Dividends: Take the Money and Run

Jan. 22, 2013 — -- In investing, there are precious few universal truths. One of them is that companies that consistently pay dividends are good investments.

There is no more reliable way to get consistent returns on your investment dollars than using a well-thought-out long-term dividend strategy.Dividends are a portion of a company's earnings for the quarter or the year that is distributed to shareholders.

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The benefits of dividends are well documented. Studies show that about 40 percent of the stock market's total returns since 1930 have come from dividends. Also, buying dividend-paying stocks tends to provide a cushion against volatility (ups and downs in the market).

A dividend strategy is a slow but steady way to win the long-term investing race — a race in which many non-dividend-paying companies lag behind or fail to finish.

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Too many investors, focused on the more speculative returns from share price appreciation, overlook returns from dividends, which are virtually assured each year by companies with long dividend-paying records. Dividends are a key part of what investment analysts call total investment return – the money you ultimately make on your portfolio by different measures.

Whether a company pays dividends for a given period is up to the discretion of the board of directors. Stocks that consistently pay dividends tend to be those of mature companies that don't necessarily need to retain earnings to pay for additional plants, equipment and people.

The great thing about dividends is that they are cash in your pocket, and you can decide what to do with it, as opposed to letting boards of directors use the money to pay outsize bonuses to CEOs. Further, even highly successful, mature companies sometimes get lured into mergers and acquisitions that may not work out. So instead of reinvesting dividends, it's a good idea to just take the cash and keep it. This way, if bad management decisions cause the stock price to fall, your total return doesn't take as big a hit.

Dividends allow investors to get cash out of the market without selling stock and incurring nettlesome trading costs. This is particularly attractive during retirement, when seniors want to hold on to their stocks so they don't outlive their assets.

When comparing dividend payers with non-payers, consider companies' potential uses of their earnings:

1) Buying back shares from investors. Buybacks can be beneficial to shareholders, but their effects aren't immediately clear. Dividends amount to certainty.

2) Investing in expansion, including the purchase of other companies. The problem with this is that even great companies sometimes make regrettable decisions. For example, Microsoft bought Expedia, only to sell it at a loss.

3) Holding on to a lot of cash, à la Apple, which has done so for decades. The company didn't announce its first dividend until March 2012.

4) Distributing cash from earnings by paying dividends to shareholders. Bingo.

Of course, just because a company is paying dividends, this doesn't mean that you should necessarily invest in it. Here are some rules of the road for evaluating dividend payers:

• Seek dividends; don't chase them. Sometimes companies declare dividends just to get more investors now and boost share price in the short run. But down the road, investors drawn in by this may regret buying because the market punishes companies for decreasing dividends or paying them inconsistently.

When companies pay a lower dividend or skip a year, this can affect the stock's value. So investigate whether the company can afford to continue paying dividends. Is the company amply covering its dividends with profits? What is its growth rate? Is this rate rapid enough now, and based on competitive advantages that are promising enough, to assure dividend-generating earnings in the future?