin Grogan
Absolutely right. So the bedrock core philosophy on the fixed income side is that we want that portion of the portfolio to be the bedrock of the portfolio. To be that true diversification for the equity side of the portfolio. And if you’re using dividend paying stocks as your fixed income, then those two assets will look pretty similar to one another, both in good times and in bad times.

Kevin Grogan
So again, I should mention that when things are going really well, dividend stocks will tend to do really well, but that’s not providing diversification for you the way a safe, fixed income portfolio would.

Tim Maurer
Can you give us any perspective if we looked at, say the S&P 500, for example, what percentage of those stocks might fall into this category of dividend paying?

Kevin Grogan
So that’s one, I don’t know off the top of my head, but if you looked at the S&P 500 as a whole, kind of the weighted average dividend of those stocks is right around 2% or so. And that, that moves around throughout time. But if you just bought the S&P 500 as a whole, you could expect to get roughly 2% paid out in terms of a dividend yield on an annual basis.

Kevin Grogan
And so people who employ a dividend focused strategy would tend to overweight the companies that are paying higher dividends and then underweight the companies that aren’t paying dividends.

Tim Maurer
Okay, great. And lastly, Kevin, have you seen dividend paying stocks responding in a particular way to the crisis at hand and the volatility that has been associated with it?

Kevin Grogan
So, a couple of quick things. So number one, that we’ve seen a lot of companies have to cut their dividend, or basically skip the dividend payments as a result of the crisis that we’re all going through. So again, it kind of underlies that point that you can’t count on dividend income to be there. The dividend is not a promise to pay the way an interest payment is on a bond or a coupon payment is on a bond. A bond, kind of going all the way back, the reason it’s called a bond is that that’s bonding you to your word, that you will make good on that debt. Whereas a dividend payment is a sharing of profits, and if there are no profits, then those dividends can be cut or eliminated altogether. And we’ve seen that happen. And we’ve seen the price of those stocks and stocks in general come down as a result of the recent crisis.

Tim Maurer
Kevin Grogan, thank you very much. And thank you for tuning into this episode of Ask Buckingham. If you have a question that you’d like to see us address, you can do so by navigating to the website, askbuckingham.com or by emailing your question to question@askbuckingham.com or just clicking the corner of the screen, it’ll take you directly to the website. Remember that there are no dumb questions, but unfortunately there are plenty of poor answers out there. Our hope is that in giving you straight answers to your questions, it will bring a sense of calm and allow you to apply what you’ve learned in pursuit of good decision making. So please follow us. And by all means, Ask Buckingham.

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Meet your guests.

Tom Bodin
Tom Bodin
Practice Integration Officer

As a Practice Integration Officer at Buckingham, Tom Bodin provides fractional CFO services to align wealth creation strategies for owners of legal, dental, and medical offices including tax, pension and retirement planning.

Vince Crivello
Vince Crivello
Head of the Practice Management Group

As head of the Practice Management Group at Buckingham, Vince helps lead client experience design initiatives, oversee consulting and training programs, and provide key industry insights to advisors.

Aaron Grey
Aaron Grey
Director of Planning Integration

As the director of planning integration at Buckingham, Aaron helps advisors develop, implement, monitor and update wealth management strategies in pursuit of their clients’ financial goals.

Kevin Grogan
Kevin Grogan
Managing Director, Investment Strategy

Guided by academic research, Kevin Grogan, Director of Investment Strategy, oversees our overall strategy and helps clients and advisors alike distill complex investing topics. 

Jared Hoffman
Jared Hoffman
Managing Director, Relationship Management

As Managing Director at Buckingham, Jared provides education on best practices around cybersecurity. He is a member of Infraguard, a partnership between the FBI and public sector created to share information on cybercrime.

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Blerina Hysi
Fixed Income Trading Manager

As fixed income trading manager, Blerina helps construct and maintain customized bond portfolios, all with an eye toward finding the best way to implement the client’s comprehensive financial plan.

Mike Kenneally
Vice President & Co-Founder at ECD Lacrosse

Mike Kenneally is vice-president and co-founder of East Coast Dyes Lacrosse, a small lacrosse equipment manufacturing company in Maryland.

Jared Kizer, CFA
Chief Investment Officer

As Chief Investment Officer and chair of the firm’s Investment Policy Committee, Jared evaluates findings from academic research and applies that learning to architect the firm’s investment strategy.

Jeffrey Levine
Jeffrey Levine
Director of Advanced Planning

As Director of Advanced Planning, Jeffrey serves as a technical resource for advisors and the firm’s primary thought leader regarding evidence-based planning concepts and strategies.

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Michael O'Neal
Executive Director at OneWorld Health

Michael is the executive director of the global nonprofit One World Health, which partners with communities in developing countries to bring permanent, sustainable healthcare to the chronically underserved.

Irv Rothenberg
Irv Rothenberg
Wealth Advisor

A wealth advisor with more than 40 years’ experience, Irv’s passion is helping advisors and their clients create meaningful conversations around important end of life issues.

Jonathan Scheid
Jonathan Scheid, CFA, AIF
Managing Director, Solutions

With over 20 years of experience working with advisors and their clients, Jonathan enjoys sharing interesting perspectives on a wide range of investment and economic topics.

Meir Statman
Meir Statman, PhD
Research Advisor

Meir Statman is the Glenn Klimek Professor of Finance at the Leavey School of Business, Santa Clara University. His research focuses on how investors and money managers make financial decisions and how these decisions are reflected in financial markets.

Susan Strasbaugh
Susan Strasbaugh
Wealth Advisor

As part of a firm of fiduciary, fee-only wealth advisors, Susan takes a total-care approach to identifying, organizing, planning, implementing and coordinating clients’ most important financial goals.

Larry Swedroe
Larry Swedroe
Chief Research Officer

As Chief Research Officer, Larry Swedroe has authored or co-authored 16 financial books and devotes all of his time to research and education in the areas of investing, financial planning and behavioral finance.