Why I Like Investing in Dividend Paying Stocks:
When it comes to investing in stocks, I generally prefer to invest in large stable blue-chip companies that have a history of rising revenue, rising earnings, and rising dividends. As well, I try and buy the shares of these companies when the company’s executives are buying them and when these shares are trading about 20% lower than their 52 week highs. This isn’t always easy and it often takes a great deal of patience. However, it has been a strategy that has generally worked out well for me in the past. One stock that has seen its stock price fall in recent weeks and that now appears to meet these above mentioned criteria is AT&T. I’ll discuss this stock below, but before I do, let me explain why I like investing with the criteria mentioned above.
Dividend Paying Stocks Tend to Outperform the Market
As far as I can tell, a strategy of investing in large blue-chip dividend paying stocks has historically outperformed the market by 1-2% per year. One index that can be used to track the performance of stocks that have a history of increasing their dividends is the S&P 500 Dividend Aristocrats Index. This index tracks companies on the S&P 500 that have increased dividends every year for the last 25 consecutive years. A recent search at S&P Indices of the most recent 10 year annualized returns of the S&P 500 Dividend Aristocrats Index versus the S&P 500 Index, ending Nov 4th 2016, shows that the S&P 500 Dividend Aristocrats Index returned roughly 9.5% a year. This is compared to only 6.6% for the S&P 500 Index. If you hold stocks for the long term (like I do), then that type of difference in annual returns could lead to a substantial difference in the growth of your overall investment.
For example, if you were to invest $10,000 and earn a return of 9.5% a year, your investment would be worth roughly $96,700 after 25 years. If that same investment earned a return of 6.6% a year, however, it would be worth only $49,400. This means you would end up with almost twice as much money with the 9.5% annual return compared to the 6.6% annual return. In fact, according to a chart released by Bloomberg Finance, over the twenty-five year time period between 1990 – 2015, the S&P Dividends Aristocrats had a total return of roughly 1,500% versus a total return of roughly 800% for the S&P 500.
As an aside, one easy way to invest in dividend paying stocks with a history of rising dividends is to invest in an ETF that buys these types of companies. ProShares sells an ETF that mirrors the S&P Dividend Aristocrats Index under the ticker symbol NOBL.
Other Advantages of Dividend Paying Stocks
As well as historically delivering higher returns, owners of large blue-chip dividend paying companies get to enjoy the income their stocks generate. Even if there is a stock market decline, if you have invested in companies with a history of paying out a dividend, you will get paid to wait for the recovery.
Even better, assuming you are able to build up a large enough portfolio of dividend paying stocks, you may actually be able to live off of the income your investments generate without having to sell these investments. And assuming you pick companies that have a history of raising their dividends every year, and that these companies continue to do so, your income would also have a good chance of keeping up with inflation.
Furthermore, in many cases, dividend income in the US and Canada gets taxed at rates much less than normal employment income gets taxed. In fact, depending on how much dividend income you receive and if your dividends meet certain requirements, it may actually be possible to pay no tax at all on your dividend income. I talk about this in my post “Three Ways to Legally Avoid Paying Income Taxes”
Investing Versus Speculating
Legendary investor and father of value investing, Benjamin Graham, once said, “The individual investor should act consistently as an investor and not a speculator.” If you want to follow in the footsteps of some of the greatest investors of our time, you would be wise to follow this advice. Compare a strategy that involves investing in large blue-chip companies that increase their earnings and dividends every year to a different strategy that may require you to buy the shares of a company that is not generating any earnings or not paying out any dividends, and you may find such a strategy a little harder to make sense of. An investment in a company with little to no earnings is better described as speculating, not investing.
What’s more, unlike some accounting metrics, it’s hard to manipulate dividend payments. Either a company is making enough money to consistently pay out and increase its dividend each year or it isn’t. If a company has been paying out and raising its dividend for over 25 years, there’s a pretty good chance it’s a stable business and a good investment.
Margin of Safety
Warren Buffett, considered to be one of the greatest investors of our time, once said, “It’s far better to buy a wonderful company at a fair price than to buy a fair company at a wonderful price.” This likely refers to Warren Buffett’s belief that not only is it better to act as an investor and not a speculator, but that one should also be careful to not pay too much for an investment. Warren Buffett’s mentor, Benjamin Graham, felt the same way.
