# Downside to Dividends... ?



## Maj34 (Oct 7, 2011)

In the short time that I've been learning about investing, I've come to realize that a lot of people are into dividend stocks these days. It seems to be all the rage really. 

I get it. But I also get the concept of "if everyone's doing it, and if everyone's talking about it, then a big red flag should go up".

I think of investment bubbles that go:
- Everyone is interested in something
- Everyone gets on board with that thing
- Eventually there is a bubble that pops and some people lose a lot of money

I think of the guy I knew who always SOLD LOW and BOUGHT HIGH because he was chasing the performance of his peers.

I think of Warren Buffet when he says "Be Fearful When Others Are Greedy and Greedy When Others Are Fearful".

My question is this (and I'm assuming that the bull feeling about dividend stocks is SOMEWHAT of a new thing in the history of investment): 

Is it possible that dividend stocks are a little over-hyped? Is it possible that dividend stocks are overly expensive because they're so desired and that one day they will take a fall because investors start seeing greener grass elsewhere?

What sort of scenario would need to come about to make dividend stock less valuable? 

Thoughts? 

Thanks for any comment on this. I've been wondering for a while!


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## hboy43 (May 10, 2009)

Hi:

Good question, no answer for you.

I would not be inclined to buy the utility div players, ie FTS, TRP etc. on account they are quite pricy these days.

If I didn't have a full plate of financials, I think I'd add at these prices.

I have bought in the last few weeks RUS when it was yielding about 6%, and in the last few months BBD.B when it was yielding 2.8 and 1.9%. Don't know if you are inclined to cal BBD a dividend stock or not, maybe at 2.8% it is, and 1.9% is not.

I have also bought recently two non (high) dividend stocks, NBD and SU.

So if I am part of "everybody", then not everybody is just buying dividend stocks.

Oh, and a rising interest rate environment would let some gas out of the bubble, if there is one.

There is my non-answer commentary for you.

Regards,

hboy43


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## jamesbe (May 8, 2010)

I think interest rates are a big part of it. But is "everyone" doing it just a perception? My father-in-law has been doing it for 30+ years. His strategy has been not to care how much a stock is worth but only care about how much income it makes him. He retired at 50 and has been living off the dividends since then. 

When / If he cashes out I'm sure he has made a profit as well, but he doesn't care at this point only about the dividends.

The low interest rates right now sure make dividends seem nice. When I can put $5000 in a solid stock like RBC or BNS or something and get near 4% while I only get 1.5% on a high interest savings account... why not? As long as I realize the possible downside obviously.


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## Spudd (Oct 11, 2011)

I just started reading "The Intelligent Investor" which was originally written in 1949. It recommends only purchasing dividend stocks. So, I don't think it's a new trend. If the value is there, I see no reason not to buy them.


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## humble_pie (Jun 7, 2009)

hello Maj - if it's only a short time that you've been investing, this is a most insightful & thoughtful post.

never mind that there are no formula answers. It's enuf to articulate the question as well as you have done. Ye'll go far, laddie.


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## Dibs (May 26, 2011)

Maj34 said:


> Is it possible that dividend stocks are overly expensive because they're so desired and that one day they will take a fall because investors start seeing greener grass elsewhere?
> 
> What sort of scenario would need to come about to make dividend stock less valuable?


The price of a dividend stock will be strongly tied to the dividend payout. So one such scenario would be if the dividend is cut - the stock would adjust accordingly. Not all dividend stocks consistently increase their dividends.

I think dividend stocks have become popular recently because of the recent drops in the stock market. Many solid dividend paying companies have seen their share prices decrease with no significant reason other than the current headlines on the world news. Assuming that these companies still have a sound business, the increased yields are attractive.


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## HaroldCrump (Jun 10, 2009)

Dibs said:


> I think dividend stocks have become popular recently because of the recent drops in the stock market.


Another reason is the extended low interest rate environment.
Dividend stocks have been the refuge of income investors.


