Welcome to the Investing for Beginners Podcast. In today’s show we discuss a few diferent topics:
- How DRIP investing works
- The power of dividends over a long period
- Shareholder yield, the growth of share buybacks plus dividends
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All right, folks, we’ll welcome you to the Investing for Beginners podcast. Tonight is episode 184, and we’re going to return to a subject we have not talked about in a little bit. We’re going to get you all jazzed and excited about dividends. Yeah, that’s it dividends. So I’m going to turn it over to the Drip King himself. My friend, Andrew, we’re going to start talking about some dividends, Andrew, take it away.
The only thing I can promise is there’ll be one person excited about dividends, and outside of that, there’ll be no more promises because when it comes to the stock market, dividends are not the most exciting thing. And I get it right, especially in the market environment. Like now you have an IPO like door dash to go up 50% in. How, how, how, how fast are they going? 50% Dave, you should take five days, five whole days.
Okay. So obviously, old folks like me who invest money in the old way, very boring way. I don’t know what they’re doing. And you know, you see these big gains and, and crazy price appreciations from a lot of different stocks. And so it can become very hard to get excited. When you look at a dividend-paying stock and you see a yield of, you know, 2% or 3%, and you compare it to some big return percentages, and you’re like, I don’t get it. Why, why they get excited about 2% a year? And so I want to try to break that down, make it simple, and hopefully give my viewpoint on it. So you can maybe conceptualize it for yourself. And as you apply it to your portfolio and see those numbers grow, and you start to see it accelerate over time, it doesn’t happen overnight.
But as you start to see it, do that, then you can start to get why dividends are so exciting. Particularly if you can link that in with the right type of company and the right businesses, if you can get in with the best businesses, they’re the ones who are going to give you the most bang for your dividends. So dividends very simply when you buy a stock, you’re buying part ownership in a business. As an owner, you get dividends, which is a part of the profits that accompany makes. And when they distribute those profits to the shareholders, that comes out in a dividend. So if you go on Yahoo finance, or, you know, it’s like been so long since I’ve been to any other as a basic financial website, I don’t know what the other ones would be. Just Google finance even exists anymore.
Oh, that’s a good question. I don’t know. I haven’t used Google in years, right?
So I know they used to have a great platform. They don’t anymore, but I would assume whatever platform you use, you should be able to look up a stock ticker. And on there they’ll show you, you know, stock price. And a lot of times, you’ll see dividend yield. And so what that dividend yield is telling you, is that okay if I’m buying a stock at $25 a share, and if the dividend in yield is 2%, well, I’m going to pay 25 bucks to get this stock. And I will get 2% of my capital paid back to me as a dividend. And that will be over a one-year timeframe. And in general, that will continue. And it tends to grow over time if you pick the right companies. So that 2%, what gets exciting about it, is not that you got, that you made 2% on your money for a year.
That would be a pretty bad return. What gets exciting is what that can do over the life of your investment. Because, you know, if you buy a stock and it goes up, let’s say 15%, you have to sell it to get that 15% gain. And then you have to put it somewhere else if you want to make more money on it; what’s great about dividends. And the dividend-paying stock is, let’s say we’re investing something small, like $25. You just put that $25 in once. And then you get a steady stream of payments year after year after year. And many, many companies grow that. So, you know, if you get a small little bit your first year and then the next year, a little bit more, and then the next year more, and that grows, grows and expands. That’s something that’s very, very cool for something you did once and didn’t have to do ever after that.
And, and what becomes magical is when you start to reinvest it. So I wanted to give an example; this was the best performing stock I’ve had in the e-letter portfolio. So far, the best stock I’ve ever bought husband Microsoft. And, you know, I wish I did that for the leather too, but I can’t cry over spilled milk. So I bought this stock, LRCX; it’s a technology stock, and I must’ve bought it. I think it was 2015. Yeah, 2015. So when I bought it, I bought two little bitty shares, and I paid; I’m looking at my brokerage account. Now I paid $146 and 77 cents for two shares of Lam Research. And so the very first dividend I got from this company was 60 cents. So I, I, I get people who say all the time, you know, they don’t understand why something is so small.
