Aesop could well have been talking about dividends when he declared over 2000 years ago that “a bird in the hand is worth two in the bush.” There is something very comforting about receiving a regular dividend check in the mail.
The problem is that aiming at stocks with higher dividends may actually be destroying your capital at a faster rate than if you considered both capital gains and dividends.
The terminology in this area is that dividend yield is the yearly dividend divided by the stock price. Total return is a calculation that assumes that dividends are being reinvested. Although you may not be doing that, it is a useful benchmark to compare investments in different stocks.
My studies show that, on average, stocks that pay dividends slightly outperform (in terms of total return) those that don’t pay dividends. However, when we only consider stocks that pay dividends, those that have a lower dividend yield tend to slightly outperform those with a higher dividend yield.
When considering dividends, I think that there are three things to be aware of.
(1) Many people do not like to sell shares because they say that this means “eating into their capital”. To combat this, they buy shares with a higher dividend yield to provide them with necessary funds. However, it is important not to confuse the number of shares with the amount of capital that you might have. Selling a percentage of shares that are rising in value (but with no dividends) may mean less of a reduction in capital than focusing on shares with minimum capital gain but a higher yield.
(2) If a company is achieving a high return on equity and return on capital, for the benefit of its shareholders it may be better for it pay little or no dividends. This is because it is likely to be getting a higher return on the money than its shareholders would be getting.
(3) The Conscious Investor approach is that whether there are dividends or not, at the basis of your investment is a company with real products and services. In the end it is how well that company performs as a business that will determine your return. But if you do want to seek out companies with dividends, on average it is the companies with the lower dividend yields that provide the best performance.