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## Eclectic12 (Oct 20, 2010)

Maj34 said:


> In the short time that I've been learning about investing, I've come to realize that a lot of people are into dividend stocks these days. It seems to be all the rage really.
> 
> I get it. But I also get the concept of "if everyone's doing it, and if everyone's talking about it, then a big red flag should go up".
> 
> ...


Dividend investing is like any other type - there are those who stick to it through thick and thin and there are those who jump in then out when they see other options.

For example, in 1998 when I started doing my own investing, a co-worker who was doing the same told me I wasting time with dividends when high tech was going up so much. As tech crashed in about 2000, overall he was down 30% where the dividend portion of my portfolio had made up for the few tech losses I had.

One of benefits I like is that when I bought Agrium at about May 2005 on good fundamentals at about $22, it took until late 2008 to hit over $100 but I was getting dividends in the meantime. 


I'd recommend focusing on the business potential of the company and dividend payout rather than "is it a bubble". Certainly - knowing people are paying extra for dividends should be factored in but the key driver is the business prospects.


As for drops when greener pastures come up - that does happen. However, for me while others have jumped on "greener pastures" is usually when I've been able to add to the dividend payers at a good price.


The current low interest environment certainly drives prices up as people compare 4% dividends that are taxed more cheaply than say 2% that is 100% taxed.

There are other scenarios as well. 

One example that I did well with was when TransCanada Pipe was overly aggressive at expanding their business. Eventually they had cut their dividend. I liked the $10 per share and after checking out the plans to deal with the issues - I bought. I'd have to check but as I recall, the dividend was about $0.70 after being cut. Within two years the dividend had been raised and the stock was trading at something like $20. 

Another example is Transalta was hammered one year because the headlines were pointing out that compared to last year, profits "were down 70%". A closer look indicated that when the one-time asset sale the previous year was excluded, profits were up 17% even with higher fuel costs. I was able to pick it up for $16 and within three years it was over $30.

The assets sold had been used to pay down debt and prepare for the higher fuel costs.


One of the bad scenarios was where one of the trucking companies over-paid for a US company to add to their empire. The profits from the Canadian company were funneled into the US company debts until both declared bankrupcy.


Bottom line is if you are worried about it, learn about the dividend payers so you are familiar with their business and the names. Then when prices are good or others are chasing "greener pastures" you can add them at a cheaper cost.



Cheers


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## Cal (Jun 17, 2009)

I am a big fan of dividend investing, but there can be a downside.

Yes, it does seem to be popular now, I believe that to be more of a reflection of the low interest rate enviroment, and alot of people are chasing yield.

Yes...some dividend payers could be overbought due to the popularity.

The other downside, that I see is more directly related to the company, as vs a company that retains earnings, the dividend co has to pay them out, leaving them with less $ to re-invest into the company or buy out another.

It sounds like you are familiar w the up side, so I will not go into detail.


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## Sampson (Apr 3, 2009)

I can think of one significant downside.

If a company is paying out dividends, then it is investing less money back into its business. Certainly returns from classic dividend payers like KO and MCD have been good, but compare them to non-dividend payers or Co's that pay little out such as AAPL and POT.

Dividends might be sustainable, but they do take away from a company's ability to grow.


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## OptsyEagle (Nov 29, 2009)

Sampson said:


> Dividends might be sustainable, but they do take away from a company's ability to grow.


I remember seeing a study that went over some longer time frame and looked at the longer term returns of dividend payers, non-dividend payers, dividend increasers, dividend cutters and dividend stoppers.

All I remember was that the dividend payers did better then the market as a whole and the non-dividend payers. The cutters and omitter were the worst.

When I asked myself why that could be, I figure it is because a dividend payout of 30% plus or minus 10% will not really hurt a companies longer term prospects. They have enough money to re-invest in the company but not too much money that they start doing stupid things with it.

Anyway, I am sure there are many reasons, but I have seen other studies as well and they usually show dividend payers as a better performer then non-dividend payers, your examples aside.


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## Causalien (Apr 4, 2009)

Not everyone is doing dividend.

Dividend tax law is different everywhere and is usually localized to countries. So as Canadians, I only get the benefit of dividend tax law if I buy Canadian companies that are approved and even then, the tax benefit varies across provinces. For example it is best to be a Dividend investor if you live in the west side of Canada and some provinces have a negative dividend tax rate if your total income is less than certain amount.