It can be so exciting. And it’s again because as time goes on, these dividends grow in scale. And if you reinvest the dividend, you’re like putting more F more fire into the flame and allowing it to grow. And what that does is it creates a force. It’s called compound interest. So you can picture it by saying, like, if you were in a white winter land and you were trying to build a snowman, and you built a nice little snowman, and then you decide you want it to get bigger. So you started pushing the snowman and started rolling it, and then you pushed it down the Hill and saw it, saw it roll down the Hill. So what you would have to do to get it started is you would have to put a lot of effort into first building the ball and then rolling it down the Hill.
But as it continued to roll down the Hill, it starts to accumulate more and more snow. And then, as it gets bigger, that acceleration goes faster and faster. And that’s what compound interest does. And that’s how dividend reinvestment can work too. It’s, it’s called drip for short. And all you’re doing is you’re just collecting the dividends. A stock pays you. And then you’re just putting that money back and buying more shares of that same stock. So again, I started with a 60 cent dividend; as the years went on, that started to grow, and the company was growing. So they started to pay a higher and higher dividend on that. So if I got paid 60 cents, the first time I got paid, I’m looking now in each year, you know, so I got two dividends in 2015 because I bought this thing and around the beginning of the year.
The first year I got a dollar and 20 cents, and then the next year, it was $2. The next year three, the next year six, and then I bought another share by the next year it was nine. So you see how I’m getting the same number of dividend payments, right? I’m getting four dividend payments. It’s the same stock, but because I have two forces working together to grow the dividend payment and grow the number of shares I have, which allows me to get more of a dividend payment, you start to get this big compounding effect. And so, over the life of my investment in Lam research, remember I was just $150. I collected $23 and 24 cents in dividends. When I ended up selling the stock after a lot appreciated it, those shares that I dripped ended up netting me $37 and 96 cents on top of the, what was it, four or $500 I made in total from selling the stock.
So I a huge return. And so you can see how much the dividends I received in total. What I got when I saw the stock at the end was much more. And that’s because even though you’re, you’re getting dividends in the amount that you sell those dividends for. After all, you’ve reinvested into drip shares becomes that much more, and you can see how that small first baby, 60 cent dividend can turn into something like almost for the dollars worth of drip shares because I let the thing compound over time. I added another share in; I think 2018, and the company did well and kept em and kept raising their dividend over time. So that was just one kind of simple example of where I got excited about dividends to see it in action. And I didn’t even hold the stock all that long. This was only a, what is it? Three, four, or five-year period. Imagine this on a 10 or 20 year period. And you could see some drip shares. Maybe I can; maybe I can update on my one, share Microsoft. I bought it, and we can, we can talk about it in 15 years. And, and I bet you, we would be talking about multiples of whatever that first dividend payment was.
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Yeah, that’s amazing. Yeah. I mean, listening to that story, it gets me excited thinking just about the fact that you made all that money for literally doing nothing. You bought the company, and you held onto it, and you made all that money. And for the $150 of the original investment, if you left that in a savings account, you would have made 14 cents or something, those lines, you know, so that’s, again, just the power of dividends. I was thinking about one of the companies that I bought not too long ago, that’s a REIT, and it pays a dividend of $2 and 65 cents a year. And so I bought ten shares. So at the end of the year, I’m going to make $26 from that company for literally doing nothing. And if I take that same investment and put it in the savings account and just leave it there for a year, I’m going to make 10 cents. And so just the power of dividends. And we’re not even talking about any sort of reinvestment in the compounding you were talking about. I’m just talking about one simple investment for a company, one company that I will make just that little bit amount. And the more you invest in the company, obviously the more I would make. But I think that just illustrates just the kind
Of the power that you can get from, from those kinds of things. And I mean, think about what you can buy for $26, what you could buy for 40 bucks. I mean, that’s, those are, that’s not, it’s not chump change to start with those things. And as you said, as it grows and builds, and its compounds, it just illustrates the power of dividends again. And another thing that I wanted to throw out there is we talk a lot about total returns and what kinds of returns people can make in the market. And by and large, over the last a hundred years, the stock market has returned between eight to 10%, depending on who you talk to. And of that percentage, around 2% is from dividends for that period. So those big numbers and it’s, it has a huge impact. And the other bonus that I guess I haven’t thought about until just now is it’s free money, that the company is willing to give to you for the privilege of owning a piece of that business and who doesn’t want free money.
