What are the Advantages to Dividend Paying Stocks?


Ask SmallIvy

Dear SmallIvy,

Why would an investor buy stocks that pay dividends?  What is the importance of dividends?

Thanks for the help,

Carl M.

Dear Carl,

The net return for stock investing during any given year is the dividend plus the % change in price.  In general the changes in price will be much larger than the dividends, but price changes are unpredictable.  While over the long-term stocks may increase in price by 10-15% per year, they may go up 40% in one year and down 20% the next.  If one needs to generate current income – withdraw a certain amount of money from the account for living expenses – such changes can be nerve-racking.

While dividends tend to be lower than the return from capital gains, dividends tend to be more certain.  While a company can cut its dividend if the business turns sour, most companies try to maintain a steady dividend and even increase it if possible.  For the company, if investors know they will receive a certain dividend, they will tend to buy shares if the price drops too low (because the yield becomes large compared to other investments).  This creates some degree of price stability.

For investors, dividends create a sense that at least something will be received each year.  In a period where the stock market was essentially flat (like the last 10 years), the investor in stocks with decent yields would have at least made some return on her money.  Because of the price stability described above, buying stocks with large dividends also resulted (in general) in less severe price changes during the recent bear market.  Some stocks however ended up cutting their dividends, which can have a huge effect on stock price since investors who bought the stock for the dividends will then wish to get out.

Comments appreciated! What are your thoughts? Questions?

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