Misguided thinking about Dividend Investing

I’ve received an uptick in emails and comments from investors about dividends and so I thought I’d address some common misconceptions around dividend investing.

One reader in particular wanted to know if he should take the commuted value of his pension ($750,000) and put it all in Enbridge stock because it was yielding around 6.5%. That reminds me of the reader who, several years ago, asked if he should borrow money at 4% to buy Canadian Oil Sands stock that was paying an 8% dividend yield.

Related: How did that leveraged investment work out?

I shouldn’t have to tell you why it’s not sensible to put your entire retirement savings into one stock – dividend payer or not.

Most comments were much more sensible and reflected what I perceive to be some misguided thinking about dividend investing.

Dividends + Price Growth = Magic?

Some companies pay a dividend to shareholders. Some do not. Investors shouldn’t have a preference either way.

Amazon doesn’t pay a dividend, focusing instead on reinvesting their profits back into their business for more growth opportunities.

Apple, on the other hand, is awash in cash thanks to the tremendous success of the iPhone and decided to start paying a dividend in 2012. It likely cannot reinvest or grow fast enough to keep up with its cash flow and so it returns some of that cash to shareholders.

Investors shouldn’t prefer Apple to Amazon just because of Apple’s dividend policy.

But what happens when a dividend is paid? The value of the company decreases by the amount of the dividend. That must be true, since the dividend didn’t just appear out of thin air – it came from the company’s earnings.

Company A and Company B are worth $10 each. Company A pays out a $1 dividend, while Company B does not.

Company A is now worth $9, and its shareholders received $1. Company B is still worth $10 and its shareholders received $0.

But some investors do seem to think the dividend comes from thin air and that it does not reduce the value of the dividend paying company.

Consider this example: Let’s say expected stock returns are 8% per year. The average dividend yield from all stocks (both non-dividend payers and dividend payers) is around 2%. That leaves 6% to come from the increase in share prices or capital gains.

Shopify doesn’t pay a dividend. You could consider its expected annual return to be 8% (ignoring the extreme dispersion of possible outcomes for a single stock), but all 8% would come from increases to its share price.

Enbridge has a dividend yield of 6.5%. Should we expect its price to also increase by 8%? Of course not. It would be more reasonable to expect price growth of 1.5% (again, ignoring the extreme dispersion of possible outcomes).

Here’s a more diversified example featuring Vanguard’s VCN (Canadian equities, represented by the yellow line) versus iShares’ CDZ (Canadian dividend aristocrats, in blue):


3 thoughts on “Misguided thinking about Dividend Investing

  1. My portfolio consists of about 20 financially strong high dividend stocks with high scores. No bonds, no preferred shares, no mutual funds, no ETFs, etc. I have lived very well off my dividend income for 16 years while I have watched my portfolio more than triple in value.

    I live off the divided income from my main trading account. I had to start selling off a percentage of my RIF account every year five years ago. I save up the cash dividends from the RIF and transfer that money out once each year. The RIF continues to grow and generate more dividends. Since I don’t need that RIF cash, it gets spent on non-essentials or re-invested into existing shares in my trading account. I pay much less than 20% tax on my annual six figure income.

    While common sense says that putting all your money in Enbridge would be dangerous, for safety reasons it is wise to diversify into other stocks. However, there are far worse stocks that he could have picked. The following is a chart on Enbridge, from my latest book due out this summer (Canadian High Dividend Handbook). It uses the IDM stock scoring software. You can instantly see the strength of Engbridge in the eleven sub scores. Look at the historical trend. Not only has the share price climbed for 20 years but so has the dividend payout, keeping you well ahead of inflation. The Total score of 70 is excellent. The highest score I have ever calculated was a 78. The lowest was 8. I avoid stocks scoring under 50.

    Date: 15 MAY 2021
    Company Name: Enbridge Inc
    Stock Symbol: ENB
    Today’s Stock Price $47.20 Score = 8
    Price 4 Years Ago $52.00 Score = 9
    Current to Historical Price Comparison Score = 5
    Stock’s Book Value $30.29 Score = 8
    Book Price to Book Value Comparison Score = 0
    Analysts Buy Ratings # 9 Score = 5
    Analyst Strong Buy Ratings # 1 Score = 3
    Dividend Yield % 7.08 Score = 8
    Stock’s Operating Margin % 21.34 Score = 5
    Daily Shares Traded # 16,508,203 Score = 10
    Price to Earnings Ratio 15.1x Score = 9
    Total Score = 70
    Month Day Year Dividend $ Stock Price $
    May 13 2021 $0.83 $49.86
    May 12 2016 $0.53 $52.09
    May 11 2011 $0.24 $31.36
    May 16 2001 $0.09 $10.30

    Investing the way I do there should never be a time when I need to dip into my capital but it is always there as a form of insurance, if I ever had to. I do intend to leave behind a large inheritance. All this came about because a financial advisor lost $300,000 of my money and motivated me to find a better, safer way to invest. To get more information on scoring stocks go to my website, http://www.SaferBetterDividendInvesting.com.

    1. I agree with Ian. If you have enough money to create a diverse portolio of blue chip dividend paying stocks with a good track record of increasing dividends, then you can live off the dividends. You will of course leave an inheritance unless you choose to eventually convert your nest egg to annuities. Stocks such as financials, utilities, certain REITS, pipelines can qualify. Such a portfolio can be built gradually over many years using DRIPs.

      At present bonds seem to be a good way to lose money through erosion and taxes.

      See Gordon Pape (The Income Investor).

  2. You state this

    “ You must convert your RRSP to a RRIF at the end of the year in which you turn 71. The RRIF minimum mandatory withdrawal schedule forces you to take out ever increasing amounts, starting at 5.40% in your age 72 year.”

    You ignore other possibilities. When converting a RRSP to a RRIF, a couple can use the younger spouses age for the minimum withdrawal schedule. This can only be done at the time you convert, it cannot be done after.

    But in my case, my spouse is six years older than I. So, at her age 72 the minimum withdrawal will be based on my age (66) and she will only have to withdraw 4.17%, which is under her portfolio yield.

    Yes, at some point dividend yield will not cover mandatory withdrawals, but it can be deferred under certain circumstances.

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