I mean, it’s, I do. I mean, I work hard for my money, just like everybody else does. And if somebody else is willing to give me a little bit extra, I’m going to be right there to partake of it.
Yeah. Sign me up to, obviously; I’m, I’m, I’m a hundred percent on board with it. And depending on what study you look at and what timeframe they’re looking at, I’ve heard studies when they look back after, like a really bad bear market or a stock market crash. And if you look at the periods right before that returns are actually, the returns from dividends are higher than the returns from the stocks because they’ve done so poorly. Not only does it give you high returns over life, but it also provides a shield when the market’s not doing as well.
Yeah. That’s a great point. And thinking along those lines, the rate that I was talking about, the dividend yield or the return on that is around six or 7%. So even without share appreciation or the company growing the stock price, I’m still making six or 7% just from the dividend alone, which I’m guaranteed to get. And so, again, that’s just another bonus on top of buying a great company. And, Oh, you mentioned Microsoft, you know, they pay a dividend, they’ve paid a growing dividend for a long time, and it’s another bonus of investing in a company like that.
Yeah, it is. What what’s sad though, is, you know, there’s, there’s been a move away from dividends, and it’s something that I think again, going back to call myself and the old folk or a boomer, it’s something that companies used to do a lot in the past. And as time has gone on, particularly in the last two to three decades, companies Have moved away from paying dividends. And so, to be clear, it’s not as easy to be a Dividend investor, as it was, say, 50 years ago, where you could throw a dart at the wall and Get a company with a, with a pretty juicy dividend. You have to look a little Hardware nowadays, and you have to be careful because a lot of times the rates, your example, and the rates are an exception because they’re, they’re a special kind of investment vehicle that is Made to pay dividends. So you will see high yields on those just in general. But you know, when you look at other stocks during a bull market that has high yields, 4%, 5%, 6%, there’s a lot of Value traps gathered within that because when a company’s yield gets so high, a lot of times that can be Because people don’t like the stock in a lot of times, People don’t like a sock for a good reason, it’s because the business sucks. So you have to be careful not to chase yield while you’re looking for these things. But you know, You also want to make sure you’re getting a decent yield too.
For me. I, I, I don’t think because of my timeframe so long I don’t care so much, even if it’s like a 0.6% yield, I don’t, I don’t care do particularly bad about that, but I do want to see it grow over time. And that’s something that I prioritize when I look at my investments. Yeah. That’s a great point. So one of the things that I guess I wanted to touch on with a thought that I had about the dividend yield and chasing the yield is that companies out there pay nice dividends and have done it consistently. Like you were saying, the flip side of that is the challenge of finding good companies that pay a great dividend, a company that Springs to mind are at, and T it’s not a value trap.
It’s not necessarily a company that’s in jeopardy of going out of business per se. But one of the things that I know that frustrates the heck out of people who invest in the company is that there doesn’t seem to be much share appreciation, and it pays a great dividend. It, it, it encourages a lot of income investors to, to partake of, of owning that company. But I think what frustrates a lot of people that have bought that company is that the shares don’t appreciate that the price just doesn’t seem to go up much, and it’s kind of trades within a range of, you know, $28 to $34 give or take, and it doesn’t fluctuate much. And so there isn’t a lot of growth in that realm. And so I know that frustrates a lot of people, with the income investing part of it. So you mentioned something just a moment ago about how dividends have kind of decreased in importance,
I guess, or focus on, in the capital allocation section of the world. So I guess I talk a little bit about that. What do, what do you mean by that? So, you know, if you go to the basics of what a company can do with its money, there, there’s, there are several options. So, so a company makes a profit, they can let the profits sit as cash in their balance sheet. They can take those profits. And like I said, they could give them back to shareholders as a dividend. They can repurchase shares, and they can also reinvest in the business, whether that’s buying more assets or acquiring another company for future growth. But, but those two things right there, the dividends or the share buybacks, are both ways to help shareholders and increase total return for shareholders. So as a shareholder, if I get a dividend that gives me an instant return, that’s a tangible return.
