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Friday, September 21, 2007

Dividend Investing

Why dividends are important.

Dividends set a floor price – Dividend stocks tend to trade within their yield range, and rarely do they yield much higher than Treasury bill.

Dividends account for over half of the long-term real return – If you own 100 shares of BMO and receive 4% of dividends, you can DRIP your dividends to buy another 4 more shares. If you keep up the DRIP for 20 years, you’ll have a handsome 219 BMO shares in your portfolio. Even better, some Canadian corporations offer 5% discounts through DRIP.

Companies with long-term track records of stable and raising dividends show quality of the managements – Managements show commitment to shareholders by improving fundamentals and sharing profits.

Dividends cannot be manipulated like earnings – Dividends are real hard cash in your lap. Earnings can be faked by creative accounting.

A stable stream of dividends reward investors even during market down turn – Management pays you to wait even during market setbacks.

Dividends are more tax efficient than regular incomes and capital gains – In British Columbia, if you can make $66,000 in dividends, you pay $0 tax. In regular incomes, you pay $16,880 in taxes. In capital gains, you pay $5,097.

You can safely spend your dividends without harming your portfolio – If you think in terms of income streams instead of portfolio size, you can consume 100% of your dividends without hurting your portfolio. If instead you go for capital gains, consuming your capital during a depressed market will harm your portfolio immensely.

Receiving dividends are passive – Dividends and increases are given to you each quarter automatically without any action on your part. On the other hand, to receive capital gains, you must monitor the share prices continuously.

High dividend paying stocks have historically out-performed low-yield stocks – In David Dreman’s Forbes column (April 2004), he cited that between 1970 and 2003, the top fifth highest yield stocks returned 14.5%, while the lowest fifth returned only 8.8%.

Dividends are more predictable than capital gains – Suppose BMO averages 10% over the long term with 4% in dividends and 6% in capital gains. In a given year, you can count on seeing the 4% in your brokerage account, but the 6% capital gain is less dependable.

Your investment return depends on the company’s fundamentals, not the market’s temperament- You may think a business is wonderful and its stock is outrageously undervalued, but if market doesn’t share your excitement, your effort won’t bring you fruition, and you’re needlessly squandering away precious time. On the other hand, if dividends and dividend increases are your investment objectives, you don’t need the market’s blessing to celebrate. This is one fundamental advantage of dividend investing. When you buy dividend-paying stocks, there’s a strong linkage between your analysis and your reward, and this linkage isn’t compromised by market psychology.

Dividend investing forces you to think in a healthy frame of mind in terms of buying low - I bought Harvest Energy Trust last year. I bought it again this year. I will buy it next year, and possibly for the next 20 years. Why would I want my initial purchase to rise at the expense of penalizing my next 20 purchases? The next time you see dividend-paying stocks tumbling down, please come and give me a high-five.

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