Dividend Stocks Pros & Cons & 3 Dividend Stocks You Must Own

Dividend Paying Stocks

Today we’re going to be looking at the three companies you might be interested in investing in. These three stocks have one thing in common: They are dividend-paying stocks.

Dividends are varying amounts of money paid out by companies, typically once a year, to their investors or stockholders.

The dividend yield is the ratio of a company’s annual dividend compared to its share price. The dividend yield is represented as a percentage and is calculated as follows:

The equation for calculating the dividend yield:

Dividend Yield

The dividend yield is a more important number than the actual dividend because it actually shows you the return you are getting on your investment.

Two companies could have a dividend of 100 pounds, but say the shares of one of those companies cost 1000 and the shares of the other one 10.0000.

Using our dividend yield formula it’s easy to see that the dividend yield of the second one(0.01 or 1%) is much lower than the first one. (0.1 or 10%)

Dividend-paying stocks can be a great way of getting a steady and constant return on your investment, but they are disliked by some investors, most notably, Warren Buffet.

Here are some of the advantages and disadvantages of dividend stocks.

Read: Our Guide to Value Investing

Advantages of Dividend Stocks

Like I just said, dividend stocks are a great way to simply put cash in your pocket. You don’t have to rely on a new product to make the share price skyrocket before collecting on your investment.

While they are not risk-free, some people compare dividend stocks to bonds.(Although in today’s climate I wouldn’t say they are risk-free either)

Companies that pay dividends are typically old and well-established. You can often find these types of companies in the utility sector or old industrial businesses.

While there are no laws regarding what dividends a company has to pay, except perhaps it’s internal laws, most dividend-paying companies have a record of increasing their dividends over-time, keeping up with inflation and giving a similar return to the market, without all the volatility.

Finally, it’s worth noting that in some countries dividends are more tax efficient than other types of investment like bonds. (Yes, sorry, your dividends will be taxed.)

Disadvantages of Dividend Stocks

One of the disadvantages of dividend stocks is that because they are concentrated in specific sectors, they do not provide much diversification. However, with the ever increasing availability of stocks worldwide this can be somewhat mitigated.

Another problem is that like I said before, there is nothing preventing a company from changing its dividend policy, for better or for worse. When investing in dividend stocks, it’s vital that you look at the history of the company and their track record when it comes to dividend payments.

Lastly, many investors and businesses are simply against paying dividends by principle.

The idea is, that a profitable company, should be able to reinvest their earnings in a more profitable way, rather than paying out dividends to their investors. If your company was achieving a 30% return on its capital, wouldn’t you rather invest in that than receive the dividends now?

This is certainly a good point and one that Warren Buffet has always made.

But it is true that some companies may not be able to expand more, despite being good profitable companies, and for the investor who doesn’t want to automatically reinvest his money and would rather have some cash, dividend stocks can be a part of a well-balanced portfolio.

How to Deal With Stock Market Volatility

Read: How to Deal with Stock Market Volatility

3 Dividend Stocks you Should Look Into

Now could be a good time to get into some dividend stocks. With valuations dropping, this means an increase in dividend-yield. If the price of a stock drops and the dividend payout stays the same you are effectively receiving a better return on your money.

Furthermore, in times of volatility, some companies might even opt to increase their dividends in the short term to attract more investors.

Without further ado, here are three companies, all listed in the FTSE, I recommend you have a look at and consider for investment.

Associated British Foods (LSE: ABF)

ABF is a sugar-to-retail business best known for its chain of clothing Primark.

ABF has a great track record boasting an increase in earnings per share (EPS) of 9% annually.

Analysts in the City are predicting a growth rate of 8.3% for this company in 2018. This would leave a P/E ratio around 17 which is high, but lower than the five-year average of 25.

Most impressive of all about this company is their rate of dividend growth.

ABF has been consistently increasing its dividend payout by a steady 8%. This payout is covered three times over by earning per share, giving us a wide margin of safety.

Although the yield on this stocks sits on the lower side, 1.9%. This is a safe bet with a lot of potential.

Sage (LSE: SGE).

Another interesting stock I’d like to mention is Sage. This software company has a very solid business model.

By far, the greatest attribute of this company is the fact that its earnings are sticky.

What do I mean by this?

In economics, we refer to things as being sticky when they don’t have a tendency to change much. In economics courses, you will often see the issue of sticky prices addressed.

A price is “sticky” if it doesn’t change much with changes in supply costs or demand. It can also be sticky up if it can decrease easily but not increase. Likewise, a price is sticky down if it’s easy for it to increase but hard for it to fall.

Wages are always used as an example of stickiness. A wage is, after all, the price of labour. Wages change slowly, because of various reasons. One is that normally work contracts are long-term. Another reason could be psychological, people are often very reluctant to take a wage cut.

Anyway…back to Sage!

This company has sticky earnings because it is rare for companies to change their operating software in the short term since this involves a lot of hassle.

Based on current City growth estimates, shares in this business are trading at a forward (2019) P/E of just 15.7, which is high, but it’s a multiple I am prepared to pay given the sticky nature of sales. The multiple is also below the five-year average of around 20.

Furthermore, Sage has also been steadily increasing its dividends, with an increase of 70% in the last five years.

Currently, this dividend is covered twice by the EPS and after recent declines in the price the yield is up to around 3%

BP (LSE: BP)

There’s no need to go into much detail on the nature of the business BP conducts.

This integrated oil & gas giant pays a juicy dividend yield of around 5.3% and is solely responsible for 7% of the FTSE’s dividend payments.

Companies in the energy sector tend to pay high dividends because they generate very strong cash flows.

Cash flow is the net amount of cash and cash-equivalents being transferred into and out of a business. At the most fundamental level, a company’s ability to create value for shareholders is determined by its ability to generate positive cash flows, or more specifically, maximize long-term free cash flow.

With the expectations of higher oil prices in the near future, BP looks set to produce more operating cash flow than it can reinvest in the business. Some of this excess cash flow could be put to use in cutting its debt pile — which is only starting to decline. But that still leaves plenty of room for the company to grow its payout.

With a forward P/E ratio of 11.3,(below the average FTSE P/E of 13) this company looks like a buying opportunity to me.

Conclusion

While dividend stocks will not make you rich overnight, they are a safe bet in times of turmoil. As of right now, I believe the market is entering a downward trend.

Overvaluation and BREXIT uncertainties will contribute to a more volatile year and this can be mitigated by investing in some of these solid dividend stocks with a proven track record.

These stocks are on the more conservative side of dividend payments. If you have a higher appetite for risk, I’d recommend you look into Taylor Wimpey (LSE: TW). This housebuilder currently boasts a dividend yield of a whopping 9.3%.

This is due to a couple of factors.

Firstly, it’s price has declined sharply in the latest months, in part, due to a slowing housing market.

Secondly, this high yield comes in the form of special dividends, showing that management does not intend to maintain this yield indefinitely.

But with relatively strong earnings and analysts prediction positive growth for the next year, this could also be an interesting stock to hold.

James Foord

Based in Barcelona - Spain, James is an Economics Graduate and Financial Advisor offering advice on Pension Plans, Insurance & Mortgages. He has been writing about economics and investments for 7 years.


james@moneycheck.com
https://www.linkedin.com/in/james-foord-7272608a/

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