If you think that putting your money into bonds or CD’s is the only way to hedge against the roller-coaster ride of the stock market, think again! Author Charles Carlson demonstrates that an age old benefit of owning stocks called “dividends” can be used to create a stream of income and protect against market conditions.
Right now if you asking yourself “what is a dividend?”, then this is the right book for you. “The Little Book of Big Dividends” is a great introduction for anyone looking to get acquainted with dividends and how they relate to stocks. The material is easy to read and it is not overly equation-heavy (except for the Appendix) or preachy on risky investments. In fact, Carlson’s advice is very modest and follows the lines of most conventional teaching.
What is So Great About Dividend-Paying Stocks?
For starters, a dividend is a payment that you’ll receive as a stockholder from the profits that the company makes. On the surface, you could think of this similar to an interest payment from a bank account or savings bond, except that dividends are not guaranteed and can be discontinued at any time. They usually payout 4 times a year (once per quarter), and their value can fluctuate up or down at will.
One of the first facts that Carlson points out is that nearly half of the stock market’s long-term total return comes from dividends. As a whole, dividend-paying stocks have outperformed their peers throughout history.
As a tax payer, there are potential advantages to having dividend income. Most “qualified” dividends are taxed at 15% rather than at standard ordinary income rates (at 28% for example).
Tired of paying broker fees every time you buy a stock? Some dividend-paying stocks can be bought directly from the company for cheaper than if they were purchased from a discount broker. This usually requires signing up for a DRIP (a dividend reinvestment plan where the dividends are used to buy more of the same stock). In general, you will pay less fees and be able to own fractions of stocks (that pay fractions of dividends) whereas you could not with a broker. The only set-back is that you have to keep track of all your own tax-related transactions (i.e. a discount broker usually sends you a statement.
Whoa, Hold On:
Even though dividends pay out at certain times of the year, Carlson warns that you can’t just buy a stock (before the ex-date) to get the dividend, sell it, and then reap the benefits. That doesn’t work. He explains how stock prices adjust downward after the dividend payment is made.
Not all dividend paying stocks are good ones either. Carlson cautions to avoid stocks with too high of dividends percentage yield (3 points above peers and 5 times the S&P 500 yield). This is a good indication of risk. Remember, if a company isn’t making profit, it won’t be paying dividends for long.
Also, not all dividend paying investments are necessarily worth it. REIT’s, MLP’s, and royalty trusts do not receive the same favorable tax treatment. Consider the tax implications before trying one of these alternatives.
So how does Carlson propose we steer clear towards the best dividend paying stocks? By following his plan called the Big Safe Dividend (or BSD) formula. The BSD formula comes in two flavors: Basic and Advanced.
The Basic BSD Formula goes as follows:
• Payout Ratio = Current Dividend (Annualized) per Share / Earnings Estimate for the Fiscal Year ($ / Share) < 0.6.
• The Overall Quadrix Score. This is a rating awarded by the author’s firm to a stock and is based on Momentum, Quality, Value, Financial Strength, Earnings Estimates, Performance.
The Advanced BSD Formula is a convoluted equation based on 10 different factors about the stock. It is provided in the Appendix of the book (if you feel like figuring it out).
Want to bypass researching dividend stocks on your own? Carlson uses the book to pitch his website www.bigsafedividends.com which lists scores for various companies and also provides lists of which companies engage in DRIP programs. If anything, the advice is free.
Again, if you’re new to stocks and exploring investment strategies, then this would be a worthwhile and easy read to help you understand the benefits that dividends could play in your portfolio.
I plan to look into the author’s BSD formula and explore the recommendations on his website further. Plan on a follow-up post!