Companies pay dividends for a simple reason –
Management cannot find better growth opportunities to invest retained earnings within the firm, and not many acquisition options are available with the cash so the excess earnings are given back to stockholders as dividends.
Firstly, let’s throw some common beliefs out of the window, namely that dividend stocks are free money. It is not. If a company pays dividends then essentially they are lowering the amount of cash on the balance sheet which will lower equity value as well.
In the end if the amount of growth can’t overcome the amount of value lost from the dividend then the company value will go down. Keep an eye out for a company that isn’t growing and is shortening its dividend pay-out, and stay far away from it.
Now, let’s look at some examples:
Tesla Motors: A growing company that doesn’t pay dividends. What is Elon Musk more likely to do: pay a dividend with profits instead of putting it back into the company in the form of R&D (research and development) for more efficient and longer running models? No way!
If the company paid dividends it would have vanished by today. Tesla is still successful because it raised debt and invested cash flow back into the firm, that’s the bottom line.
Those who do invest in dividends should keep a look out for the interest rates. As long as cash flow is good, even if interest rates are declining, but dividend pay-out ratio is increasing or not fluctuating then it’s a good sign. These are attractive companies.
Here’s the low-down on which kind of stock you should invest in depending on age:
- Age 0-25: Growth stocks
- Ages 26-30: Growth stocks
- Ages 31-35: Growth stocks primarily 10% dividend stocks
- Ages 36-45: 70-80% Growth stocks, 20-30% dividend stocks
- Ages 46-55: 50-60% Growth stocks, 40-50% dividend stocks
- Age 55+: 40% Growth stocks, 60% dividend stocks
As we touched upon in part one of this article: the more old and wealthy you get, the less risk you want to take on, less volatility. Your focus here is passive income.
It’s more difficult to build a better financial cocoon with dividend stocks at a fast pace. When you add dividend stocks you invest in down the line as you make more and more money, the more fixed income assets you’re adding to your portfolio. Keep in mind your stage in life to decide your investment style.
What do you think? Drop a comment support@optymoney.com
Stay tuned for part 3 of this article where we discuss a very powerful investment strategy!