One of the main themes today is an emphasis on "stable" companies with generous dividends. Various advisors point out that periods with flat stock prices can nevertheless be profitable once dividends are factored in. Over longer periods, dividends make make a huge difference. These folks are absolutely right; without dividends, stock investing is, over time, a pretty pallid affair. Huge appreciation is often followed by stomach-wrenching drops. A steady diet of reinvested dividends can smooth everything out, and ultimately result in nice long-term results.
So, why not seek out those large, stable companies with stable dividends? Well, the main problem is that stable dividends are actually fairly rare and disturbingly fragile creatures. For example, the website dividendinvestor.com has a list of star performers. There are about 275 companies with three stars, indicating dividends increased for 5-10 straight years. 10-20 has about 170 entries, while 29+ (yes it jumps from 20 to 29 to make the top list) has a mere 77 members. Considering the thousands of publicly traded companies in the U..S., this is a relatively small group of companies.
So what do these income stars mean for a person looking for a steady stream of retirement income? Well, the picture is not so hot. That first groups of winners (5-10 years) means that almost all of them, at some time, either cut their dividend, froze it, or terminated it. None of those are good things. As a retiree, you need to count on income far longer than ten years. So, you'd want to pick from list two or three, the companies you can really count on. This is a relatively small group. And again, they are all only as good as their most recent results. All lists were substantially larger before 2008. Dozens and dozens of companies fell out of the all-star rankings once the great recession hit. How can you safely target the winners?
Here is the evil dynamic that can kill dividend chasers. A company runs into financial trouble for one of many possible reasons. Alert stockholders begin selling, which causes the dividend yield to rise, perhaps very sharply. A 2% dividend for a $10 stock becomes a 6% dividend if the stock falls to $3.33. At this point, yield-hungry dividend chasers might jump in, hoping to lock in those juicy returns. Like clockwork, though, this temporary situation is followed by a dividend cut, or elimination as the company pursues survival at all costs. Now, the stock plummets further, as the disillusioned income investers bail out. Finally, don't forget that some companies terminate the dividend due to financial distress, only to then file for bankruptcy or reorganization. In those dire cases, you don't just lose income, you lose your entire investment as well. So, a bit of free advice; never buy a stock just because it has a high dividend yield. You will usually wish you had held back. I have a LONG list of such dividend-oriented regrets. In nearly every such case, I would have done better to sell the stock short; in time, my returns would have been fabulous! (No, I am not touting a new "can't miss" scheme, in case you're wondering).
A dividend freeze is not so bad; the company might weather the storm and move forward in a couple of years. A dividend cut is far worse; I've cited the example of JP Morgan (a true blue blood) that cut from $.38 to $.05 in 2009. They still haven't restored that dividend completely. Bank of America is still at a penny, down from $.64 and higher). GE, perhaps the most famous "safe dividend" company of all, cut it to $.10 quarterly, a 70% drop. The dividend still only back to $.17. These are crushing cuts, if you're trying to live on the income. A complete loss of principal, though, might reduce you to munching on cat chow.
Can you see why I'm much more enthusiastic about interest income? The track record of investment grade bonds is hugely better than that of dividend stocks. Companies can go through periods of great turmoil, cut or eliminate dividends, and still pay interest like clockwork. Do they do this because they have greater loyalty to bondholders? Of course not. They pay for two fundamental reasons. First, they are legally obligated to. If there's money in the till, the bondholders can demand it. Second, every company wants access to the credit markets. If they stiff one group of lenders, they will either be unable to borrow in the foreseeable future, or at least pay painfully high interest rates. Viable companies will, therefore, go to great lengths to stay current on their bond payments. This even applies to lower-rated (i.e. junk) companies, not just investment-grade firms.
To put all this in personal terms:
Since 2008, I have bought 42 separate bond issues from 24 different companies. All of them have either been retired (paying back the entire investment at par), or continue to pay interest. Only one of the issues, Clear Channel Communications 7.25% of 2027, has been problematic. It was already junk-rated when I bought it (shame on me, a violation of my rule against buying junk), and has since descended to near-default levels (CCC). Even it, though, continues to pay on time. I did suffer a capital loss when I sold (after the downgrade), but the loss is very small compared to the huge gains most of my positions have achieved. When you consider how terrifying the world looked when I started buying these positions, I think this performance is remarkable. Bottom line? Bonds might cause you some sleepless nights, but things usually work out just fine. I don't think you can say the same about dividends.
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