I will not be able to take advantage of US dividends. So the study about whether or not dividend companies out perform the rest is only localized to the US since it is done for US.

Also, preferred dividend investing depends a lot on the current interest rate. Once the US stops messing around and allows interest rate to go up, it will become a better environment for dividend investing. Bank preferred however are on its own trajectory because the current scare is centralized on banks. But the risk is high. 

Dividend doesn't mean low risk. Since dividend (or bond) + leverage still equals to high risk like a derivative. Just ask MF global.


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## Sampson (Apr 3, 2009)

OptsyEagle said:


> I am sure there are many reasons, but I have seen other studies as well and they usually show dividend payers as a better performer then non-dividend payers, your examples aside.


Survivorship bias is the most common explanation for this "pseudo"- outperformance.


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## Eder (Feb 16, 2011)

Sampson said:


> Survivorship bias is the most common explanation for this "pseudo"- outperformance.


So the corollary is those that pay dividends tend to pseudo survive?


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## Sampson (Apr 3, 2009)

No. It means that back testing using companies that have paying dividends for extended periods disregards all the companies that stopped or cut them. This sampling bias means that these stats only look at the top performing companies.


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## Belguy (May 24, 2010)

Oh, if the solution were just that easy then everyone would be doing it. In some ways, the logic for investing in dividend stocks is loopy.

See 'Promise of riches or smoke and mirrors' section in the chapter on building the stock side of your portfolio in 'Exchange Traded Funds for Dummies' pages 156 through 158 for three pages of reasons NOT to invest in dividend funds. 

As the author states, "On the face of it, they look like free money but nothing in life is quite so simple." He goes on to cover all of the typical arguments for buying a high dividend fund, along with his retorts to each of which there are many!!

If life were so simple, there would be nothing BUT dividend funds out there.


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## Mike59 (May 22, 2010)

Maj34 said:


> Is it possible that dividend stocks are a little over-hyped?


Yes. I own no dividend payers (aside from XRE, which just happens to pay them but it wouldn't make a difference to me if it didn't)

Essential reading (read parts 1-6), changed my life, no joke  :
"Debunking Dividend Myths" (by Canadian Couch Potato)

</end thread>


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## Eclectic12 (Oct 20, 2010)

Belguy said:


> Oh, if the solution were just that easy then everyone would be doing it. In some ways, the logic for investing in dividend stocks is loopy.
> 
> [ ... ]
> 
> If life were so simple, there would be nothing BUT dividend funds out there.


Agreed that life is not so simple.

I'll check out the ETF pages listed, when I get a chance.


Of course the reverse is also true ... if life without dividends were so simple, dividend stocks wouldn't exist. I suspect each has it's palce.

As an example, water heater rentals have a high capital cost but once in place, are a cash cow. If the company doesn't like the bank rates being offered, a dividend stock or partnership is another way to raise the capital.


Cheers


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## peterboro31 (May 11, 2010)

I set up sample dividend portfolio based on an Ellen Roseman article; I set it up with the same weights of each company as explained in her article.

I started with $10000 (weighted to each stock) in total; set the Globe Investor Gold portfolio up to purchase the stocks in the first trading day of 1999.

Dividends were reinvested via DRIP.

Current market value is $32k+ for a 207.6% increase.

No  Mr. Belguy--A very sound investment for a young person. But not for geezers.


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## jcgd (Oct 30, 2011)

Mike59 said:


> Yes. I own no dividend payers (aside from XRE, which just happens to pay them but it wouldn't make a difference to me if it didn't)
> 
> Essential reading (read parts 1-6), changed my life, no joke  :
> "Debunking Dividend Myths" (by Canadian Couch Potato)
> ...


I've read many articles like that before. Funny thing is, any honest book explains all these things as well. The author of that site, IMO, is stating his opinion. He isn't actually debunking anything. He hasn't cited any proof for any of his arguments.