I have this cash that’s back in my brokerage account; share buybacks work in a somewhat similar way in that they reduce the shares outstanding. So what that means is, is the pie, your, your part of the pie gets a little bit bigger. Because everybody, all the shareholders are getting this, this little bit of the pie, that’s a little bit bigger. It causes, it causes growth because of things like earnings per share, which is what the market tends to price stocks on. At least most of the time that that rises as, as a company buys back shares. So you get a return as a shareholder because you’re getting that growth. But that’s, it’s not as tangible. It’s not as visible, and it’s not as instantaneous. So there’s a lot of good things about share buybacks, and there’s a lot of good things about dividends.
But what we’ve seen is in the past couple of decades, wall street has cheered the idea of share buybacks. And they like to see very aggressive share buybacks. And it does, it does result in really high earnings per share. So like creates this self-perpetuating loop of high stock prices. And so companies continue to do it because wall street likes it. And there’s no problem with that. But at a certain point, when a company spends too much on buying back shares, they can start to do things that are not constructive to the shareholder. And it’s like lighting cash on fire in a way if they’re buying these shares back at two high prices. And the reason for that is because, well, you know, you took, you took this dollar that should have been mine in the dividend, and you used it to, to kind of prop up your metrics.
I get that; that helps me. But if you only propped up against your metrics by like 2% that you could have given me a dollar and dividend, and that would have been like a 6% boost to me, then you’re not as a shareholder. And as a manager, you’re not aligning with what’s good for me because you’re only earning a fraction of what I should have been able to earn on that. And so that’s kind of what can happen on the opposite end, as the dark side of share buybacks. And, you know, we have seen that at some companies. I remember Dave, you probably, you long forgot about it, but I remember you did a blog post about some companies that were, that were destroying shareholder value through that. And so while there’s a lot of good things that companies can do when the market in general starts to move away from dividends and replace it with either too expensive share buybacks or too expensive acquisitions, where they’re swallowing up these other companies, but paying obscene prices for them, then, you know, over time, shareholders will not get as high as a total of a total return.
And it comes to light when you have bear markets, and crisis is where all of a sudden, these companies realize that these things that they pay money for aren’t worth anything. And then you’ll see huge losses, huge crashes, all that whole SEF, self-perpetuating cycle, upwards collapses like a house of cards downwards. And it it’s, it’s not; it’s an unfortunate place to be as a shareholder. And so that’s why when you’re buying these companies, you have to look for that balance between, you know, giving a good amount and dividends, giving a good amount in share buybacks, and then making good capital allocations in other ways. And so there’s, there are different metrics to help you do that. And that’s something that if you’re digging deep into companies, it’s worth looking into, I guess, tell me a little bit more about that.
I’m curious to know more about, I guess, some of the metrics that we could use to give us an idea of whether the company is doing right by us or not.
One is shareholder yield. And so this is something that was mentioned by med favor, and we talked about it. We did a whole episode on it, IFB72, but basically what it does is you’re trying to look at a. It’s so similar to how, you know, when you calculate the dividend yield percentage, you’re looking at what’s the dividend, the company is giving me how much am I paying for it? And then what’s that percentage of return I’m getting year after year after year for the shareholder
Yield, there’s a similar equation. I don’t want to get into the specifics, but yeah, I would say episode 72 would be a good spot to learn all about that. Okay. Yeah. That’s great. So I guess along those lines, you mentioned the blog posts that I, that I wrote a while back, I do remember some of the companies there was a Boeing McDonald’s and Caterpillar we’re all guilty of manipulating share prices via buybacks because it benefited the CEOs as well as other management. And if I’m not correct, if I’m not mistaken, I think all three of the leaders of those companies have all been fired since it became apparent that they were manipulating things such that they benefited from that. And the way that they benefited from that was their stock compensation was tied to different metrics. And one of the metrics was earnings per share.