In the last chapter of his widely acclaimed book, The Intelligent Investor, Benjamin Graham described what he referred to as “margin of safety” and highlighted it as one of his key investment tenets. Buying an investment with a margin of safety refers to the act of buying an investment for what you believe is significantly below your estimation of its intrinsic value. This act is meant to help limit the downside risk of purchasing an investment.
As well as investing in large blue-chip dividend paying companies, I also like to try and invest using a margin of safety. For me, this means attempting to buy stocks that are trading for less than I think they are worth. I usually attempt to accomplish this by buying stocks that are trading about 20% off their highs and that I expect to continue to show a similar trend of increasing earnings, increasing revenue, and increasing dividends.
Finally, in addition to considering shares that are trading well below their highs and have a history of rising dividends, earnings, and revenue, I also like to buy shares that show positive insider trading activity.
A quick note on insider trading – insider trading is only illegal when investors or executives act on information that they have access to that the public does not. Executives are not restricted from buying the shares of the companies they work for, they just need to ensure they don’t do so using information that has not yet been made public. This being the case, executives buy and sell shares in the companies that they work for all the time. When these executives do so, however, they need to report their buying and selling activity to the SEC who will in turn make this information public.
As it turns out, this type of information can be extremely useful to individual investors. Legendary investor Peter Lynch once said, “Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.” According to Investopedia , renowned University of Michigan professor, Nejat Seyhun, found that when executives bought shares in their own companies, the stock tended to outperform the market by 9% over the next 12 months. Conversely, when they sold their shares, the stock underperformed the market by 5.4%
Given these facts, I certainly like to buy the shares of companies at the same time that their executives are also buying these shares.
With all that discussed, lets now take a look at an investment that has recently caught my attention. That investment is the shares of AT&T.
AT&T is a holding company. The company offers communication and digital entertainment services in the United States and around the world and trades on the NYSE under the symbol “T”.
AT&T definitely fits the bill as a large blue-chip company with a history of steady and rising dividend payments. AT&T has a market capitalization of $224.5 billion dollars, annual revenue of over $140 billion, and has been increasing its dividends every year for the past 33 years. It’s most recent dividend increase was a 2.2% rise in its quarterly dividend to $0.49 per share just last month. In addition to increasing its dividends, AT&T also has a history of rising revenue and rising earnings per share.
The stock has traded in between $32.22 and $43.89 over the last 52 weeks and recently ended the Nov 4th trading day at $36.50. This price of $36.50 is roughly 20% lower than its recent 6 month high and has resulted in the stock having an attractive dividend yield of approximately 5.4%. The consensus recommendation from the 30 analysts covering the stock is that AT&T is a buy. The average 12 month price target from these analysts is $41.20.
What’s more, a recent detailed stock report issued by Thomson Reuters on Nov 4, 2016, gave the stock a 9 out of 10 rating in terms of favourable insider trading activity over the last month.
Part of the reason that AT&T has seen its price fall in recent months is, no doubt, due to concern that it’s proposed $85.4 billion takeover of Time Warner Inc. (NYSE:TWX) might not receive regulatory approval. Investors are also likely concerned that should the deal get regulatory approval, the fact that AT&T plans to make the purchase with 50% stock and 50% cash will result in higher debt and higher shareholder dilution. Nonetheless, according to The Street, the Time Warner deal would be immediately accretive to both earnings per share and free cash flow per share.
Speaking for myself, I do not currently own any shares of AT&T, but I plan on purchasing some next week. My decision is based on the company’s strong history of rising dividends, large dividend yield, and history of rising earnings and revenues (with or without the Time Warner Deal being approved). I am also encouraged by the recent insider trading activity and what I believe to be a margin of safety based on the recent price decline, analyst’s estimates, and the company’s P/E ratio. AT&T’s trailing P/E ratio is 15.6 versus its 5 year average of 26.8 and the S&P 500’s current average of 23.8.
As always, you should do your own independent research and/or contact an investment professional before purchasing any of the investments discussed on this blog.