Efficient market hypothesis is 100% real, IMO. But ONLY over the long term. Daily share prices are all over the place. Anyone who honestly believes that a share price can reflect true value at all times is delusional. Human nature makes damn sure that it will not happen. To say that someone cannot find a deal on a company is ridiculous. There are examples all over the place.

For me, blue chip dividend stocks can be a great investment. If you are able to pick one up when the share price is depressed (which happens for no good reason all the time) you can get a better than normal yield. Couple that with steadily increasing dividends and also capital appreciation, you can make out like a bandit over the long term.

IMO, even though many people are picking dividend stocks for the yield lately, the yields are high because the pricing haven't been keeping up. The dividend increases are still happening, dividends are still being paid, profits are still being made, but the prices haven't been rising much. I think right now a lot of blue chips are pretty good value. Just my opinion though.


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## Belguy (May 24, 2010)

peterboro31, I'm impressed and jealous!! I don't have the data for my portfolio since 1999 but it would be interesting to calculate the comparison to see how a 'Couch Potato' portfolio of broad-based ETF's has performed by comparison.

I note that Ellen is still toiling away at the Star and so perhaps she didn't follow her own advice or maybe she is independently wealthy and simply likes her job too much to quit.


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## balk (Dec 6, 2010)

jcgd said:


> For me, blue chip dividend stocks can be a great investment. If you are able to pick one up when the share price is depressed (which happens for no good reason all the time) you can get a better than normal yield. .


Why not just pick up an index fund when share prices are depressed? It will have the same effect. The major point is whether the total returns of dividend investing will beat index investing. Remember that index funds tend to pay out the dividends too.


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## LBCfan (Jan 13, 2011)

jcgd said:


> I've read many articles like that before. Funny thing is, any honest book explains all these things as well. The author of that site, IMO, is stating his opinion. He isn't actually debunking anything. He hasn't cited any proof for any of his arguments.
> 
> Efficient market hypothesis is 100% real, IMO. But ONLY over the long term. Daily share prices are all over the place. Anyone who honestly believes that a share price can reflect true value at all times is delusional. Human nature makes damn sure that it will not happen. To say that someone cannot find a deal on a company is ridiculous. There are examples all over the place.
> 
> ...


You forgot about the dividend tax credit. Doesn't that up the yield by about 40% to a typical Canuck?


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## jcgd (Oct 30, 2011)

balk said:


> Why not just pick up an index fund when share prices are depressed? It will have the same effect. The major point is whether the total returns of dividend investing will beat index investing. Remember that index funds tend to pay out the dividends too.


I guess I'm not really fighting for that point, so good point. 

My overall reasoning more lies on what I want in retirement. Any growth stocks I'd have to slowly sell off to get income. If I own a nice fat portfolio of dividend payers they throw off income. My goal is to live off passive income in the end.

I'm planning to have two portfolios, a indexed type, and a value/ dividend portion. While I believe in dividend stocks, I most certainly cannot deny the logic of indexing. Anyone should be happy to make slightly better than the average market return. Index and keep costs down and you are doing better than half the investors.


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## jcgd (Oct 30, 2011)

LBCfan said:


> You forgot about the dividend tax credit. Doesn't that up the yield by about 40% to a typical Canuck?


Yeah, forgot about that.


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## Maj34 (Oct 7, 2011)

Hey all. Original poster here. Thanks for all the input! I missed most of the thread because I thought I'd get an email notification... turns out you only get one for the first response.

Anyway, that's some great information for me to consider. For now I'm just doing TD e-Series indexes (as per Canadian Couch Potato guide with international explosure). But I plan to start buying stocks next year when I learn more about the world of investing. 

Thanks again!
M.


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## Cal (Jun 17, 2009)

http://www.dividendninja.com/getting-started-with-drips-and-spps-1


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## londoncalling (Sep 17, 2011)

Great link Cal. I definitely can see the advantages of Drips. I prefer to time my purchases as I prefer to wait for weakness in share price. The other disadvantage of DRIPs is that it dilutes the stock


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## doctrine (Sep 30, 2011)

Always nice to see a company that doesn't dilute their stock - not a lot of them around these days.


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