And so as earnings per share increased because of the buybacks, as opposed to the actual performance of the business, then the CEOs were able to get stock options, which they were able to increase the price of because they were able to, as Andrew said wall street loves earnings, and they love earnings that go up. And so when earnings go up, generally the stock price that goes up most of the time, that’s so 2019 anyway. But so that’s how the seed used buybacks to their further gain. And so I guess that’s one of the things when you’re doing some research on any company is trying to look at some of those aspects to determine if, like Andrew was saying, their interests aligned with us, the shareholders, or with themselves. You know, would you find people who are doing those things for themselves, then that’s probably not going to be the best investment for you in the long run.
I’ll try to give an example, and let’s be clear like this isn’t a real-world example, but I’ll use it for illustration purposes. Let’s say we were running McDonald’s as an example, and McDonald’s had all this cash, and so what they could have done with it, let’s say they identify Chipola at an early age, you know? And so I think they did have to pull it. Maybe that’s a bad example. Let’s say Chick-fil-A, let’s say they saw Chick-fil-A and could have invested, or they could have bought, they could have bought that company at a reasonable price and decided not to, and instead, they decided to buy back shares. And then let’s say there was another opportunity to expand to, you know, some booming city in Florida, but it was going to
Be pricey. You know, they weren’t going to see a return on that investment right away. Instead of doing something smart for the longterm and opening the restaurant in this new expensive city, they decided to buy back more shares because that would prop stuff up for them immediately. And so a company that continues to do things like this, yeah, they’ll grow, but they won’t grow like they should have because they didn’t make good investments with the cash that they had. That does eventually come back to bite the company, and then you can get into situations. Like I believe Dave, at least one of them I think was, was, was borrowing money to make these share buybacks. And that’s, that’s a whole other thing. Cause now you’re mortgaging your feature to get these immediate boosts to EPS.
And that’s, that’s just not a good way to, to treat the shareholder. So, you know, that same boss makes a dollar. I make a dime if managing makes a dollar and shareholders only make a dime; something’s not right there. And, you know, being somebody who’s focused on dividends, not to say it’s going to fix all your problems or anything. Still, a lot of times, pain, a healthy, rising dividend can force management to be more prudent with their cash to allocate for the shareholders. And so you, you do get a sort of nice effect built into buying dividend stocks when that restriction is making companies double, you know, cause because another thing that at least before 2020 and 2021, another thing that wall street didn’t like to see was when the company would cut their dividend. And so when you have that restriction as, as a CEO, you’re, you’re going to try hard to, to, to manage money wisely.
So you never deal with a situation like that. So that’s where there can be another benefit of dividends. And, you know, I, I hope I do like buybacks, and I think with low-interest rates and everything, I think there’s a lot of great buybacks happening right now. It’s tough with so much capital around this stuff for companies to find good returns on their investment. I get all that. And I do think there’s, there’s a lot of good buybacks happening right now, but you know, I would like to see some sort of a, a movement back towards dividends because I think in a lot of cases, especially with matured companies, they’re all there. A lot of times, it isn’t another good place for that cash. So if that’s the case, you’re going to want to see that money, come back to you and, and you know, we’ll see what happens, but these are things to keep in mind.
If I go back to the basics of what investing is, it is receiving something for the money I’m putting out. And like Dave said, and he said it so eloquently and simply, it’s free money. And, and, and it, it comes at the cost of you putting your money with them. But it’s, it’s something that investments do. They work for you and create income streams, and that’s what the dividends are all about. And so if you can remember that when it comes to your investments, you can save yourself from a lot of heartache from companies and managements who won’t even think twice to pay a dividend, and shareholders do and will get burned. And they always do. It’s nice to be in situations where you’re; you’re sticking to stuff that’s more consistent and reliable over the long run.
It’s, it’s a lot less of a headache that helps you sleep at night. And if that’s not a definition of a margin of safety, I don’t know what is.
all right, folks will with that, we are going to go ahead and wrap up the conversation with this DV. I hope you enjoyed our discussion on dividends and buybacks. They are a great advantage and something you should take advantage of when you can. Like I said, and as Andrew reiterated, it’s free money or who doesn’t want free money. So without any further ado, I’m going to go ahead and sign us off, go out there and invest with a margin of safety emphasis on the safety. Have a great week. And we’ll talk to you all next week.
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