Endless Gibberish

Not dividends, not growth, but both.

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I like growth companies. I like dividend paying companies. I LOVE a company that grows and pays dividends however. Companies that grow and pay a sustainable dividend are great investments in my book. Note the word “sustainable” also. Companies that pay dividends that aren’t sustainable in the long run are generally not good investments at all. Generally a company’s earnings should cover the dividend payout. One huge red flag is a company that has to take on debt to fund the dividends. If a dividend is sustainable, generally the stock has minimal downside to it. As long as no fundamentals of the company are changed, any downside in a stock paying a dividend increases the yield.

For example:
Company A’s stock price is $100. The dividend payout is $5 or 5% currently. The stock drops to $50 on news that the CEO has diarhea. No real fundamentals about the company have changed, yet the stock is now yielding 10%! Time to buy? Yep.

I love adding to my investments on weakness. However, you have to figure out whether the drop in price was a result of general noise or real weakness in the company.

Generally I love companies that pay steady and growing dividends. Why? Dividend increases also increase your yield on your original investment and often send the stock price higher to correspond to the yield.

For example, I invested in Bank of America (BAC) at $44.55 in July of 2005. The stock paid $0.50 per quarter ($2/year) so the yield was about 4.5% at the time. Bank of America’s earnings easily covered the dividend so I figured even if the stock’s movement was flat, I’d make 4.5% on my investment which is equivalent to high yield savings account.

Bank of America increased their dividend 12% recently to $0.56 per quarter ($2.24/year). My initial investment now yields about 5% in dividends. 5% in dividends is chump change but the corresponding upside in the stock price as a result of the dividend increase was 18%!

I don’t see Bank of America cutting their dividend or stopping the increases anytime soon. Their latest EPS was $4.11 so the dividend cover is about half. The dividend is definitely going to be sustainable and increasing for a long time unless some core fundamentals in the company change.

The dividend increases could be higher but they do put some of their earnings into growth. Growth and dividends, usually if done right, are especially rewarding.

Investing in dividend growers has another added benefit. In your later years, after numerous dividend increases, your initial investment should be yielding an extremely high %. You can use this to either re-invest or help pay off expenses. One of the reasons I prefer dividends payers to non-dividend payers is regular income. If you’re an investor of Berkshire Hathaway, which does not pay dividends, the only way to live off your investment is to sell shares. With dividend paying stocks, you feel more like an owner in that you recieve actual income from owning the stock.

Other posts of interest:
Check out my other post on what I think about penny stocks.