By Brett Arends
There is nothing wrong in principle with buying stocks for the income they generate, through dividends, instead of growth.
It’s a strategy that’s especially appealing to retirees and others who need to live on the income from their investments.
It’s had long-term success. Multiple studies have shown that so-called “value” stocks, which typically includes companies paying out high dividends in relation to their stock price, have tended to be especially good long-term investments overall.
But before retirees and income investors wade into the market, there are three things to bear in mind.
Don’t get your hopes up
Dividend yields are still lousy on Wall Street. You won’t get much income in return for your investment.
The dividend yield of a stock is the amount of the annual dividends you get, divided by the price you pay. It can be most obviously compared to the rest of interest you get on a bond or a savings account. Today the “yield” on the entire S&P 500 /zigman2/quotes/210599714/realtime SPX -0.12% is 1.8%, according to FactSet. That means if you buy $100 worth of an S&P 500 index fund such as the SPDR S&P 500 /zigman2/quotes/209901640/composite SPY -0.12% ETF you can expect to get back about $1.80 in dividends (less fees and taxes) over the next 12 months.
That is a full 6.5 percentage points below the current inflation rate. So you’re losing money in real purchasing power terms, at least on the dividends.
To put this in perspective, according to number cruncher Andrew Lapthorne at SG Securities, the last time inflation was this high — back in the early 1980s—the yield on the S&P 500 was around 5%, or nearly three times as high as it is today. In other words payouts came much closer to keeping up with prices. Stocks were also much cheaper in relation to profits. Stockholders were getting much bigger dividend checks and were getting compensated much more for taking on stock market risk.
OK, so it’s not completely apples-to-apples. Thanks to legal and cultural changes since then, companies try to return money to stockholders by buying back stock as well as paying out dividends. But buybacks aren’t entirely the same as dividends. Studies have shown that companies tend to buy back stock more often at the peak of the market. Buybacks are intermittent, whereas dividends tend to be much steadier. And while companies use cash to buy in stock, they are often quietly shoveling a lot of stock back out again in the form of goodies for the CEO and their buddies on the top floor.
As one of my first news editors used to tell me, back when I was starting out in this business, that dividends have one great advantage over almost every other financial metric companies report, including earnings, revenues, asset values and liabilities: You can’t fake the dividends. The checks go out, or they don’t.
(He knew of what he spoke. He had once worked for a magazine publisher that claimed an audited circulation far above its actual print run.)
The current low dividend yield on the S&P 500 isn’t just about big, high-tech “growth” names that don’t pay out anything, either.
For example the yield on the cheaper, “value” half of the S&P 500 is no great shakes. It’s about 2.7%, according to FactSet data on the iShares S&P 500 Value /zigman2/quotes/206097129/composite IVE +0.01% ETF.
Don’t confuse stocks with bonds
This ought to be written on a Post-It note and stuck to the bathroom mirror of anyone planning to buy a lot of stocks for the income.