I often enjoy reading financial columnists who reply to questions from readers, and sometimes learn from their answers. One I saw recently gave me reason to think about investing in dividend stocks, a popular strategy anytime, but especially now with interest rates so low.
The questioner asked what he should do: he had purchased a stock for the dividend yield (annual dividend rate per share/market price per share), but the share price subsequently had fallen more than the dividend rate, so he was losing money on his investment. Should he sell his stock or hold onto it despite the decline?
I think this question highlights some important considerations before investing in equities of any kind, including dividend-paying stocks, especially for risk-averse investors, as this questioner appears to be. Here are a few of the things I think about before buying a stock for its dividend.
I consider my time frame. For the most part, I view purchasing a dividend stock as a long-term investment, since I am purchasing it, in part, for the stream of income it will generate. And I make the purchase knowing that any stock will have ups and downs during the short term (which I define as less than 12 months).
The trading history of Johnson & Johnson, a solid, blue chip company, illustrates this point. Since the beginning of 2007 through November 5, 2012, its shares traded as high as $72.76 per share and as low as $46.25 per share. In no year was its trading range, from high to low, less than $9 per share and in some years it was as much as $20 per share.
I think about my tolerance for seeing the value of my investment decline, at least temporarily. As Johnson & Johnson's trading history indicates, there is a good chance that an investor who purchased Johnson & Johnson shares some time since the beginning of 2007 would have seen the share price decline more than the dividend rate at least once and possibly many times. If I feel that I will lose sleep anytime the value of my investment declines, I will look elsewhere for income.
Need to Review Periodically
I review the investment when the price falls. When the share price of a stock I own declines, especially substantially, I take a closer look. In particular, I want to know why the share price is down (because the market overall is down, because of disappointing earnings, etc.) and whether I think its decline reflects a deterioration in the company's outlook, which could be a reason to sell. If not, I will probably continue to hold the stock or, possibly, even buy more at a lower price.
Quality Companies with Stable or Rising Dividends
When choosing a dividend-payer, I look for high quality companies with long histories of paying dividends and, even better, of rising dividends. Johnson & Johnson is such a company. In 2007, it paid dividends of $1.62 per share; today, its annual dividend rate is $2.44 per share. Even if I had the poor timing to purchase the shares in 2008 at $72.76 per share, or its highest price since the beginning of 2007, the shares' dividend yield at the time of my purchase would have been about 2.5% and today my yield on the same shares would be almost 3.4% (or about 33% higher). Thus, even the shares of Johnson & Johnson, which hasn't been a spectacular performer over the past six years (at the close on November 5, 2012, its shares were priced at $70.79, which is below its 2008 high), could have provided a growing stream of income even without big capital gains.
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